Residential property has become an increasingly popular investment over the past few decades, with some investors preferring it over ASX shares. It's true that many investors have reaped the rewards of steady property price rises in our major cities, especially in Sydney and Melbourne. But what some people tend to forget, however, is that the majority of property investors actually borrow funds in order to purchase those properties.
While there are pros and cons to both approaches, here's why I gravitate towards investing in ASX shares over property.
Residential property is actually riskier than it may first appear
One could argue that property price movements have largely been less volatile than ASX shares over the past few decades. However, when you take into account the borrowing or gearing factor, the volatility of residential property as an investment class is actually higher than you might initially think.
Let's take a typical, residential investment property purchase example to illustrate this point.
Say you purchase an investment property for $600,000 with a $120,000 deposit.
If property prices rise 7% in a year, then your property is now worth $642,000 (on paper). So, theoretically, your $120,000 deposit has increased in value to $162,000, which is a very impressive 35% gain.
However, using the same argument, if property prices go down by 7%, then the value of your initial investment has actually fallen by 35%. A similar fall across the value of ASX shares would be classified as share market crash. And share market crashes actually occur relatively infrequently.
The coronavirus pandemic is leading to a softening of the Australian housing market, driven by challenging economic conditions. Unemployment rates are higher than they've been for over a decade, and this could lead to further property price falls over the next 12 months.
Furthermore, residential property purchases also attract additional costs, such as stamp duty and agents' fees, that are not incurred when buying shares. There are also the ongoing expenses of maintaining your investment property to consider. These include agent management and letting fees, upkeep costs and potential loss of income when your property is vacant.
ASX shares provide better market diversification
Most property investors tend to purchase a very small number of investment properties, often only one or two. That's putting a large amount of your investment funds into only one or a few baskets. If there is a major correction to house prices in your property's area due to local factors, this can have a major impact on your overall returns.
In comparison, due to relatively low entry and exit fees, you can more easily spread your risk by purchasing a broad portfolio of ASX shares. Companies like Wesfarmers Ltd (ASX: WES) and Washington H. Soul Pattinson and Co. Ltd (ASX: SOL) are particularly attractive from a diversification point of view. That's because they invest in companies covering a wide range of industries and sectors. Other blue chip ASX shares, such as Macquarie Group Ltd (ASX: MQG) and BHP Group Ltd (ASX: BHP), also have the advantage of exposure to a wide range of international markets. This is something that simply cannot be achieved by investing in the local property market.
Foolish takeaway
I do acknowledge that residential property is a good long-term investment. However, on balance, I definitely gravitate more towards investing in ASX shares. For me, the lower fees, easy access to diversification, minimal hassle and superior long-term performance make ASX shares a more attractive investment than property.
