Experts discuss the pros and cons of borrowing to invest in property or shares
At a recent NAB webinar, prominent finance commentator Noel Whittaker, REA Group Chief Economist Nerida Conisbee and NAB Equity Lending Head of Sales Craig Saunders discussed the principles and options of borrowing to invest.
Why borrow to invest?
Borrowing money to invest in property or shares could help you move forward financially.
You may not have the cash to buy an investment property outright so investing in shares can create new opportunities for accumulating assets.
There may also be tax benefits if you’re on a high marginal tax rate.
Have a long-term approach
However, borrowing money has its risks. And, as Noel Whittaker pointed out, borrowing to invest in shares and property is not a short-term strategy. “You need a seven- to 10-year time frame,” he said. “Property’s going to have long flat times and shares will be volatile.”
Shares vs Property
Every investment decision has good and bad points. “If you borrow to buy property, it’s tangible, you get rental income, you’ve got the potential of capital gain and it doesn’t have the volatility of shares,” Conisbee said.
If you borrow for shares, you can start with $1,000 and very low entry and exit costs. “Shares are liquid, the income can have franking credits to make it highly effective for tax purposes, and you can diversify easily,” Whittaker said.
Both agreed that when weighing up what will suit you best, you have to factor in set-up costs, regular fees and any costs associated, as well as loan interest rates and the capital gains tax you’ll pay.
Include all these factors into your calculations and Whittaker believes “long term, shares have greater potential capital gain than property.”
Shares: How to borrow
Margin loans allow you to use your shares or managed funds as security against the money you borrow. However, if the value of your investment falls below a certain point, the lender can issue a margin call – a demand that you top up your investment or repay some of the loan. You could be forced to sell off some of your shares for a lower price than you paid. “If you don’t understand the risk of a margin loan you shouldn’t use the instrument,” Saunders said.
Shares require a smaller investment than property. “You can get started with as little as $1,000,” Saunders said, adding: “Entry and exit costs are also very low.”
Whittaker explained that income can have franking credits, which makes it highly effective for tax purposes. “In the long term, shares have better potential capital gain than property,” he said.
Shares are volatile and, if you have all your eggs in one basket, the risks are high. “If you pick the wrong company, you can lose all your money,” Whittaker warned.
Diversifying across different asset classes, industry sectors and geographic regions minimises this risk.
Property: How to borrow
Investment property loans can be fixed interest, variable interest or interest-only.
“Interest-only has been very popular but you need to be very careful as the repayment amount can jump significantly at the end of the interest-only period,” Conisbee explained.
Many people like property because it’s an investment they can see and touch.
“You get income from the rents, you’ve got potential capital gain and you can renovate it,” Whittaker said.
“Of course, the key to property success is to buy well and add value.”
Conisbee described Australia as possibly one of the most property-obsessed countries in the world.
“The main reason is probably that capital growth has been so amazing,” she said. “If you bought here in Sydney five years ago, for example, your home value would have increased by, on average, 50 per cent.”
Property is an illiquid asset. “If you need money, you can’t sell a back bedroom,” Whittaker pointed out.
It also has high entry/exit costs and you’ll need mortgage insurance if you borrow more than 80 per cent of the value of the property.
“One of the biggest risks is that you’ll be without a tenant for a length of time,” Conisbee said. “This can result in quite a significant loss of income.”
There are great opportunities in both asset classes. The important thing is to have a clearly thought-through strategy, based on independent advice along with a long-term objective.