Why Australian Property Sucks as an Investment Compared to an S&P 500 Index Fund

For many Australians, real estate has been sold as a dream, and a solid investment strategy, offering the promise of long-term gains and tangible assets.

However, when you break down the numbers, it becomes clear that real estate may not be as lucrative as many are led to believe, especially when compared to a simple S&P 500 index fund.

While property has its advantages, it is often fraught with hidden costs, low growth, and risks that can make it a less-than-ideal option.

Let’s dive into the numbers and explore why the S&P 500 outperforms real estate in most cases.

Average Annual Growth: Real Estate vs. S&P 500

Over the past 30 years, real estate in Australia has appreciated at an average annual growth rate of around 6.4%. This might seem reasonable on the surface, but once you account for all the costs associated with owning property, the returns diminish rapidly.

In contrast, the S&P 500 has achieved an average annual growth rate of 9.9% over the same period. This growth, free from the numerous fees associated with property, offers investors a much cleaner, more consistent return on their investment.

The Hidden Costs of Real Estate

While real estate may appear to generate decent returns, the associated costs can significantly eat into those profits. Let’s break them down:

• Land Tax and Council Rates: Depending on the property and location, you may pay thousands in land tax and council rates annually.
• Insurance: Home insurance is necessary and can range between 0.2% to 1% of the property’s value per year.
• Maintenance: Maintaining a property is costly, with repairs and upgrades required regularly. Experts suggest budgeting about 1% of the property’s value annually for upkeep.
• Real Estate Agent Fees: When you eventually sell your property, real estate agent commissions range from 2% to 3% of the sale price.
• Incidentals: Vacancy periods, property management fees, and even renovations can drain additional cash.
• Interest on Loan
• Capital Gains Tax (CGT): If your property is an investment and not your primary residence, the government will take a slice of your profits through CGT.

By the time you account for these costs, the actual return on real estate shrinks substantially. Let’s assume you have a property worth $800,000 that grows at the average rate of 6.4%.

Over 30 years, the property will appreciate to about $5,042,000. Add a weighted average rental income of about $1,000 a week over the 30 years ($1.56M) , and that’s a total of $6,602,000.

However, if we account for the following costs:

• Land tax, council rates, and insurance: 1.2% annually (~$9,600)
• Maintenance: 1% annually (~$8,000)
• Real estate agent fees on eventual sale: 2.5% (~$126,000)
• Incidentals (e.g., vacancies, repairs): ~0.5% annually ($4,000)
• Capital Gains Tax: 25% on the gain (~$1,060,500)
• Interest: ($596,000)

These costs can wipe out about $2.5 million, bringing your actual net profit down to $3.3M.

And I haven’t even accounted for selling costs like styling, conveyancing and legal fees, advertising, or the cost of a property sitting vacant for weeks or months on end when trying to sell it.

Comparing to the S&P 500

Now, let’s contrast this with an S&P 500 index fund like Vanguard’s, which historically has a flat annual fee of 0.28%.

Imagine you invested the same $800,000 in the S&P 500 index 30 years ago. With an average growth rate of 9.9%, that investment would grow to about $13,572,000.

Subtracting the expense ratio of 0.28% annually, you’ll pay a total of around $196,000 in fees over the 30 years.

This leaves you with a final investment value of approximately $11,489,600 after capital gains tax — almost four-times more than real estate, and without the hassle of managing physical property which is a time investment and expense all of its own that we haven’t even accounted for — time is money, and peace of mind is even more valuable than money.

The Leverage Argument: The Big “If”

One argument in favor of real estate is the ability to use leverage, i.e., borrowing money to buy property.

Banks are often more willing to lend large sums for real estate than for stocks, which allows investors to control a larger asset with a smaller initial outlay. This can increase returns if the property market performs well.

For instance, with a 20% deposit on an $800,000 home, you’d only need to invest $160,000 upfront, borrowing the remaining $640,000. If the property appreciates by 6.4% annually, your return on the $160,000 can be substantial due to the leverage.

However, this also increases your exposure to risk. If property values stagnate or drop, you’re left with a large debt to service. Additionally, the costs of interest on the loan, taxes, and upkeep still apply, further reducing your effective return.

The Luck Factor: Abnormal Growth Areas

It’s true that some property markets experience abnormal growth rates. For example, properties in certain suburbs of Sydney or Melbourne have appreciated far beyond the national average. However, this kind of growth is speculative and difficult to predict. Investors relying on “hot” areas to outperform often fall victim to market corrections or stagnation once the area reaches saturation.

With the S&P 500, you’re investing in the 500 largest companies in the U.S. economy, meaning your returns are tied to the overall health of the market, which has historically performed well over long periods. There is no need to get “lucky” by picking the right suburb — you’re buying into the broad market.

Luck Running Out?

Australia’s property market is widely regarded as one of the most expensive in the world, with housing prices in major cities like Sydney and Melbourne reaching unsustainable levels.

This rampant price growth has been driven by a combination of factors including historically low interest rates, foreign investment, and limited housing supply.

However, the current affordability crisis suggests that the market may be nearing a breaking point. With property prices outstripping wage growth, fewer people are able to enter the market, creating risks of a slowdown in demand.

Additionally, rising interest rates and potential regulatory changes could further cool the market, leading to stagnation or even price declines. This overvaluation makes real estate a riskier investment class, as future returns may not only be lower but also subject to sudden downturns, particularly if a housing correction occurs.

Investing in such an inflated market could result in poor returns, especially when compared to more diversified, stable options like the S&P 500 index fund.

Conclusion: Real Estate’s Hidden Disadvantages

When comparing real estate to an S&P 500 index fund, the numbers speak for themselves.

Sure, real estate has its perks, especially if you use leverage wisely or invest in high-growth areas.

And if you have the capital to develop multiple-dwelling sites, you might make something in the order of 15 to 20% returns if you’re lucky, and 10% if you’re unlucky (which you could’ve got putting your money in an index fund) — but this is essentially a full-time job, not a passive investment, and one should never discount the value of their time or sanity.

But for the average investor looking for simplicity, reliability, and long-term growth, the S&P 500 index fund is hard to beat.

With lower fees, higher growth, and fewer headaches, it’s the superior option for building wealth over time.