Psychology of ‘bricks and mortar’ investment

bricks-and-mortar

Australians love property and our high level of (expensive) property ownership is one of the reasons we are ranked as one of the wealthiest countries in the world. Not only do we desire our own block of paradise, we also love to invest in property with 1.9 million individuals declaring rental income (or more likely a rental loss) in their annual tax returns.

But do we every stop and ask why? Why do we love property so much, and why is a large chunk of the population obsessed with becoming property millionaires?

In this article I will delve into some of the psychology that drives bricks and mortar investment. My goal is not to change behaviour or even judge whether the desire to invest in property is right or wrong. I simply want to hold up a mirror so we can better understand our own decisions and biases.

Physicality of property

Property is a physical thing.  You can see it, touch it and feel it – it is a tangible asset. By contrast, most other investments, such as shares or managed funds, are intangible.  This is one of the key reasons that property investment is so popular – it gives people a sense of security.

However, share ownership is also based on tangible assets – namely the underlying business you have bought a percentage of via owning their shares. We see, touch and interact with these businesses every day. We shop at Woolworths or Coles, bank with CBA or Westpac and make calls via Telstra – but why don’t we perceive owning shares in these companies as a being something tangible?

I believe it comes down to investor behaviour. When share markets are volatile, the average investor will sell their shares to minimise the losses, and not re-invest until they feel comfortable that the market has recovered. In general this loss-adverse behaviour significantly reduces the returns to investors as the miss the earliest and most profitable part of a recovery.

By contrast, when the property market dips, we will hold onto a property investment and we will keep throwing money at it as we believe it will recover and provide significant benefits in the long term. The fear of loss of possession weighs heavily on us. So the tangible aspect works both ways – it makes want to own something physical, and also prevents us from letting go when doing so could be in our best interests.

Status symbol

Nothing says ‘I’m wealthy’ like a multi-million dollar luxury home. It is probably the most overt status symbol and display of wealth there is. The fact that property is so closely associated with wealth, success and status has a lot to do with why we love to invest in it. Property is just so darn sexy! If you don’t believe me – check out this video from a creative Victorian real estate agent:

When we invest in property, we are buying into this picture of wealth, luxury and the ‘ideal’ lifestyle that goes with it. Our motivation for status has effectively outweighed our desire for the best financial return, or more accurately some of us will convince ourselves that property will provide a superior financial return than any other type of asset.

We can also get confused with property due to our different uses of it. A home is a lifestyle investment. You should be happy to pay the cost of ownership because of the benefits it provides your lifestyle – it’s OK to bring emotion into that purchase decision. Contrast this with an investment property where it needs to be all about the numbers and how it helps you achieve your financial goals.

It is important that we look beyond the attractive veneer of property investment, dig a little deeper and analyse the numbers to determine whether a property is a good financial investment, or merely a superficially attractive money pit.

Property never goes down in value

There is a widely held misperception that property as an investment will never drop in value. This obviously cannot be the case, however real estate agents and promoters of property investment are happy to let the average punter to continue to believe this furphy.

One culprit that feeds this misnomer was the boom in Australian house prices between the early eighties and the late naughties.  This extreme growth skews quoted average returns for residential property and sets an expectation that future growth will match past performance – which is highly unlikely.

 

Property-1972 to 2010

 

Generation X and Y are especially vulnerable to the haze created by this period of abnormal growth as we witnessed it firsthand. We saw the value of our parents homes skyrocket, and if the folks were lucky enough to have an investment property or two, their wealth built very quickly with virtually no effort on their part.

For most ‘investors’ their profits were entirely derived from dumb luck. This has created a mentally among some of my peers (and dear I say clients) that the formula for wealth is simply:

Property x Time = Easy Profit

I wish it was that simple. Each property needs to be judged on its own merit as each property is effectively its own market. Although the overall market may provide great returns when based on an average, but that doesn’t guarantee that the individual properties you invest in will have the same return – they could be higher or lower.

F.O.M.O – Fear of Missing Out

If you don’t get in now, you will miss out on this great capital growth. At the time of writing, Sydney and Melbourne property prices are running hot. Other cities are following behind. Low interest rates, low supply and high competition is combining in a perfect storm many are already calling a bubble.

Fear is a strong motivator and it can make us take action we know isn’t rational. No doubt at the moment there are numerous people purchasing property that they cannot afford (i.e. they are paying too much). Their fear of missing out as values slip beyond their reach is outweighing the fear of not being able to manage the additional repayments.

History shows us is that there will always be other investment opportunities. History can also be misleading when it comes to price gains. Take the following example:
My friend purchased a property for $400,000 10 years ago and just sold it for $800,000! He banked a huge profit!

Based on the above, the annual return (before all the costs) is 7.2% per annum. A solid return, but not huge – although the superficial numbers look great. By comparison, the compounded return on shares (capital growth and dividends) over the last 30 years is 11.5%.

Tax

As Australians we are a little obsessed about the tax impact of our investments – especially property investment. Some believe that by losing money we are better off due to the magic of tax benefits! More than a decade as a tax accountant has taught me one thing: tax is the most UN-magical thing in the world!

If you earn between $80,000 and $180,000, for every dollar you lose on your investments (for example negatively geared property) you will receive $0.37 back. Although the tax impact of an investment should be considered, all the tax breaks in the world cannot hide a poor quality investment with below par income earning potential or poor capital growth prospects.

A significant annual tax refund generally will not compensate for the additional funds you are paying month on month basis on your negatively geared property (or properties) – even when non-cash deductions like depreciation and capital allowances are taken into consideration.

Investors need to ensure they are not making any decision based purely on taxation consequences.

Summary

As investors we need to better understand how our psychology impacts our decisions – especially when it comes to property investment. Before making an investment decision, critically look what why you are making that decision, what is driving it? If the answer is related to fear, greed or status – maybe take a breather before signing and seek a second opinion.

Kris Kitto 1 JPG

Kris Kitto

Director @ Superfund Partners

kris.kitto@superfundpartners.com.au

Phone: 1300 889 282

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  • Johnson

    I invested in properties for 10 years, but because naively following the spruikers bought outside the capital cities, probably make $300K for all the time & sacrifices, most regret not spent more time with the kids when they growing up. On the other hand my wife and I have well over $1m in super without any pain or efforts on our part. Moving forward hard to see how anyone can make money from properties with the $1m house price tag, and good luck not getting sick & sacked during the next 30 years because the holding cost of an investment property will be massive. Property values double every 7-10 yr as forever proagated by spruikers is a myth !!!

    • http://www.superfundwholesale.com.au/ Kris Kitto

      Agree 100% Johnson!

      “Property values double every 7-10 yr as forever propagated by spruikers is a myth !!!”

      You’ve summed up my feelings with that last sentence.

      If anyone else tried to sell any other asset class by talking about performance like that, ASIC would take immediate action – but certain elements of the property market continue to suck in an unsuspecting public.

      Thanks for your comment.

  • Spell check

    Dear I say clients….dare I say clients?

    • http://www.superfundwholesale.com.au/ Kris Kitto

      Yes – this appalling grammatical error was brought to my attention. Updated by an embarrassed Kris.