The Sydney Morning Herald – 20 march, 2015

By Scott Phillips

http://www.smh.com.au/money/investing/huge-property-profits-dont-always-add-up-20150320-1m3ljy.html

The gains look impressive … but are they, really?

If there was a “Captain Obvious” award for stating the bleeding self-evident it would be given to anyone who mentioned that Australians are just a little bit property-obsessed.

So it’s no wonder that property-related headlines are popular. And if you want to garner some extra interest, throw in some water views and/or a celebrity buyer or seller. We all love to dream about that beachside mansion, or to know what our millionaires, celebrities and business leaders are buying or selling.

It’s that last one that caught my eye earlier this week. The headline in the AFR read: “CBA chief Ian Narev the latest winner from Sydney’s house boom.”

Narev has apparently sold his inner-Sydney terrace for $2.9 million, banking a $640,000 profit for his troubles. Sounds impressive – and it is, at least in dollar terms. I don’t know anyone who’d complain about having another $600,000 in their kick.

But it’s important for investors to look behind the headline.

How good were those returns?

Ian Narev apparently bought the townhouse for $2.26 million in 2008. So he’s held it now for about six or seven years (depending on when in 2008 he bought it). That’s $100,000 a year – nice going … until you break it down.

Narev’s gain over that period is about 28 per cent. On a compound basis, that’s 3.7 per cent a year, using seven years as our basis. Not so stunning, huh?

And, of course, we need to include the various costs of buying and selling – notably the agent’s commission and stamp duty. The NSW Office of State Revenue tells me Narev would have been up for stamp duty of $109,790. And let’s take a stab at the agent’s commission on the sale, and (I think, generously) assume he negotiated a rate of 1 per cent for the sale – giving the agent a nice little $29,000 wedge in the process.

After those costs, Narev’s upside shrinks to $501,210 – a gain of 22 per cent, or 2.9 per cent a year, compounded.

Now, I’m not having a go at Ian Narev in the slightest. I’m sure he’d much prefer to not have his financial dealings reported in the press. Ian Narev is the innocent party in all of this. Hopefully, he sees his home – as he should – as a lifestyle asset, not a financial asset.

Three investment tests

The implications for investors – whether in shares, property or anything else – are clear, and threefold:

1. Take out your costs.

Repairs, brokerage costs, agent commission all erode your returns – you need to look at what you’ve paid to own (and then sell) your assets.

2. How much time is involved?

Doubling your money is wonderful – but the difference between doubling it in two years and doubling it in 20 years is immense.

3. What was the alternative?

Shares have compounded at more than 11.5 per cent a year in the past three decades. That means, if you received a lower return, you’re less wealthy than you otherwise would have been. Or, as investment commentator Peter Thornhill would say: “Invested well? Compared to what?”

So the next time you speak to someone who tells you that they sold their house for double the price they paid, make sure you do the maths – the person whose house went from $400,000 to $800,000 in 10 years has averaged a gain of 7.2 per cent a year – before costs – hardly the sort of return that justifies the headlines.

Foolish takeaway

If there’s an upside to the house price boom we’ve seen over the past couple of decades, it’s that many, many people have had their eyes opened to the potential returns from investing. But it’s very important to know what sort of return you’re likely to be able to earn from that investing – and over what timeframe. Otherwise, you may just well be someone else’s patsy.

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