Residential vs Commerical vs Stocks and Shares: The ultimate debate

It’s a classic debate – resi versus commercial. I’ve been involved in it a whole number of times over the years. This one had a third flavour though – stocks and shares.

I was invited by Manish Kataria CFA to appear on his podcast alongside (or against?) Natasha Collins MRICS to debate the merits, and the downsides of all three.

Now – I have to declare my interests up front. My net worth is over 80% contained within residential property, with the remainder split between commercial, stocks, and chattels.

In order to balance some of that out, I use some commercial strategies within residential properties (e.g. leases to housing providers), but that is because I believe most strongly in the outperformance, and lack of volatility, in the residential class.

This is where I start, and where the vast majority of portfolio landlords I know agree with me, even if they would phrase it somewhat differently. Residential property does what it shouldn’t be able to do – provide solid returns without going down much, over time. The last 70 years – or the market since the housing act 1988 – or since the first buy to let mortgages since 1996 – or even after the financial crisis if you prefer – has been robust and done very well.

Over time – let’s be clear – and it is a long time – stocks have performed at around 8-10% per year. The UK stock market has been closer to 8%, and has disappointed as a whole in the 21st century. However – using index funds can spread risk very nicely, but much more important than that – there is limited effort involved.

You do need to also accept that these are leveraged returns – public companies have debt. They therefore need to be compared to leveraged returns in buy-to-let, which since 1996 have been in the double digits and closer to 15% per annum than 10%. You must also, of course, bear in mind that past performance is absolutely no guarantee of future success, and the early days boom may well be behind us, although the asset class in its current form is still relatively young.

There’s much, much more volatility though. That 8% per annum can easily be -10% or even -20% in a bad year – and most of us don’t have much stomach for that. I reframe that slightly, on a personal level – a down year means that my regular monthly investments bought more shares when it was cheap – so that’s fine. As long as I’m not selling that month (a bit like when the property market goes down) it is actually a potential positive (as long as I am also still buying).

If you aren’t actively buying or selling, it is just a ride you might not want to go on. I don’t watch my own stock portfolios on anything more than either an annual or a quarterly basis. It’s a habit I trained myself into. Day trading – well, that sounds like effort to me – and emotion.

Resi has broken the risk-reward paradigm for many years. What it offers at the very worst is inflation protection with a coupon, or yield, in the form of net rent. That hasn’t always been the case – pre-2008 for example, lending and also investor behaviour led to people buying assets that were negatively cashflowing, on the basis that they were speculating on their prices going upwards.
You can’t do that now (using leverage) unless you lie to the lenders, which isn’t recommended – indeed, it might well be mortgage fraud.

Commercial adds a different dimension. Natasha made some solid points as you would expect – solid, high yields are available. Effort is lower. Recovering possession is far easier. I don’t disagree with any of those – but values are much more sensitive to the tenant, and that “sub-contracts” the value of the asset somewhat. Also, volatility is much larger – and values are also much more subject to interest rate fluctuations (of which there have been many over the past couple of years, and we are by no means done yet).

Natasha told a tale of a cycle that changes every few years – I prefer the safety of knowing that people need somewhere to live. I see much less emotional effort in resi (and many might disagree – people tend to take bad tenants personally, rather than treat them in a business-like manner – to an extent I guess it depends on the size of your portfolio, although I know some landlords with very large portfolios that still get incensed at rent arrears and bad debt – a waste of emotion, just build better processes on the back of it and use it as learning).

The sensible investor has some exposure to all three, and can decide on how much effort they want to put in or not – manage their own, pay someone to do it for them – buy REITS with residential, or commercial property exposure, or both – or get actively involved of course.

As always, education is paramount – there is so much out there, but stick with those who are qualified, ideally with relevant trade qualifications and also with a track record that you can evidence!

I suspect the audience will be somewhat biased – but – what’s your favourite and why? And where have I got it wrong – and what have I missed?

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