In January 2003 a friend decided to buy an older unit in an inner city Brisbane area for $220,000. The location was perfect, and it has been rented ever since.

By the beginning of 2016 its value had grown to $475,000, but by the end of that year its value had dropped to $430,000. The reason for the drop was the glut of new apartments that had come on the market in the area. Being new, they looked far more attractive, as well as offering much greater tax incentives.

Our friend thought this might be the beginning of a downward spiral and contemplated quitting the property. But that is not as easy as it sounds – the problem he would face is capital gains tax.

Even after taking advantage of the 50% discount for owning the property for more than a year, a sale would add about $100,000 to his taxable income in the year of sale. To make matters worse his current rental income is just $14,000 a year after outgoings –  a yield of less than 3%,

It would have been a different story if he had invested his $220,000 in a managed fund that matched the All Ordinaries Accumulation Index, which takes into account both income and growth.

The value of the portfolio would now be $774,000 and it would be producing an income of around $35,000 a year. Furthermore, there would be no outgoings for items such as body corporate fees, maintenance, rates and land tax. Also, the bulk of the income would be franked, which means it would taxed at a much lower rate that income from rents.

The cream on the cake is that my friend could cash in part of the portfolio on five days notice, and such withdrawals could be done in a timely manner to minimise or eliminate capital gains tax.

There are two lessons here – property can fall as well as rise, and does not have the liquidity of shares.

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