Whether you choose to buy a house or rent is one of the biggest financial decisions you’ll ever make.
The sheer cost of houses compared to crisps, cars, and fancy shoes means this was true even 50 years ago.
Nowadays you could pay five or six times average earnings to get onto the property ladder. At today’s high house prices – even in the midst of a slump – the risks of making the wrong decision look greater than ever before.
Is there reason to believe today’s levels are justified, or will UK house prices fall?
In the next few posts I’ll explain how we got to today’s high house prices, and consider if there’s any justification for them.
I can’t tell you for sure if or when UK house prices will fall further, but hopefully you’ll feel in a better position to make your own mind up.
Why house prices matter
Most older people (say 50 or over) will tell you that you can’t go wrong in buying your own house.
Few of the older generation invested much money outside their home. The capital gains they saw from rising house prices – even as inflation reduced the burden of their once-daunting mortgage – was beyond their wildest dreams!
A few gnarly veterans do however warn that prices can go down as well as up.
I see both sides.
I know that house prices can go down. But I also think that NOT buying my own home a decade ago was my biggest financial mistake.
True, saving hard for my aspirational loft apartment (hey, I was young!) got me interest in investing, which is my passion now.
Would that be true if I’d bought a flat and spent my surplus income on broken boilers and Banksy prints?
I doubt it. Buying a house would have been a far easier path to wealth, however.
A little knowledge is a dangerous thing, and my knowledge that London property looked expensive compared to incomes and renting kept me from buying. Yet prices still kept rising.
- Friends who bought naively thinking “London house prices never go down” made a killing.
- Those of us who knew prices had fallen before and so could again have paid for it.
Should you care about house prices?
You might ask what does it matter? Why are the British obsessed with property?
After all, you could choose never to buy a house, and to rent all your life. Some people do exactly that.
The huge advantage of buying your own home is that you lock in the cost of living in it when you buy. Once you’ve paid off your mortgage, you only need to pay the cost of maintenance to keep living there. No more rent!
In contrast, someone who rents will need to pay ever rising rents throughout the next 25 years, when they could have been paying off a mortgage – and beyond that into retirement, too.
They’ll also miss out on any capital gains from rising prices, which are especially attractive because price gains on your own home are tax free.
On the other hand, it’s much easier to move if you rent. You don’t have to pay for decoration and upkeep, either, which you can estimate will cost you about 1% of your house’s value over the long-term, unless you fancy living with the equivalent of an avocado bathroom suite for your whole life.
It’s worth noting that the house price indices completely ignore these extra costs of ownership, and also the cost of adding value through loft extensions and other improvements.
Even so, most people have made a good profit by buying a home in the UK over the past 40 years.
Are UK house prices too high?
This is a financial blog, and I am not going to consider the lifestyle benefits of living in your own home in any great detail.
I’m also not going to go into the morality of high house prices, and the fact that young people are disadvantaged compared to the old by endless house price appreciation.
What you want to know is are house prices too high, or will they come down? The rest is personal opinion.
Next part: Historical UK house prices.
Comments on this entry are closed.
Interesting post and good topic – there is nothing like the subject of house prices to generate debate!
I find there are a couple problems at the moment which make it difficult to think of UK-wide house prices as a whole. The first is the way in which the London market is distorted by huge foreign inflows of capital (it seems it’s not only grandads but also Russian and Saudi billionaires that think London property is as good as gold!), and the second would be the huge discrepancy now between house prices in Wales, the Midlands and North (where there has been a reasonable correction), compared to London and South England (where prices seem to hardly have fallen from the peak). Those of us living in the latter gnash our teeth while friends in the north are now finding house prices more affordable.
For what it’s worth I’m not sure that property in most of the UK has been a good investment since late 2002/early 2003 (when the real average house price in 2011 pounds first passed £150K). It could easily drop to that level again over the next year, which would mean a decade of zero returns after inflation, and probably worse given the large one-off costs you mention when buying (taxes, fees, maintenance etc). Maybe it’s wishful thinking, but if the house price bubble has encouraged a new generation to invest rather than stuff their savings into mortgages this might be a blessing in disguise.
@Faustus — Thanks for your thoughts — our brief exchange about house prices the other day was one factor that prompted this series! We’ve looked at house prices before, but I want to go a bit deeper into a couple of specific and interesting areas. I think it’s very odd that prices have held up so much in nominal terms, and even if I end up deciding prices are still too high for me to buy, I want to be sure I gave the evidence a chance! 🙂
It was originally one post but it was approaching 3,000 words, so I decided it’d be better for all of us if I split it up. Hang on in there, and happy Christmas!
Here’s a tip for you all: when you buy a house treat it as you would buying a business.
Before you buy a house divide the value of the house by 10 and 15 and then the house is good value if you would be willing to pay those two divided sums in rent.
For example if a house is worth £300k that would imply that you would be willing to pay between £1.7k and £2.5k a month to rent that house. How suitable this is should be judged on what proportion of your income you’d be happy to pay in rent.
Alongside this you also have a speculative value, whereby if you would be willing to sell to a developer or indeed develop yourself you have the extra value of new houses minus the costs. However, this should be discounted for how likely this is to happen.
If you pay much more than 20 times what you’d be willing to pay in rent, you’ve overpaid and will lose money. Homes are a good way to protect against wage inflation, but that does not justify over-valuations.
The rules for REITs are likely to be relaxed in 2012, and the stamp duty changed for bulk purchases, so we should expect far more REIT involvement in residential.
I bought my first house at age 24 and paid off the mortgage before I was 30! Yes, I got lucky, very lucky.
@Robert — Interesting — is there a cunning mathematical underpinning, or is it a rule of thumb? My house would cost 23x annual rent. I presume my landlord holds it as a hedge against rising London house prices (he works overseas).
@gadgetmind — Yes, London and Stamford have talked about a residential REIT recently.
@TheInvestor – in the case where it is 23x annual rent it may not be overvalued if there is a reason to justify such an excess, but that excess must suggest that the present value of the additional earnings from that asset are worth an extra 50% to someone. If you want to make a reasonable income out of a property after costs you need 15x rent or less. Other wise why bother?
Either the landlord is acting irrationally and this would be one of the less extreme cases, there is more rent potentially to be got out of the asset through redevelopment or they have an abnormal fondness for the house. The latter is a good reason for paying an excess, but does not alter the value. I discount hedging for rising prices, because why would you buy something overvalued to discount against rising prices… why not hedge against inflation of wages for which there would surely be a better way?
PS – I’m not sure how many assets are better valued through cunning mathematical underpinnings against a rule of thumb based on simple return calculations discounted or inflated by a surjective analysis. I’m sure folksy Mr Buffet, who I see you have an interest in, would agree.
@Robert — Yes, it’s probably a bit of all the above. Speculation on London houses prices included.
As this series will explore, one has applied rationality to London houses prices at one’s peril for years!
In terms of cunning mathematics, I meant more does it imply a rental yield at x-y% above long run rates or similar. Unfortunately I have a slightly rotten hangover, and intentional thought seems beyond me, but I presume it does (7.5-10%).
I periodically check up on BTL yields to see what I’m missing and they haven’t looked good for years. I think I’d want at least 8% and preferably 10% to compensate for the downside risks and upkeep.
@TheInvestor, after the expenses of renting a property, from people I know who’ve been renting unprofitably you often need about 7.5-10% rental yield in order to earn a reasonable return after costs. With good tenants you get more, with bad ones you get less and when the property is empty you get nothing, but that would appear to be the norm. If you have a property which doesn’t cost much to keep at a rentable standard and long term tenants 20x would be fine. If you keep needing to find new tenants or get hit by costly repairs you might need 10x. 15x tends to be a safe average, but its good to be cautious.
In London personally, I think it’s a stalemate. The “foreign billionnaires” are buying up a few very expensive high profile deals but meanwhile down the “bread-and-butter” end (<£1m) it's very different story – stalemate.
Sellers won't take less unless they're desparate – many are speculators, having bought very often < 5 years ago, and still think 6-figure cap gains are normal. Buyers – particularly FTB – can't get more credit – despite being very willing to stretch to historically ridiculous levels; many have grown up knowing only crazy prices/credit as the norm. The bubble's stalled only through mechanics – and it'll go again once the mechanics permit. Why? Because not enough people have got hurt badly enough (yet) this time – hence, the "get-rich-quick-BTL/cap gains" mentality is still very much alive and kicking.
I say buy – the wind has dropped from the sails but the attitude of most hasn't changed. The government's proven it's more than happy to bail you out – and indeed are doing so. It's in the interest of a lot of people to keep the bubble going.
@Guzumpy — Yes, I think you’ve caught the emotion of the market there. The question is whether it’s mutable — sentiment is the quickest thing to change.
The trouble is I’d have to sink a lot of capital in London to buy, and I see the stock market as much more attractive right now. (We can’t really get affordable debt to buy shares, except via a mortgage by proxy so it’s not a fair fight unfortunately…)
Totally agree the BTL mentality still rules. As I say, I regularly check the yields myself and wish I’d BTL-d a decade ago (who doesn’t?) One reason why prices might stay high is that residential property is ‘outed’ now as a way to gear up and make wealth, as opposed to in the 70s when a house was still just something “one” did along with your 2.4 kids etc.