My post of the week, plus plenty more worth reading across the Web.
I can’t get enough well-argued explanations as to why UK houses are overvalued. These people might be as wrong as me, prices might (or more specifically, ‘do’, at least here in London) go up regardless, but at least you feel you’re wrong with the smart money.
True, that won’t keep us refuseniks warm when we’re 68 and forced to live in some huge commune/squat in Milton Keynes with a bunch of other people who posted evidence of prices falls that never really came at House Price Crash like a middle-class cargo cult.
But heck, you can’t take it with you.
So on the property theme, my post of the week comes from Alan Dick, a financial planner from Glasgow.
Alan writes (apologies for going straight to informal Christian names, but to use his surname seemed provocative):
Most of us apply dubious mental accounting to convince ourselves that we have made a substantial profit on property.
Unfortunately, this is largely an illusion. Much of the so called profit is actually just the effect of inflation. Anyone over 50 probably paid more for their last car than they did for their first house. As house sales and purchases are generally infrequent activities we have plenty of time to put on our rose tinted glasses and ignore the effect of inflation.
Alan has crunched data since 1956 on house prices, shares, government bonds and RPI inflation, which is summed up in the following graph:
Pretty definitive win for shares. It’s worth noting, however, that the mid-1950s was when the ‘cult of the equity’ took off in the UK; I wouldn’t expect share prices to outperform over all timeframes like this (though right now, after two bear markets in a decade, is probably as good a starting point as any).
On the other hand, Alan also offers supporting data from the US and – intriguingly – Amsterdam, where records going back over several centuries for the same row of highly-prized townhouses shows prices rose by merely 0.2% per year in real terms (that is, after inflation) across 350 years.
Houses cost a lot to maintain and update, too, and they’re illiquid.
On the other hand, they have the great advantage of being the only way the average person can safely borrow to invest – provided they pay a reasonable initial price when they do so. It’s the gearing from a mortgage that in fact produces the bulk of the returns for anyone who isn’t lucky enough to buy at the start of a house price boom (most recently the late 1990s, in the UK).
A fair price for property
So what’s a reasonable price to pay? Alan cites the famed US writer William Bernstein’s suggestion of 15x the fair rental value of a property.
That would put my London place I rent at about £300,000, which seems about right – still eye-wateringly expensive, but understandably so given London wages and housing restrictions – as opposed to the £450,000 that similar places around here sell for, which just seems bonkers.
Do download the PDF and have a read yourself (there is good US graph, too, and details of a 100-year bear market for US property!)
p.s. Apologies if you’re used to getting this roundup on a Saturday morning and the email isn’t coming until Sunday. For logistical reasons (no, not a hangover!) I’m having to write around Saturday lunchtime currently, unless I have time free on Friday night. Shouldn’t be forever.
From the money blogs
- Rick Ferri on gold – Canadian Couch Potato
- The trouble with P/E 10 – Investing Caffeine
- Why do we make such a pig’s ear of UK housing? – Simple in Suffolk
- Risk, reality, and Richard Feynman – The Psy-Fi blog
- How the Fed creates money, and where it goes – Weakonomics
- Negative yields are not crazy – Bad Money Advice
- A softer approach to RDR – The Munro Blog
- Farewell to Speenhamland – A Grain of Salt
- On the value of networking – Get Rich Slowly
Morsels from the mainstream financial media
- Investment banking: Mutiny over the bounty – Economist
- Money woes can be early cue of Alzheimer’s – New York Times
- Who’s smartest: Active or passive investors? – Swedroe/Moneywatch
- Have you been misled by returns information? – Swedroe/Moneywatch
- Mortgage squeeze to widen price gap – FT
- A curious trend-following tracker fund – FT
- John Lee loves low P/E stocks – FT
- Bearish Merryn likes QE2 as an excuse for rally – FT
- Oil prices hit a two-year high – Telegraph
- The impact of privatizing the Land Registry – Independent
- Terry Smith’s new 1% p.a. ‘cheap’ fund – Guardian
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Hi TI
You make a really important point in this post. This IMO is the reason ‘everyone’ seems to love property and are shouting from the roof tops about how property is my pension. That is the leverage.
When the average punter buys equities in his/her pension they buy with zero leverage. In contrast a couple of years ago when you could buy a property with £0 deposit you effectively had infinite leverage. Even today with a 25% deposit your still carrying x4 leverage.
This is all well and good when property is rising. What most people don’t however realise is the damage it will do to their ‘wealth’ (to be honest I hate calling a home part of you wealth, but that’s another story) if property prices start to fall.
Cheers
RIT
.-= RetirementInvestingToday on: Happy birthday to me and the FTSE 100 cyclically adjusted PE ratio – November 2010 =-.
Whilst I agree that property is not, long term, such a good investment as equities, it is still a reasonable investment for most people, if you are prepared to widen the term “investment” beyond the narrowly economic.
I think the main driver for property ownership is the fear of paying rent in old age that won’t decrease in real terms. Yes, renters could use equities with dividend reinvestment and probably amass sufficient capital to do better than homeowners, but most people are not that savvy.
Moving house, capex and maintenance do erode the benefits probably more than most people realise, but having first bought 25 years ago and now in my third home, my 5% outstanding LTV, rightly, wrongly (or perhaps smugly) does give me a warm feeling.
.-= Salis Grano on: Weekly Roundup 5-11-10 =-.
I think the appeal of property is based on two things; people need to live somewhere and it’s something people can easily understand, touch, see and improve. You have no control over share prices but can spend 10k on a house and gain 20k. There’s also the status and stability of owning something of worth (not necessarily high value).
Property as an investment is usually an afterthought for most people, whereas good value is important. A 300k flat will be worth 300k if someone thinks it is, not whether some financial data says so. Of course demand, location, etc, etc plays its part as well. People up north wouldn’t pay 100k for something that would be snapped up at 5 times that in central London. Worth is in the eyes of the beholder.
On the flip side, paying a hundreds in rent and service charge is going knowhere but someone elses pocket. A friend of mine has a mortgage on a 1 bed flat in greater london that costs the same as renting an equivalent flat in his block. Interest will take up the bulk of his payments but at least some of it turns to equity and there’s always the potential of rising prices. Which, coincidentally, has happened even during the recent doom and gloom.
As an investor in shares, property developer and Monevator follower I can’t help but look at property from an investment angle. Obviously, current times require a greater respect for thorough research and realistic profit margins. The effect of tighter credit and scary headlines have caused many buyers to stay put. However, there are still plenty of buyers out there willing to pay for good value and cash buyers can find them selves a real bargain.
If anyone has enough spare cash picking up a buy-to-let at auction is something to explore. You should be able to get at least a 7% yield after costs.
I do agree with the essence of what you’re saying but never underestimate the allure of being able to say ‘I own this’.
Thanks for the feedback guys. For the avoidance of doubt, I do think property is a decent asset worth owning – both financially, and for the ex-financial reasons that JT alludes to of owning your own place (although that can have downsides, too, of course).
Landlords are in business to make money – if they can make money renting a property to us, then clearly we’d potentially be better off cutting them out and owning it ourselves.
Also, leverage as mentioned is not a minor point – it makes a big difference, and again makes your own property an attractive investment.
All that said, I’m still not convinced the answer is “at any price”, even for your own home, where on a taxed basis the benefits are most evident. And if I was buying to let, I’d want at least 10% yield before costs and wear and tear I think. 7% might seem good now, but we’re in a period of extremely low rates and some have seen the economy as flirting with deflation (not a view I’ve held, but still).
In summary, I feel very uncomfortable being ‘short’ the property market, and not buying a home years ago is easily the worst financial decision I’ve ever made! I’d also like to lock in today’s low rates with a big fix – particularly as I fear an inflationary spike.
But I just think equities look massively cheaper than property. If the market doubled in the next year but house prices stayed static, I’d certainly look again at property, even if I felt the latter still look pricey.
Very interesting piece which tries to link up a few threads I have been wondering about myself. Well done. I do however thinki we have serious problems looming for UK market. Everyone has an axe to grind here not least housebuilders who rode the boom like everyone else – buyers, sellers, agents – and thought it was never going to end. People, well builders in particular, have been arguing lending restrictions are a real drag, not least for the poor first time buyer but this is a market that looks now badly in need of some kind normalisation, unwinding – its a bubble that is clearly (for me) deflating, and it might deflate faster than expected next year. I know price v earning chart 9see here http://www.mindfulmoney.co.uk/2123/economic-impact/uk-house-price-falls-accelerating.html) does not tell you everything, but its still worrying looking at where we are at even right now versus long term average considering the economic outlook. Do feel first time buyers smell blood and are not just going to wait.
Also, not to forget that mortgage forces people to save, so it’s a best chance of accumulating wealth for people who otherwise have problem with actually saving money.
“In summary, I feel very uncomfortable being ‘short’ the property market, and not buying a home years ago is easily the worst financial decision I’ve ever made!”
I think this sums it up Monevator. Would you agree you’re a little negative towards property and property investors because of this?
My thoughts about property investment are as follows;
Pro’s
1. Leverage, already mentioned. The man in the street cannot normally borrow 200k + to fund an investement. Property is therefore the only way to secure large sums of money from institutions.
2. You can rent property, which essentially pays the fees/interest on the huge loans taken out to finance your investment. What other investment vehicle gives you a ‘free’ 200k to play with? Once you’ve purchased a property, ensured rental yeilds cover costs and start paying back the mortgage, it’s a investment that pays for itself. If capital values increase you’re an even bigger winner.
3. Its a long term (usually) play, where the illiquid nature of the investment means you generally tend to hold longer than you would with other assets.
Cons
1. Its illiquid
2. Buying property, at the wrong price at the wrong time with insufficient capital is risky and can lead to financial ruin. The numbers ar big and the swing from profit to loss does not have to be great to land you with a big loss.