Property investment is just one choice for people looking to save for retirement, increase their passive income or become wealthy. So why is property such a good choice for many investors and what makes it stand out from other asset classes such as equities, gilts and bonds?
Property investment has certainly caught people's imagination over the last few years with many building substantial portfolios and others at least acquiring a holiday home abroad, or a single buy-to-let flat to contribute towards their retirement savings. But is property a temporary investment fad or is there more to it than that?
Generally people have a short memory with regards to almost any market. For example, people remember the stock market crash after the Dot Com boom, but not so much the boom itself which was enjoyed for many years previously. Equally, people remember the last few years of substantial house price gains but not so much the falls/ static period over the early to mid 1990s. Now that prices have been reducing again more recently people will doubtless become more cautious about assuming continuous property price growth once more.
To obtain an accurate picture of house price performance versus the stock market, it is necessary to look over a longer period such as the last 35 years for which accurate house price index information is available. Over this period house prices have increased 11% per year on average, whereas the stock market has produced around 13% growth - at first sight this suggests that the stock market would be a better place to put your money.
Firstly take a look at a chart of property average house prices (taken from government data) below :
Whilst this looks like it is growing at a dangerous pace it is important to show the chart on a log scale as compound growth (steady year on year growth) charts always look like those above - a log scale will show a straight line if the compound growth is at a steady rate - and indeed that is close to what we do see below :
However, when looking at these growth curves and comparing to stock-market growth, it is important to bear in mind that many people borrow money to purchase property and that the interest payable on this loan is usually covered by the rent charged to a tenant on the property, or in the case of your own home, the interest payable is similar to the rent you would have to pay anyway if you were a tenant. Therefore, property growth should perhaps be considered in relation to the deposit paid for the property rather than assuming the property has no mortgage.
If a property is purchased with, for example, a 20% deposit (equity), a 5% price gain is actually returning 25% on your equity in just that one year - for example, a £100,000 property bought with a £20,000 deposit and going up 5% or £5,000 would make you a 25% return on your £20,000 deposit. On the other hand if the property was purchased for cash then a 5% gain would only return 5% on your equity. Recent gains of 10 to 20% in property prices per year and the resulting 50% to 100% return on equity is what has attracted speculative property investors. These large gains are due to the power of ‘gearing’ and it should be noted that if prices dropped by 5% the same magnification would apply to the losses, so property should never be treated as a short term investment if you are seeking safety.
As another example of the effect of gearing upon property returns, if a property had been purchased in 1969 with a 20% deposit then the capital gains as a return on the cash invested would not have been 11% as quoted above, but a much greater 16% per year. This type of long-term return is exactly why so many long-term investors prefer property as a place to invest their money.
For those more active investors who re mortgage to release cash in order to enlarge their property portfolio the returns have been much higher, with many seeing growth in their equity of 50%-100% or more a year over recent years due to the gearing effect upon their relatively low deposits.
The current focus on property is a result of people looking for another investment they can rely upon for their retirement, after the failure of the stock markets to so far regain the heights of the late 1990s and a series of pension scandals. Property can be a solution but it should never be the only one, regardless of how good the returns appear to have been. In addition, relying upon rent as your retirement income can be risky if you only have a small portfolio. Nevertheless property can be a great asset and the fact you already own your own home should not lead you to assume that you have enough property already – many experts reckon you should ignore your own home.This is because your own home is rarely a realisable asset, as most people never downsize in value and hence cannot release the value easily in retirement other than through equity release schemes.
For example as a fairly depressing but realistic calculation for those planning to use their own home as an income generator in retirement; let us look at a couple with a £400,000 house they live in and own outright and assume they decide to use 25% of the equity in the property for releasing cash to generate further income. Upon releasing 25% or £100,000 (a fairly typical limit as the interest rolls up over the years and so the borrowed amount needs to be fairly small) they could either spend £5,000 a year over the next 20 years or so or invest in an annuity that may produce around £5,000 annuity income per year through retirement. A very poor pension indeed.
My opinion is that a true asset should produce an income and that your home is actually a liability, in that it brings several taxes on your income including mortgage repayments, rates, redecoration, refurbishment of kitchens and bathrooms, gardening etc and the bigger the house the bigger these taxes. A buy-to-let property should have these other costs paid by someone else going to work each day to earn the rent they pay you. It is investment property, not your own home, that provides the real return in the long run.
Let us look at a table showing the equity (net asset value after loans etc) of several investments at different rates of return and inflation. We will invest £100,000 and assume that the investments are made with the best available borrowings (maximum gearing), that the investments are made for 20 years and that property inflation is running at 5% pa. Buying costs are factored in where significant. Stock Market Growth (total returns including dividends) is assumed at the 35 year average rate of 5.8% pa plus inflation (although Barclays state that it is unlikely to be able to maintain this rate going forwards).
With the retracement in UK property prices over the last year, opportunities abound. If UK price rises settle to 5% a year over the next few years following these recent price falls , that is still a 20% return per year on a 25% deposit.
Many people are also seeking opportunities abroad and certainly the arguments already expounded can also apply overseas. With European mortgage also relatively low, having a holiday home that can be let out as well as providing a long term retirement nest-egg may well prove similarly attractive to having a UK buy-to-let portfolio.
The perfect time to begin investing is easily seen with hindsight but provided a long-term view is taken, now is as good a time as any to make a start. With recent price adjustments, this is even more so than recent years.
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