“Buy land, they’re not making it anymore.” (Mark Twain)
Treat house price indices with caution
Houses vary in size, quality, location and a lot more besides. Depending on these characteristics, the prices of different properties will grow at different rates over time. House prices in the North have increased nearly sixteen-fold since 1973, compared to thirty-six-fold in London. This disparity is important for would-be investors; in contrast to investing in financial markets, homeowners are usually unable to diversify their property holdings easily, and thus cannot explicitly aim towards the overall average market return.
Calculating overall house price performance is a particular challenge because only a small fraction of the total stock is traded each month. So what does the “average house price” tell us? Is it limited to only the actual transactions that occurred, or is it representative of the entire market at a moment in time? Whilst house price indices are widely interpreted as measuring the latter, the adjustments they perform actually make the data more like the former. This is a further reason for interpreting house price indices with a pinch of salt.
Historical house prices
Amongst the common house price indices in the UK, the Nationwide Building Society’s measure has the longest history (starting in 1952), and shows a dramatic rise in the price of an average house: from around £51,800 in today’s terms back in 1952, to around £211,400 in 2017. In fact, prices rarely fell; there are only two brief periods with negative changes: the early 1990s recession, and the recent fall in the wake of the great financial crisis.
But the Nationwide index is based on a sample of around 12,000 mortgage transactions a month, at their approval stage but after the corresponding valuation has been completed. So it has two drawbacks: the prices recorded may differ from the final sale price, and it may be biased from not including cash-only transactions.
Annualising price performance removes the effect of compounding and makes gains comparable over different time periods. From 1995 onwards, inflation-adjusted house prices increased at an impressive 3.8% annually. Even the annualised house price growth rate for the full history of the index since 1952 (2.2%) is larger than the 2.0% real GDP per capita economic growth rate over the same period. In other words, property prices have outpaced gains in economic productivity.
But you can’t invest in national statistics – what about other types of investment? Based on Barclays Equity Gilt Study data, UK equities have returned 6.7% annually (over inflation) and a 50/50 UK equities/gilts portfolio has returned 4.9% annually.
Of course, for a full comparison, we have to take into account the benefit of living in the house rent-free, and adjust for fees and taxes. An estimate for this net benefit would be in the region of a 2.5% after expenses such as repairs, transaction costs and letting fees. This makes the returns of housing close to that of a balanced portfolio – but importantly both are far ahead of cash, which has historically returned just 1.2% above inflation annually.
The aspect in which housing stands out relative to many other investments is the scope to use leverage by means of a mortgage, with some providing up to 90% of the finance. This borrowing acts to effectively amplify price movements, both on the upside and downside; while it can open the door to very profitable investments, it can also leave homeowners vulnerable to a position of negative equity, should a price drop eclipse the initial deposit.
The longer term picture
In the UK, while house prices have fluctuated during the last several decades, overall they have risen steadily and sometimes spectacularly. The accepted wisdom is that houses are a safe and excellent investment for the long term.
However, whilst many people think that owning a house is a certain money-maker, this is not the long term historical experience. In his book “Safe as Houses? A Historical Analysis of Property Prices”, Neil Monnery presents data from an array of nations, in some cases going back several centuries. His findings are that real house prices have generally been flat over time, or have increased at most 1% a year. Similar to gold, house prices have been a good store of value rather than an automatic route to riches. The UK is no exception, as Monnery shows with a house price index pieced together from various sources that span the whole previous century: he finds that the average house price in 1900 was just under £49,000, in 2017 terms. It took about 60 years for prices to rise consistently above that level, adjusted for inflation. The period from 1900 to 1995 is consistent with Monnery’s other historical experiences, in that real house prices only rose 0.7% annually. For the entire period from 1900 to 2017, the annual real house price gain is 1.3%. This compares to a real annual UK equity return of 5.1% and a balanced portfolio return of 3.5% over the same period.
The past 20 years or so have been the exception to the historical pattern of inflation-beating but low returns for property. Some factors driving prices are not new: A growing population supported demand, whilst supply was slow to respond. What sets this period from 1995-2017 apart is that investors/speculators held increasingly stronger beliefs that house prices would rise and therefore tried, desperately in some cases, to buy. Banks facilitated this by relaxing deposit requirements and increasing the amount you could borrow relative to your income. On the other hand, low interest rates and rising incomes have made mortgage costs more manageable; the UK household debt to GDP ratio rose from 58% in 1995 to 87% in 2017. With prices soaring, this system has become self-reinforcing. We will discuss where this leads us in another article.