You cannot go wrong with property seems to be the confirmed narrative in the UK. The experience of 1988-1994 appears to have dropped from the memory file. The experience of other countries may also not register. Things change and the past is no guide to the future. Understanding the nature of this narrative might help those that have or are inclined to invest directly in property.
The most common direct property investment is to own a home. There is no capital gains tax and the implied payment of rent (to yourself) does not involve HMRC. In order to own a home however most must employ leverage. They put down a deposit (equity) and borrow the rest. The loan is secured on the property ( a mortgage) and the lender registers a charge on the property with the Land Registry. You don’t really own it until this charge is removed. The leverage is what makes direct property investment seem so attractive.
If you put down a deposit of 50k and buy a property that costs 500k you are very leveraged. If property prices rise by 10%, equity rises to 100k. That is a 100% return. Of course if property prices fall by 10%, the equity falls to zero. But of course property prices never fall do they (1988-1994) and in any event so long as you service the debt (pay the interest and sinking fund on the mortgage) you can keep living there and paying yourself the implied rent. The problem is that in a world in which property prices have fallen by 10% other things may also be going on. One might be unemployed or have to pay a much higher interest rate. The base rate in October 1989 was 15%.
If you have 50k to invest in stocks and the market rises by 10% the equity rises to 55k. Not so exciting because you have not leveraged. You could leverage by signing up to a spread betting service which allows you to bet on equities using margin payments. The latter is regarded as ‘risky’ and ‘speculative’ but apparently doing the same thing through direct property investment is prudent. After all property prices always go up don’t they? The same could be said of equity prices in the long term. The point to take from this is that with a leveraged investment you are taking a risk.
Another aspect of the direct property investment narrative is that there exists a housing ladder. Compare two properties one costing 500k and the other 1m ( a London flat versus a detached home in London). If you buy the flat hoping to trade up later how might this work? Assume you have 50k as a deposit. To buy the flat you need to borrow 450k. To have bought the more expensive property you would have needed to borrow 950k. Now assume property prices rise by 10%. Your flat is worth 450k and you have 100k for a deposit. The more expensive property now costs 1.1m. You now have to borrow 1m in order to buy it. How did buying the flat help? Assume property prices fall by 10%. Your flat is worth 450k and you have zero equity. The more expensive property now only costs 900k but you have lost your equity so have nothing for a deposit. Once again how did owning the flat help?
The key to trading up is income and income growth. It requires that income grows fast enough to enable you to get ever larger mortgage debt. At 5x gross salary you would have needed to be earning 90k per annum to buy the flat. Perhaps joint income would have reached this and the lender liked you. To buy the more expensive property you would have needed to be earning 190k. After property has risen by 10% you would need to be earning 200k. So to trade up you would need to have seen income growth of more than 100%. In your dreams maybe. The assumption of 5x salary is generous by the way.
Median income in London is 35k. The average price of a flat is approximately 500k and the average price of a terraced house 750k. The average price of a detached house is approximately 1m. The numbers simply do not add up. Incomes in London are obviously too low to justify the level of house prices. The reason is partly that the averages include a lot of properties at silly prices owned by people with silly wealth. But this does not adjust the ratios sufficiently. Try finding a one bed flat for less than 350k. The other explanation is that landlords have acquired many properties and are letting at attractive rents. The rental on a one bed flat seems to be about 1300 per month or 15600 per annum. That is a yield of 4.5% on a 350k one bed flat. This makes more sense.
House prices, in London at least, are being driven by rental yields. Take home pay is 27180. So for a single person the rent alone is 57% of take home pay. Does not leave much for all the other expenses. For a couple it is half this which is more manageable but it does beg the question where do single people live? And what of those earning less than the median? The rental yield also looks to be unsustainably high. And the housing economics for half of Londoners look to be brutal. Where does this end?
If it is left to a market solution then it will eventually sort itself out but the ‘equilibrium’ might not look socially acceptable. Low paid workers will either find themselves living in squalor or migrating out of London until wage relativities compress a bit. If we leave the EU there could be quite an adjustment depending on how we leave. The BoE has said that it will raise interest rates in response to a supply shock and that is what leaving with no deal could bring. The arithmetic of buying and letting cannot cope with a jump in interest rates. Tenants cannot absorb higher rents and demand may well drop after Brexit. But why is property being left to an unregulated market solution?
Water, energy, telecoms, financial advice, etc all have regulation. There seems to be little regulation of the ‘somewhere to live’ sector, yet it is an essential social need. What regulation there is seems not to be effective or enforced. One would have thought that something that takes over 50% of disposable income and cannot be avoided should be regulated as a high priority. The fact that many of those that might promote regulation also profit from it, is coincidence of course. Indeed why is public provision of ‘somewhere to live’ not up there with education and health. It is hard to maintain health or benefit from education if you are living in squalor and spending half of your disposable income on rent alone. There is something very wrong here and it needs to be addressed immediately.
My preferred solution is a national housing association. This would be non-profit making in the sense that there are no distributions to shareholders but would be self financing. The purpose would be to ensure adequate supply of ‘somewhere to live’ near places of employment. The implied reduction in commuting would also ease pressure on transport services as well as the quality of existence. This would take a while to become fully effective so the sooner it is put into place the better. It comes with the ideological principle that ‘somewhere to live’ near ones place of employment is a social right and not a privilege and indeed is good for society. In the meantime more enforced regulation of private property rentals is essential with rent caps. As I grew up the term ‘Rachmanism’ entered the OED. It was not a compliment, yet today I see it is rife and people take pride in being successful slum landlords.
The reality is that the first property you buy will also be your last unless your income rises. So, buy carefully. If you want to invest there may be better ways to invest in property that offer more liquidity. There may be better assets in which to invest. The right to ‘somewhere to live’ is increasingly on the agenda and will impact property investment in the future. Socialisation of housing is fast becoming a policy reality once again.
Postscript 23 01 2019
I have just read that Sadiq Khan, the present London Mayor, will make rent controls a key plank for his 2020 re-election platform.