In the first part of our review of property as an investment, the headline was that the annual real (after inflation) growth of property values in the UK was under 3% p.a. since 1975.
The second part of the report will focus on the other major way people invest their wealth, shares.
A direct comparison with property from 1975 isn’t possible for the UK FTSE 100 index as it only came into existence in 1984, so we will use that date.
The index was set at a value of 1,000 in 1984.
Today it stands at 6,100.
In simple terms therefore it has risen by around 500%.
We identified in part one that inflation has cumulatively been far higher over the last 30 years than most people realise. Therefore what appears to be very impressive growth rates for asset prices are in fact far less so when inflation is stripped out.
This equally therefore needs to be done for the growth of the FTSE index to give a like for like comparison.
Since 1984 the total for inflation is around 105% so the 500% equity market increase is reduced to 395% real growth.
If this 395% is then divided by 30 years it equates to an average return of 13.15% per year. In comparison (excluding rental income) residential property would have returned 3.83% per year.
That’s around a 300% difference in returns.
So the next question is “why do most people generally prefer property investments to owning shares when the returns on shares have been so much better historically?”.
The fear factor…
The answer for most centres on the volatility of equities.
The largest single day fall in the FTSE 100 occurred on October 20th 1987, when it was down by 12.22%!
The largest single year fall was 2008 at -31%.
It was also down 25% in 2002 and 16% in 2001 so over those two years it fell a cumulative 41%.
So it’s not hard to understand that most would find such periods highly stressful.
The reality as was illustrated in the first report is that property has fallen by equal amounts if not greater (around 60% between 1989 and 1996). But the slide was far more gradual and therefore the anxiety it caused much more muted.
Property is useful
Share ownership is effectively the accumulation of bits of paper (certificates) but owning your own home is to live in the physical investment and enjoy it daily.
This is undeniably a major benefit, and owning a home to live in has (over the last 30 years) evidently been a complete no brainer, this factor however is not relevant for investment property and this is the focus of our analysis as it’s then comparable to share ownership.
As we illustrated in the first report most property owners gear a house purchase by taking on a mortgage.
So if in 1984 a house was purchased for £100,000 and a mortgage was taken for £75,000 the investment of owner capital would be £25,000.
In 2015 that house value would have risen around 116.43% net of inflation.
The return on the £25,000 invested however would not be 116.43%, it would be 465.73%.
(£100,000 rises to £216,430, therefore £25,000 equity becomes £141,430).
Now if the same level of gearing (leverage would be the equity term) was applied to an investment in the FTSE in 1984, the result would be that the £100,000 would have risen to £495,000.
That equates to nearly 1,580% on the initial stake of £25,000 personal money (again like with property the other £75,000 was borrowed).
Now virtually no one would consider taking on that level of leverage for that length of time with shares. We have already demonstrated however that property fell by a comparable amount to equity markets during the period 30 years, so the volatility was actually not significantly different, property losses were just more gradual.
An argument against the property growth rates we are using is they are National and don’t properly reflect the far higher returns achieved by owners in London, the South East and South West, which is undoubtedly true.
The counter argument is that this averaging of growth is the same with the FTSE index over the same period; the best companies must have grown far more than the average to compensate for those growing their share price by less.
So for example; if we are comparing investment property with share ownership we can look to buy a rental property in London if we live in Bristol, as we can equally buy Aggreko, SABMiller or BG Group from the FTSE 100 (which are all up considerably more than their index over the last 10 years).
A key realisation for an investor in equities is that “Mr Market” quotes prices daily and for the majority of the time they are both rational and fairly unattractive, those who are selling want a good price for what they own.
However there are times when markets become hysterical and prices either rocket up or crash down during fits of exuberance or panic.
The maxim then is:
Be Greedy when others are Fearful.
Be Fearful when others are Greedy.
The cost of owning shares is the emotional toll this takes but the reward is a potentially higher long term return.
Property is less stressful to own but as we have illustrated also less rewarding.
We are constantly reminded of the psychological element to investing when discussing the funds people hold in Building Society accounts.
Since 1984 an investment in the average high yield Building Society account (assuming interest is taken as income taxable at the individual’s highest rate) would have halved in value. Compared to either shares (which pay dividends) or investment property which creates rental yield, both would create income PLUS the rise in capital value.
So the conclusion to this part of the review is that for many the key criteria for investing is their perception and tolerance for risk, how the investment makes them feel, not how it actually benefits them over time.
The facts clearly demonstrate that volatility is actually the friend of a long term investor but is erroneously perceived as an enemy.
Whilst ‘safe’ and ‘low risk’ is in fact, over longer periods, often the quite the opposite.
Source: The information for this blog has been sourced from various places. The key sources include; Bank of England Interest Rate Database and Inflation Calculator, MeasuringWorth.com Earnings Database, Independent Article ‘Interest Only Mortgages A Million Face Payment Problems Yet Lenders Are Still Pushing Them’, York University Research on Rent, Government Data Statistics on Dwelling Stocks and Private Rental Market Statistics, EconomicsHelp.com data on housing market. Telegraph article ‘Buy to let returns beat all other mainstream investments’, HousePriceCrash.co.uk indices from Nationwide, Nationwide.co.uk article comparing Stocks and Shares to Buy to Let
Note: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.