The growth in house prices over the past ten years or so has encouraged many people to think that property is a better investment than equities – especially since the stock market falls of 2000 to 2003. Let’s have a closer look at property as an asset class.
Is our home an investment or simply somewhere to live?
For most of us, our home is somewhere to live. We didn't buy it purely as an investment, and its investment value is incidental to its value as a home. We choose the property we live in because of its appeal to us. If you are buying a property purely as an investment, you would (hopefully) look at it in a different way. It doesn't mean that your home won’t prove to have been a good buy: it should at least grow in value in line with the economy and you may have the opportunity to downsize or move to a cheaper area at some time in the future and release some cash in the process. The point we are trying to make here is that you can’t afford to ignore other forms of investment because of a short term bubble in house prices. It is a short-term effect: in the long run house prices will not grow faster than the economy. Just as with equities, the returns on investment properties in the long run come in the form of income. In general, that rules out your home unless you put into a self-invested pension plan and pay a market rent.
Equity release and other issues
The abnormally rapid growth in prices over the past few years has left many people in the happy position of having significant equity in their home. The amount they owe on their mortgages is perhaps less than half of the market value of their properties. There is a temptation to take advantage of that, especially if there is pressure on cash from other directions. There are lots of people who are only too keen to lend you money secured on the equity in your home. Equity release, debt consolidation, home improvement loans… you name it, and there will be somebody knocking on your door with an offer you can’t refuse.
The Financial Services Authority (FSA) is currently looking into possibly misleading advertisements for equity release schemes. Equity release is not necessarily a bad idea, but you need to be fully aware of the pitfalls and be able to judge the value of whatever it is you are being offered. There is a helpful booklet on the subject (Raising money from your home) available from the FSA.
If you are considering investing in property you are primarily concerned with the potential income stream from rents. You can expect the capital value to reflect the rental yield, just as in an efficient market we would expect share prices to reflect the cash generated in the companies concerned. Since rents should move broadly in line with economic growth (because that is the measure of peoples’ ability to pay the rent) you can expect asset values to grow too. However, it is much more difficult to diversify a property portfolio and you are taking big risks if you are not adequately diversified. The other major issue with property is managing and maintaining it. To some extent these issues are related: you have to decide whether you are simply an investor or in the property business.
There are two aspects to diversifying. Firstly you have to decide whether you should invest across several sectors. For example, should you have retail, commercial and industrial property as well as domestic? The second question is location: can you risk having all your property investments in the same area?
As with equities, there is a balance between risk and return. If you are widely diversified, you will have an average rate of return and fairly low risk. If you concentrate on a small number of carefully chosen (and managed) properties you have the potential for earning above average returns but your risk is higher. Perhaps more than any other asset class, successful property investment involves a combination of skills and active management.
Is property an investment or a business?
If you are thinking about buying individual properties to let, then essentially you are going into the property business and you need to approach it in a businesslike way. That doesn't mean that you have to run it as a full-time business, but it does mean a methodical and realistic approach. Like other areas of investment, if you simply play at it you will probably get your fingers burnt. This is a specialised subject beyond the scope of this site.
There are other managed funds that invest specifically in the shares of property companies in the UK and overseas.
|9 October, 2008 © 2008 K.R.Wade and Co Ltd|