Is Housing The Best Investment?
Posted by admin Sun, 18 Nov 2007 23:00:00 GMT
In order to answer this question, first of all it is necessary to define what is meant by "investment". There are many definitions, but to illustrate what investment means in this context it is useful to contrast it with a few other things. Broadly speaking, there are three things you can do with your spare money (aside from spending it of course!):
- Saving. This means putting your money in a risk-free pot such as a savings account or government bond. Usually this is a long-term strategy, where money is put away for 10+ years. Of course you can withdraw money from savings accounts earlier than that, but usually you will aim to keep the bulk of your money in there for a long time.
- Investing. This means using your money to buy (hopefully) low-risk assets for the medium to long term, i.e. at least 5 years. You might expect some short term fluctuations in the value of your investment, but broadly speaking over a period of 5 years or more you would plan for little risk of losing money.
- Speculation. This is the high-risk option with potential for high short-term returns. You might double or triple your money over a few months or even days, but on the other hand you stand a not-inconsiderable chance of losing it all.
The important distinction with regards to housing is between investment and speculation. Investment means you must plan to hold onto the asset for at least 5 years, and seek to minimise risk. With housing, you can of course obtain mortgage borrowing to "leverage" the investment, but this multiplies the risk. For example, with only a 10% deposit and 90% mortgage borrowing, the risk of losing money is 10 times that of the risk in buying a house with no debt. This approach is speculative in nature, as the risk is arguably too high to qualify as investment.
Unfortunately some amount of leverage is almost always required to invest in housing (unless you have a spare £200,000, which most people do not). Comparable leverage, of course, is also available for investing in the stock market without too much difficulty, either via margin, or derivatives such as options, contracts for difference, etc.
The stock market can also be invested in tax-free via spread betting, or with tax breaks via a pension scheme. In the housing market, gains are subject to capital gains tax. Until recently this tax ebbed away over time due to taper relief, but from April 2008 the government plans to change it to a flat rate of 18%.
The stock market also has a distinct advantage over the housing market in that it is very liquid. This means that it is very easy to sell your investment for cash very quickly. In the housing market it can take weeks or months to sell depending on the time of year, and selling incurs considerable costs. The liquidity of the stock market also means that it is possible to rotate to different types of stocks very easily, if for example you believed that a particular sector was going to perform very well in the next few years. In housing, you can also rotate (from say flats to houses, or one geographical area to another) but again it takes time and costs money.
Another factor to consider is the cost of holding the investment. Housing requires maintenance, which can cost 1% of the investment per year. As for the stock market, simple index-trackers usually carry no fees, although actively managed funds will have a management fee of up to 2% per year.
Leaving aside the various practical pros and cons of each market listed above, the remaining obvious question is to ask which market has performed best over the long term? In all investments it is important to realise that past performance is not necessarily an indicator of future gains. However, looking at the past performance of the stock market and housing market, as shown by the graphs below, the answer is not obvious.
The graph above shows an index of stocks (the FTSE all-share, in blue) vs. housing (average national price according to Nationwide, in red) over the last 50 years, both starting at 100, adjusted for inflation. The graph shows stocks ahead for the first 15 years, then housing for 20 years, followed by stocks again which took off during the dot-com bubble. Since the bubble burst in 2000, housing has rocketed, and looks to be clearly ahead. However, consider the graph below, showing the relative performance of stocks and housing over the last 25 years.
The above shows that over the last 25 years, even when taking into account the dot-com bubble bursting, stocks are still ahead by a small amount, although they have been somewhat more volatile!
The final conclusions are that the two markets have comparable performance, with no clear winner, and entry and exit timing are very important. But history has shown that in tricky economic times, when cash is most likely to be needed, houses can be tricky to sell for their fair value, whereas stocks can always be sold for their quoted value in seconds. This is not, of course, a show-stopper for housing - it just means that a little extra care is needed when planning an exit strategy.
