Ian Thomas, Pilot Fiancial Planning
'Property or Pensions'
Each week in the Sunday Times ‘Money’ Section, a well-known personality is asked whether they believe ‘property or pension’ is the better investment. In common with most other people I meet, their answer is generally that you can’t go wrong with bricks and mortar. We British are, by international standards, nutty about property. We love to own our own homes, develop them and talk about them at dinner parties. Increasing numbers of people have also come to view property as the best way to build a retirement income. But are they right?
Strict planning rules which limit the supply of property, cheap and abundant credit and a growing population (not to mention Kirsty and Phil) are all factors which have fuelled a significant increase in post-war property prices. The average annual appreciation in UK residential property prices between 1952 and 2010 was 8.4%*.
It’s also important to note that this average omits any rental income which may be generated, which could be a significant additional contributor to overall investment returns. There can also be opportunities to develop and improve a property, options not available to arms-length investment in other types of asset such as shares.
Another significant factor in property returns is that many investors borrow the majority of money used to purchase their property. A house purchased for £200,000, with a 10% deposit only needs to rise in value by 20%, to £240,000, for an investor to receive a 200% return on their initial capital!
As we all know from financial adverts, however, ‘past performance isn’t necessarily a guide to the future and prices can fall as well as rise’. This health warning is familiar in regulated areas such as pensions and ISAs, but I don’t ever remember a similar caveat being applied to any of the advice dispatched on ‘Location, Location, Location’ or ‘A Place in the Sun’! Yet there have been periods of significant property price falls; for example between the third quarter of 1989 and the end of March 1993 when UK house prices fell by over 20%, and during the recent financial crisis when prices again dropped by a similar amount.
Borrowing to invest also cuts both ways. If the £200,000 property mentioned above were to fall in value to £180,000 then the investor with a 10% deposit would lose everything. Unless you own a very large portfolio, risk is also increased due to a lack of diversification – the equivalent in the stock market would be having all your capital invested in just one or two companies. Of course, this can pay-off handsomely, but not always…
And there are other downsides to property. Transaction costs (stamp duty, legal fees, etc.) as well as on-going maintenance charges, mortgage costs, vacant periods and the general ‘hassle factor’ of property ownership need to be factored into any analysis. There can also be a lack of liquidity (the ability to sell an investment and realise its value), a serious issue which is affecting a number of people I know at the moment.
Predicting future investment returns is a lottery, but trees do not grow to the sky and when it comes to investment, no asset grows at the same rate for ever. After the debt-fuelled boom, could property now be entering a period of extended below-par growth? Several independent commentators seem to think so.
In May this year, the National Institute of Economic and Social Research predicted UK house prices would experience a 4.5 per cent fall in 2011, followed by an average fall of 1½ per cent per annum in the subsequent four years. Price Waterhouse Coopers (PWC) recently gave only a 12% probability that real house prices will regain their 2007 peak level by 2015. Even by 2020, after five years of further growth, PWC forecast house prices to be only 1% above the peak in inflation-adjusted terms.
Looking at the current ratio of prices to rents in July 2011, The Economist magazine assessed UK house prices, despite recent falls, to still be 27.8% over-valued against their long-run average. And that is not to say that prices can’t ever fall below ‘fair’ value, the average is just that, not a floor.
So is now perhaps the time to consider alternatives such as pensions and ISAs? The key benefit is that, in return for offering to help support yourself in retirement, the government is offering a significant bribe in the form of tax breaks. For example, a top-rate tax payer could currently make a £50,000 investment into a pension at an effective cost of only £25,000.
I appreciate that there’s not a lot of love for the financial services industry at the moment and commission-driven selling, stockmarket crashes, as well as over-complex and ever-changing legislation have all been reasons for many people to avoid pensions like my 9-year old son avoids bath time. But in the post-war period, UK shares have increased in value by an average of 11.9%* each year (assuming dividends were re-invested); other asset classes have performed even better. Don’t forget, a pension is simply a tax efficient ‘wrapper’ which can hold all sorts of different types of investment, including shares, but also commercial property such as offices or shops and sometimes even more unusual investments.
So what are my conclusions?
•Buy a property to live in and enjoy, first and foremost;
•Go into property development or the buy-to-let market with great caution – it’s not regulated and there’s no such thing as a free lunch;
•If property is your only investment asset or retirement plan then seriously consider diversifying . The financial services market has a poor reputation (with some good reason), but an experienced, well-qualified fee-based adviser will be able to help you navigate the shark-infested waters!
Contact Ian Thomas at Pilot Financial Planning:
08453 712 808, ian@pilotfinancialplanning.co.uk
www.pilotfinancialplanning.co.uk
Pilot Financial Planning is authorised and regulated by the FCA. This article is intended to provide helpful information of a general nature and does not constitute financial advice.
First published October 2011 By the Dart