The mortgage creates the profit and allows for the ladder effect to take place.
Now imagine that
- (a) mortgages are restricted in the future and
- (b) prices still increase.
Mortgages won’t disappear but they will be heavily restricted and it must be a short price bet that this restriction will last for at least 5 years and probably 10. Just as it took a generation for Alt A, Sub Prime and Self Certificated mortgages to come to the fore so it will take another generation for the situation to reverse. And without the aggressive mortgage lending and the imbedded belief that prices will relentlessly increase, property prices will not go up! And if property prices don’t go up then the equation between buying and renting will change quickly.
In nearly every other European country property ownership is not seen as anything special.
My belief is that property prices can only ever increase at roughly the same pace as savings. There is a logic to this that is allied to classic economic theory (there is not enough space for this in this article though!), which like much economics is actually remarkably simple. However, if you accept that this is right then think of this: property prices have gone up 400% since 1990 and the savings ratio has not gone up at all! In real terms nobody has any more money today than they did nearly 20 years ago.
So forget about supply and demand, forget about multiples of salary, and concentrate on the maths. If savings are correlated to house prices then prices must fall back to the level of wealth comparable to the starting point. I don’t know if 1990 is the starting point or not but if it is then house prices would have to halve from their peak to get back to the right level and then would take a generation thereafter to produce a profit.
At the time of writing property prices are reported to have fallen 10% from their 2007 peak. Let us look at a house valued at £200,000 in 2007; somebody buying today would have to pay about £180,000. But my assertion is that the price would have to fall back to £100,000 to make it a fair price in relation to savings.
If this is right, then this may take three years to occur, after which the market would start to recover (maybe?), but only at a “normal” level, in line with inflation and the savings rate (say a total of 5% per year on average). How long would this take for today’s buyer to get their money back from a future sale? 15 years!! And this gets them back to where they started.
Property ownership is far more expensive than renting. To own a property today costs about 10% of the property value, if you factor in mortgage costs, taxes, running costs and so on. Renting costs about 8%. So owning a property is a quarter more expensive.
It’s probably fine if you’re a mature home owner, but not if you aren’t. And if you aren’t you are the architects of future house price movements.
Wanting to own a property is firmly imbedded in the UK psyche but it is a mental aberration. We all want to live somewhere nice, and somewhere we can call our own but the cost of this is now too high and the odd 10% fall here and there isn’t going to change this at all.
Prepare for the mother of all downturns and don’t be fooled into thinking that property prices are suddenly cheap in two or three years time if they are a third or a half of today’s values, because all that will happen is they will have reverted to a more economic level. The “wrong” price is today’s price because it is so divorced from the UK savings ratio until it gets back to somewhere in line with the saving ratio (in about 15 years) then owning a property will be a luxury rather than a sensible investment.
And if you think this is exaggerating the possibilities, then I only have one thing to say to you: Japan. Property prices in Japan are roughly the same today as they were in 1990.
www.challengingadvice.co.uk is a web site dedicated to educating and informing investors about the investment world. Our view is that property ownership is looked upon as the be all and end all of many an individual’s route to wealth. We suggest that this may not work in the future and good old fashioned savings programmes will win the day. To find out how to make money without relying on your property click here.
Written by Matthew Morris July 2008
