UK house prices are forecast to fall by almost 10%, according to the Office for Budgetary Responsibility (OBR). In a way, this is unsurprising, given the backdrop of double-digit inflation and economic malaise.
But hang on a minute. Didn’t global stocks fall last year, for the same reasons? Haven’t bonds already suffered losses in the face of rapidly rising interest rates? Why is property so late to this dismal party?
The Nationwide UK House Price Index shows that average house prices actually increased by almost 3% in 2022! It’s as if real estate, as an investment asset class, has been floating in mid-air, pumping its legs like a cartoon critter in brief defiance of gravity. What’s up?
The price is right
Let’s go back to the basics of what gives assets their value. The answer is a combination of what people think investments are worth – and what they feel.
On the one hand, we might get out our calculators and work out how much income a bond is due to yield until its maturity – or, with an added layer of uncertainty, how much dividend income we might hope to receive from shares in a company. Then, with an eye on interest rates, we could deduce how valuable such assets are today, compared to just sticking the money in a savings account.
(It’s worth pausing to reflect that any mathematical model is doomed to limitations. In this context, it could only work perfectly if every investor sang from the same hymn sheet, which they evidently don’t.)
On the other hand, let’s admit that a great many assets have value just because we reckon so. It might be only a handful of people who share the opinion – about family heirlooms, for example. Or, it might be a very significant number of investors who think alike – for instance, gold is highly prized worldwide as a kind of ‘ultimate store of value’, despite not offering its owners anything by means of ongoing recompense.
(Note that although prices are affected by limited supply, scarcity does not automatically confer value. Cryptocurrency enthusiasts and gold fans alike make great fanfare of their finite reserves – but the same could be said of my daughter’s doodles of Disney princesses, yet for some reason they’re not gracing Christie’s.)
To summarise, either an asset provides regular income, in which case you can hazard a (flawed) guess as to what this stream is worth, or it doesn’t, and investors just hope that one day, someone will come along and be willing to pay more for it than they originally did.
Immune to rate rises?
Viewed through this lens, it’s clear that share prices have fallen in the past year partly because most people have pencilled in declining dividends. And, more dramatically, both stocks and supposedly safe bonds have depreciated in value as the mechanical consequence of higher interest rates – in other words, £100 paid in a few years’ time isn’t worth as much as it used to be.
So what about property? Which type of asset is it?
You could argue that it’s part of the ‘income stream’ set. It’s quite common to talk about a property’s yield, after all, in the form of rent.
But in that case, why didn’t real estate prices sink in the first half of last year, when interest rates were aggressively hiked? Shouldn’t they have performed a synchronised dive with stocks and bonds?
Part of your world
The other possibility is that property is more of a sentimental sort of asset. After all, most people live in homes, not investments. The ‘utility’ of a house, to put it in coldly economic terms, is not to be found in its hypothetical yield, but in its location, its condition and a whole lot else that’s impossible to quantify.
That said, we must remember that much of the real estate market isn’t residential but commercial, where more calculating forces apply. On that front, CBRE’s UK Commercial Property index indicated a decline of almost 7% in 2022 up to November, more in step with the losses suffered by broader financial assets.
Furthermore, neither commercial nor residential property purchase decisions are divorced from economic reality. You aren’t likely to upscale if you’ve been laid off, or your wages are stagnating in real terms.
All in all, property prices are subject to both the prevailing economic winds – albeit in their own peculiar way – as well as myriad other idiosyncratic factors. This is why real estate investments are feted for their diversifying… er… properties.
Unfortunately, though, you can’t just buy a ‘Real Estate 100’ tracker fund as you might with the FTSE. Or rather, you can, in the form of a Real Estate Investment Trust (REIT), but this would defeat the purpose, because the trouble is that REITs are publicly listed companies like any other. And, being traded on the stock exchange, they are contaminated by the caprices of equity investors – ultimately resembling nothing so much as a certain stripe of share.
There are other types of real estate fund, as well, including those which are not companies in and of themselves. However, those offering daily liquidity, i.e. the ability to get your money out at a moment’s notice, have been on a downwards trajectory (in terms of assets under management) since the summer of 2016, when several big name funds suspended trading as a great many investors all rushed for the exits simultaneously.
Near-instant access to assets that are tricky to offload is a dangerous mirage.
Your only other option is bricks and mortar. Here, the challenges are, firstly, to achieve a decent level of diversification (not easy, given the sums necessary) and, secondly, all the fees, taxes and other vexing little costs involved.
The conundrum for homeowners is that they already have exposure to the property market – whether or not they consider it part of their investment portfolio. Does it really make sense to add more, for example through a buy-to-let? (Especially considering the tax implications, beyond the scope of this article.)
Perhaps the best answer is not to force an illiquid asset like property to do a job best left to a highly liquid and diversified portfolio of stocks and bonds.
To bring real estate into the equation – to try to satisfy the same objectives and constraints as instantly tradable shares and fixed income – is to attempt a stir-fry and 10-hour slow cooker recipe in the same pan.
There is nothing wrong with real estate investments per se. In fact, they can be excellent diversifiers, as we’ve seen with their performance lately, decoupled from stocks and bonds. However, it’s arguably worth doing property properly, rather than through a fund offering unrealistic liquidity.
And, as with so much in the world of investing, the true value of advice lies not in the intriguing detail of what will be bought and sold on your behalf, but rather in the high-level financial planning that makes sense of it all from 30,000 feet.
So, whether you already own huge tracts of land or are still a first-time buyer, it’s probably best to take advice on your whole estate. In other words, let a fresh pair of eyes assess whether you’re potentially over-allocated to property – in case it’s tying up your capital in an inefficient way. Then, work out if and how a portfolio of stocks and bonds can fill in the missing pieces of your financial goals’ jigsaw.
As for dour house price forecasts? Unless you’re under pressure to sell in the near future, don’t dwell on them. Even if property values decline, it’s hard to imagine they’ll be depressed forever – and after all, a blip could represent a good opportunity to upsize.
Past performance is not a guide to future returns. Please note that the value of investments can go down as well as up, and you may get back less than you originally invested.