Friday, 2 October 2009

Whats the deal with house prices?

You can't seem to escape news regarding the property market, regardless of how insignificant it is. Both the UK's main indexes, the Nationwide and Halifax, have been putting together recent small upticks. Historically when house prices turn they don't reverse for years. Could it be different this time? It's never different, in fact this is how it always works in history, prices drop a bit, drag a long for a while or show slight upwards movements, then the process repeats for years. The housing market is so illiquid it is always very hard to determine what a market price is.

I have become tired of news regarding house prices. Throughout my adult life I have heard nothing else, the news gives greater coverage to the value of your home then real issues that occur throughout the world.

House prices are one of the most misunderstood asset classes. A while back I said that houses are historically a poor investment (a house is a home, but many believe them to be the best investment you can make) and I think many people would find that hard to believe as we have been continually told for the past 10 years that houses are the best investment. During the boom, pundits and experts were proclaiming that houses had the largest returns, yet also had the least risk associated with them compared with stocks and bonds (in fact many said no risk). This is what happens during a bubble, history is disregarded with risk/reward concepts turned upside down.

However when history is examined prices of homes performed poorly against all other assets. We can run through the numbers to illustrate this. If we take the Dow Jones during its 1980's and 1990's bull market along with the upturn in the current decade, it went from around 850 in 1982 to 14,000 in 2007. This equates to a return of 1657%. The Gold bull market during the seventies, went from around $35 to $850, a return of 2428%. Even if you disregard $850 as a top as this price was only achieved for one day, gold consistently hovered around the $450 mark for years after, a return of 1285%. So what about housing? This is where we come to the relative poor performance of home prices. Using the Nationwide's figures from a low in 1982 of around £67,000 to £186,000 in 2007 - a return of 277%. This was under two of the greatest housing bull markets in history. Even if we take the recent boom it gave around 250% returns on average. So to summarise:
  • Stocks - 1657%
  • Gold - 1285%
  • Housing - 277%
Of course the figures I have used are by no means rigorous, they just illustrate the performance of particular asset classes during their bull market. So what gives the impression that returns on a house are so great? One word, leverage. Most people that buy a house have to take out a mortgage and subsequently only put 10% or so down. Therefore any gains that are made seem all the greater. If you bought a house for £100,000 with £10,000 down, if the house rises 10% in price then you have doubled your money. This is the power of leverage. However in the event that the asset falls in price this is where the story gets a lot more painful. Just as gains are amplified, losses are also increased. The house would only have to fall 10% in value for your deposit to be cleaned out.

Leave it to the professionals to make their living from property, for the rest of us it should always be viewed for its primary function, a home.

With the bull market figures above you can see how people have got it wrong when they talk about the recent 'commodity bubble' or the current 'gold bubble'. Gold in dollars has only gone up around 300% since its low. Its only just above its all time high 30 years ago. History says bull markets in these types of assets have much further to go. Another good indicator is the Dow to Gold ratio. In recent history when stocks are in a bear market and commodities are in a bull market this ratio gets close to around 1:1 meaning an once of gold is the same value in dollars as the Dow Jones index. We are around 9:1 currently, however what happens if the Dow increases over the years to come as the government continues to inflate all asset classes? The gold target moves. 15,000, 20,000, 50,000 Dow? However high it goes, until fundamentals return to the stock market, I'm sure golds price will match it at some point in the future.

When the news reports on house prices, they always make statements like "Good news, house prices are on the rise" or "Bad news, house prices have fallen". Why is it that rising house prices is deemed to be good news? Many would find it odd if the journalist said "Good news, bread has risen again in price", but that's what they are saying with housing. The higher they go, the richer we are? Not at all, it just means there is more domestic currency in circulation and that rising prices are symptom of this action. Not too long ago when I was a teenager I remember being able to buy a good half a dozen sweets and chocolates with a pound. You could buy a mars bar for around 20-25p. I recently went to buy chocolate for my partner and couldn't believe the prices now. It was around 50-55p for the same bar. You would struggle to buy two items with a pound these days. Maybe the media should report this as good news, or if they ever fell in value report it as bad news.

Of course we are hearing all the usual babble as to why house prices will rise forever, the old myth of supply and demand, there is not enough houses. I always forget how we have waiting lists to buy houses as they are rationed out, or like under a Communist regime we form queues to buy our house. I always feel for those poor estate agents, their windows empty, as there no supply to meet demand or people resort to homelessness. Last time I looked there was plenty of houses to buy, in fact I get a paper full of them every week. Its more pounds that pushes prices up, not supply and demand. It becomes supply and demand issues when you start to see some of the above happening.

The recent reported 'rise' in prices will run out of steam at some point. The governments and central banks have declared war on anyone holding cash. Many people have turned to stocks or houses to place their money rather than in a bank earning nothing, but it won't last. QE have enabled the government to buy up bonds with the bailouts they gave to banks used to push up stock prices. The FTSE-100 recently had its largest quarterly gain, larger than during the tech bubble mania. As I've said before, bubbles are not inherent human 'flaws' or greed and so forth. They are caused by the exact expansive monetary polices we see today. Once you understand this, the financial system becomes a whole lot clearer. In fact you start seeing where the next bubbles will occur. There will be great volatility in many asset classes over the years to come as the governments try to inflate everything. This includes the price of our homes.

3 comments:

  1. Yeah it's a funny statement really. Housing prices falling are good news for those who do not own, but wish to own. Of course those who own like when prices rise, but even then if they are purchasing another home in the future it nullifys the gains.

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  2. Yep Stocks to Buy Now, it is a classic case of Government run inflation. People who own houses like to think of themselves as a finance whizz when their house rises in price, however all assets go up against pounds over time. It's just houses had their moment in the sun recently.

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  3. Hello. I quite agree that people should realize that purchasing a house is not a profitable investment! Quite the opposit, people often get in debt because of buying a house. They should certainly consult a professional first before they decide to buy a new home, especially, if they are thinking of taking a loan.
    However, thank you for your post. As I am Canadian I don't know much about the UK, so your article and opinions were very infomative for me.
    All the best,
    Jay

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