The truth about house prices
– David Kuo is director of financial website The Motley Fool. The opinions expressed are his own.-
The housing market is probably one of the most keenly followed markets in Britain. Every month we are hit between the eyes with no fewer than eight separate indices that provide pointers to the state of play in the property market. These include supply side figures from Rightmove, demand side numbers from Nationwide and mixed-adjusted indices from the Department of Communities and Local Government.
The plethora of indices is enough to make anyone draw the curtains and lie down in a darkened room. But it is important to appreciate that each set of data will be different because they are drawn from very different data pools. For instance Rightmove’s index is based on sellers’ asking prices, which tend to be more optimistic than say, Nationwide’s index which is based on agreed sale prices. Additionally, Nationwide’s index is derived from mortgage approvals, and not everyone may need to apply for a mortgage.
Our anxiety over house prices probably stems from the fact that a home is the single biggest purchase that most of us will make in our lives. So, it is understandable that we want to know that our money is well spent. Worryingly, there are some seven million people who are hoping that rising house prices will save them from poverty because they have not put away enough money for their retirement.
If you are wondering if house prices have bottomed, the answer is probably not. Currently, the price of a typical home in the UK is around £153,000, which is still six times the average annual wage of a British worker of £24,000. The cuts in mortgage rates have helped to ease the burden of servicing mortgages. However, there are dangers to relying on low interest rates.
Whilst house-price watching is a popular national pastime, and one that I have to do professionally, it has never interested me that much on a personal level. That’s because I have neither considered my house as either an investment or as a substitute for my pension.
I have always thought of my home as a roof over my head that meets my living needs. After all, if I didn’t buy one then I would have to pay rent to a landlord, which wouldn’t bother me too much. At least as a tenant I wouldn’t find myself knee-deep in sewage unblocking a drain with a plunger on a sunny Sunday afternoon.
During my twenty or so years as a homeowner, I have seen property prices rise and I have also seen them fall. That said, over the long term I have been fortunate to benefit from rising house prices. The appreciation in property values has allowed me to steadily build up equity in my home albeit punctuated by periods when prices fell. Nevertheless, house prices would now need to drop quite significantly to catch my attention.
Clearly, adopting a relaxed attitude towards house prices has taken many years of practice. It has also been helped by regularly channelling money into other assets such as the stock market, bonds and cash. By doing so, the value of a home, no longer becomes a fixation but instead just another part of your growing portfolio.
The allocation of assets, albeit crudely in the case of offsetting rising property values with shares, is one of the keys to building wealth over the long term. So, if property prices rise, it is important to adjust the mix of assets you own by investing more in assets other than property. This means investing not only in shares but also in bonds and cash. In other words, it is important that you have a well diversified portfolio.
One thing to bear in mind is that asset allocation will not maximise your returns. But it should do the next best thing. It will reduce the risk to your wealth. In a nutshell, living modestly, overpaying your mortgage and having a properly diversified portfolio will enable most of us to ride out market downturns. And any paper losses you may incur from time to time will not affect your life too much because you are not losing actual cash!