I am in my mid 30s and I live in London with my family. One of the questions I frequently face is, “Why haven’t you bought a house yet?” to which I reply, "I don’t think it is a good investment.” I am usually frowned down with contempt for making this statement. I soon find myself debating with a group of people who collectively oppose my opinion. I eventually lose my argument and they walk away victoriously.
I would blame most of that on my inability to explain my thoughts on-the-fly. And in other cases I can sense that the debaters have either made up their mind already or don’t like being told that their recent investment was not that great. If it is the latter, they find it convenient to counter-argue their way out of this uneasiness thereby ignoring the fundamentals. Their points look valid at the first glance but can a detailed analysis prove otherwise?
Before we start I recommend you to have an open mind while evaluating my arguments. Usually, when you have made up your mind, your mind tricks you into finding numerous reasons to justify your decision. I guess this is normal; it may be because the person's mind is too focussed on just one thing.
#1: You save the rent
To an investor, saving the rent is akin to dividends received on an investment. If you are buying a house on mortgage, which is likely in most cases, your down payment is usually 10% of the price of the house; you borrow the remaining from a bank. This is called a 'leveraged investment' where the investor takes a calculated risk to maximise his gains by borrowing n-times more than his principal. This works well if you know what you are doing but the downside of this strategy is that your losses could be terrible if things go bad. In the case of housing the general consensus is that nothing will ever go wrong.
Let us consider a hypothetical scenario. You found a company that ticks all the boxes to be a long term investment. It will pay you a dividend somewhere equivalent to the rent you are going to be saving. You are fairly certain that nothing could go wrong with this company. 1. Would you bet all your savings on it? 2. Would you borrow money from your parents and friends to buy shares of this company? 3. If you could get cheap loan, would you borrow 10 times more than your savings to invest in this company?
You probably answered no to all the three questions. A seasoned investor assigns no more than 10% of his portfolio on a single asset as there is always room for something to go wrong. Famed investor Warren Buffet advises not to test the depth of the river with both your feet. But here you have put not just 100% but 10 times of your entire savings into just one asset for a return of 3-4% annually. Historically, the stock markets (S&P500) have paid more than 11% annual return on an average. A good investment fund should give you more than that.
#2: Housing price always goes up
This is wrong and to prove my point we don’t need to look very far into the history. The 2008 financial crisis showed us just this. The counter argument here is that even if the price falls it cannot go too low and that it will come back up quickly. This assumption is wrong too.
The only reason housing prices bounced back up soon after the great recession is because of the cheap monetary policies implemented by central banks around the world to stimulate economic growth. They gave the banks money that was created out of thin air. These retail banks then multiplied this money supply by lending them to consumers using the technique we know as fractional reserve banking. The interest rates were reduced to near zero, the cheapest we have seen in 5000 years of human history, to make consumers borrow as much as possible.
The mortgages that were once expensive are now dirt cheap. The monthly payments became much more affordable to people who couldn’t once afford to buy a house. With artificially induced buying power people raced against each other bidding up the price of houses.
To make the situation worse, some countries like UK, implemented government sponsored help-to-buy schemes that looks like a great relief to the buyers but only superficially. What a buyer fails to notice is the fact that many others like him, in the property market, also have access to the same help-to-buy schemes who then collectively drive up the prices. In reality, these schemes help the sellers (real estate industry), not the buyers.
You may have noticed the flaw in this monetary policy by now. The debt induced artificial economic growth cannot sustain very long as the number of credit worthy consumers diminishes over time. House prices soon go above the affordability factor for most buyers again. The high prices can only be justified if the economy is booming and the wages are growing at the same pace. Unfortunately, that has not been the case in the past 10 years.
People who bought their houses right at the bottom of the economic downturn around 2010/11/12 did a great job. Like me, many of you, missed the boat here. It seems like we are now reaching the end of the government stimulated economic growth a.k.a. 'business cycle’. And with interest rates now slowly creeping up, it is highly likely that the economy has started slowing down again.
#3 The government can fix it.
Historically, the central banks have been fixing the problems that we call an economic slow down, a market crash, a credit crunch or a recession by increasing the consumer debt. People are encouraged to borrow and spend which then stimulates the economy. This is done by reducing the interest rates. Housing is just one asset class distorted by this fixing game.
It is widely argued that somewhere close to 97% of the money we see in the economy today has been borrowed into existence.
If the number of creditworthy people fall, the amount of money borrowed into existence also falls, leading to a reduction in money supply. Now that the central banks have gradually reduced interest rates from about 20% in 1980s to close to 0% today, this fixing game seems to be almost over. In other words, it seems like they have ran out of ammunition at least in increasing money supply in the form of debt.
There are other measures they could possibly try. Tax relief, tax refunds, free basic income are some examples that could potentially be used to increase the spending power of an average consumer. This will cost the central banks nothing but such policies will have their own repercussions in the economy; details of which are outside the scope of this discussion.
#4 Interest rates will not go up too quickly
The real estate industry directly depends on the interest rate at which consumers can borrow. And the interest rates are closely dependent on inflation. Inflation makes a dollar today worth only a fraction of what it was worth a while ago.
The income generated by the governments through taxation isn’t enough to cover their expenses; so they issue bonds which is a promise to pay the investor his principal plus an interest on the maturity date. If the investor thinks his returns are not going to be worth his initial investment because of the inflation, he wouldn’t be interested in buying those bonds. So the governments across the globe always have to make sure that the interest rate paid on their bonds are always at par or slightly above the inflation to keep them attractive.
The central banks inflate the money supply to fuel economic growth but at the same time have to keep the bond markets attractive. This is like walking on wire; as long as they can hold the balance the markets are happy. This is a confidence game and the balancing act could tumble to either side anytime.
If the inflation picks up, the interest rates automatically rise. If that happens the financial institutions don’t have to lend you cheap loans as they can get better returns elsewhere. In other words, you may have to pay higher interest rates in order to secure a long term mortgage.
#5 Short term price fluctuations are trivial, housing is for long term
Your house is only worth what another person is willing to pay for it. If the economy slows down, other houses in your locality may start selling for a much lower price than what you had anticipated. This may be insignificant to you as your aim is to hold on to your house for a very very long time. But if you are buying the house on a mortgage you should also know that it doesn’t come with a teaser flat rate for it’s entire life.
When the teaser rate expires, irrespective of whether you decide to remortgage or not, your bank revalues your house to assign a new interest rate on your mortgage. The new interest rate, flat or variable, may or may not be in your favour. If the bank's valuation is significantly lower than what you bought it for, your equity on the house could possibly be less if not negative. This is risky for the bank and a risky loan always comes with a terrible interest rate.
The affordability of mortgages may not always be unwavering for consumers. When the monthly mortgage payments reaches the tipping point of unaffordability, home owners put their houses up for sale. As more such houses starts coming into the market the prices start falling and this market behaviour feeds onto itself in a vicious circle like what we saw in 2007/08.
#6 Other arguments
Some people want to buy a house for the pride of owning one, “what would others think if I don't own a nice house?" You actually own the property only on paper; the major equity holder of your house is the bank. Pride is complicated - the pride of owning a Jaguar; the pride of flying business class; the pride of having an expensive steak dinner - these are not investments for obvious reasons.
Some of other reasons other put forward by families for owning a house are freedom and escape from letting agents. In a worst case scenario, the costs associated with these are insignificant considering amount you are investing.
By taking a mortgage you are also risking your predicted future income thereby locking you up from making any further investments for the rest of your productive life.
Owning a house is also very expensive. Apart from the initial expenses incurred in the form of stamp duty and fees paid to the estate agent/surveyor, a house comes with a lot of maintenance cost. But if anything goes wrong with your rented property, all you need to do is to call the landlord who is legally obliged to fix it within a reasonable time.
You may also find that you are geographically tied to your house. You will either have to disregard good career opportunities away from home or commute long distances that may soon turn frustrating.
Conclusion
The media shows a lot of sympathy towards us, the consumers, for not being able to get on the "property ladder” (whatever that means). They also express unhappiness for our locality not having enough houses. Nevertheless, we don't see those people who cannot afford a mortgage living rough on the streets. I consider these as noise that can be safely ignored.
When it comes to investing, I do shop around for opinion as this helps me gather as much information as possible. If you are planning to buy a house, doing some research stirred with a little bit of rational thinking wouldn't hurt.
This article was an attempt at explaining my thoughts on why I consider buying a house today is not a good investment. It may have been a good one in 2010. I guess I have been able to give a reasonable summary to defend my contrarian thinking that may help you before making the biggest investment decision of your life.
And finally, the workings of any economy is obviously very complicated. It is highly likely that I may have missed something important as I don't know all the moving parts. Also, your personal circumstances may be different and I recommend doing your own due diligence. Do not take this as a financial advise and I am not a financial advisor. After all, I am only a computer programmer. :-)
UPDATE: minor grammer corrections
Submitted April 23, 2018 at 04:42AM by choorakkadan https://ift.tt/2F8n0pe
