Why property is profitable

The British love investing in property but why is it so profitable?

I’ve been a finance nerd for a long time. I’ve bought and sold countless shares, saved into pension funds, moved money between savings accounts and written at least a thousand articles on money matters. But my best financial decision was very simple – buying my first property in 2001. It’s proved to be a highly profitable transaction.

I’m sure that many readers would say the same thing. So why has property been such a profitable investment?

The simplest explanation is that house prices have gone up a lot! Between 1959 and 2009, the price of the average UK house has risen from £2,507 to £162,085, according to Halifax. Even if you strip out inflation, UK house prices still rose 278% over that period. That’s an average rise of 2.7% a year – on top of inflation.

Gearing

But those figures only tell half the story. Most homeowners have made bigger profits than that thanks to gearing.

Related how-to guide

Buy a property

Buying a property is a massive financial commitment. Follow these tips and it should all go relatively smoothly!

See the guide

Let’s look at an example:

Peter is 30 years old and has saved £40,000 for a deposit on his first property purchase. He buys a house for £200,000 and takes out a £160,000 interest-only mortgage. In other words, he’s only paying the interest on the loan, he’s not paying off the actual debt. He pays 5% interest on the debt which works out at £8,000 a year.

After ten years, the value of the property has increased by 50% from £200,000 to £300,000, but Peter’s profit is much larger. His original investment was the £40,000 deposit, but his equity in the property is now worth £140,000 – so he’s made a 250% profit!

Admittedly, Peter has also paid out £80,000 in interest, but as he’s been living in the property, you could regard that sum as the equivalent of rent. The same principle would apply if he had taken out a repayment mortgage except he would also have paid off some of his mortgage debt.

If Peter had bought the house purely as an investment and hadn’t lived there, he would, of course, have received rent. That would probably have been sufficient to meet his monthly mortgage repayments.

So that's why gearing has been a great boon for many homeowners but there is a potential downside. Just as it can boost your profits, it can also increase your losses if things go wrong.

If the value of Peter’s property fell from £200,000 to £125,000, Peter would lose all of his deposit and he’d have £35,000 of negative equity. In other words, if he sold his house, he’d still owe £35,000 to the lender. Nasty!

Inflation

Gearing isn’t the only reason property has been so profitable. Surprisingly, inflation has also helped homeowners to make good money in the past. Back in the 70s and 80s, inflation was higher than 10% for much of the time and even went over 20% on more than one occasion. That was bad news in many ways, but it meant that the real value of a homeowner’s mortgage was eroded away by inflation.

Yes, interest rates were higher back then, but given that inflation was also higher, those rates weren’t quite as punitive as they might seem now.

The future

Looking at the past is all very well, but the really important question is what will happen in the future. Will property be a great way to make money for the next 20 or 30 years?

Related blog post

• John Fitzsimons writes:

  How your home can cover your retirement

  Guest blogger Clive Bolton of Aviva explains how equity release schemes offer older people the chance to cash in on their biggest asset, without the need to move.

  Read this post

Of course, nobody knows for sure, and forecasters frequently end up with egg on their faces. However, history suggests that property is a good long-term performer and given that there remains a shortage of housing stock in the right parts of the UK, I can see house prices rising gently over the next couple of decades.

That said, there is one factor which could act as a brake on house prices, and that’s the gradual ageing of the UK population. When people retire, they often downsize and sell their home at a profit. As the baby boom generation retires, more family properties could come on the market when there are fewer youngsters around to buy them.

I also think it will be many, many years before the banks are lending as aggressively to homebuyers as they did in the mid-noughties.

In my opinion, it’s always a mistake to put all your eggs in one basket. That means you shouldn’t put all your savings into one asset class – i.e property – and you also shouldn’t put all your savings into one asset – i.e a single property.

I’m a great believer in spreading your wealth between property, shares, and cash, and that’s one reason why you should look at your finances as a whole and work out how you want to split up your assets.

Even though buying a flat has been my best financial decision, I’m not going to become a property obsessive.

More: If you're gonna sell, sell now | Shares vs property: which is best for savers?