Property Versus Shares

Property and share prices often go through booms and busts, but which market has performed better in recent decades?

Habitual readers of my Fool articles will know that I am something of an enthusiast when it comes to investing in the stock market. I've been buying shares for around twenty years and this is the source of much of my personal wealth.

However, riding the stock-market rollercoaster has been a far from smooth ride. Early in my investing career, I witnessed Black Monday and the events of October 1987, when the UK and US stock markets plunged. The benchmark FTSE 100 index ended up diving by more than a quarter (28%) in the final three months of 1987. On the other hand, many people forget that, despite this massive setback, the 'Footsie' actually finished up 2% on the year.

Obviously, as with any other market, the UK stock market is subject to periodic surges and setbacks. Most recently, we ran into a three-year bear market between 2000 and March 2003, when the FTSE 100 more than halved from peak to rock bottom. However, as this graph reveals, despite its sporadic stumbles, the value of the UK's biggest business does tend to rise over time.

On the other hand, I've also done quite nicely out of property, purely by buying a family home. I bought my first (and only) house in the dog days of late 1992, when no-one seemed to be interested in buying property, thanks to a housing crash which began in 1989.

I went on to sell my house in April 2005 for more than 3½ times what I paid for it. This amounts to a return of 11% a year compounded, which is more than satisfactory. Of course, since I leapt off the property ladder two years ago, house prices have continued to surge -- but so have the shares which I purchased with the proceeds of my house sale.

Thus, my big question today is: how well has the stock market performed against domestic property prices during my investing lifetime? Happily, this gives me an excuse to build a spreadsheet incorporating large sets of data in order to find out the answer. Accordingly, I downloaded and analysed quarterly data for the FTSE 100 going back to early 1984 and acquired matching house-price data from the UK's largest mortgage lender, Halifax.

Here's what my number-crunching revealed:

The long game: June 1984 to March 2007

Here's how both markets performed over this period:

As you can see, since mid-1984, the Footsie has slightly beaten the Halifax house price index, rising by 7.4% a year compounded as compared to 7.2% a year. So, at the top level, there's not much in it between shares and houses.

The yearly game: 1984 to 2006

Now let's take a look at how annual returns have varied across both markets:

Over the past 22 years, the Footsie has seen five down years (1990, 1994, and 2000/02), with the worst being 2002, when it fell by almost a quarter. The best year was back in the yuppie heyday of 1989, when the FTSE 100 rose by over a third (35%).

Over the same period, the housing market has experienced four down years: 1991, 1992, 1994 and 1995. However, three of these setbacks were very modest (less than 2.5%) and the worst, 1992, was less severe than any of the Footsie drawbacks. Hence, at the top level at least, housing downturns have been less severe than stock-market declines.

The quarterly game: June 1984 to March 2007

Finally, I will slice and dice my data on a quarter-by-quarter basis. The table is too long to produce here, so I'll cut to the chase:

In these 91 quarters, there were 28 occasions when the FTSE 100 fell over the course of a quarter. In other words, the index fell around three times in every ten quarters. As you'd expect, the worst fall was around Black Monday: in Q4 1987, the index lost 27.6%. The best quarter was Q1 1987, when the Footsie rose by almost a fifth (19%).

Over the same period, the Halifax house-price index fell 19 times, or roughly one in five quarters. The best quarter was Q3 1988 (up 10%), during the previous housing boom, and the worst was Q4 1992, when house prices fell by 3.6%. Hence, Footsie falls happen more often than housing declines, which you'd expect, given the higher volatility of share prices.

If I were to summarise these results, I would say that both asset classes have produced useful returns for investors since 1984, with shares winning by a nose. However, the FTSE 100 is considerably more volatile than house prices, so investors in shares need to be patient in order to ride out the fairly frequent setbacks which the stock market springs on us.

In addition, it's important to note that the vast majority of private investors put their money directly into shares or funds with no gearing. In other words, they don't use extra borrowing or derivatives (such as contracts for difference, futures, options or spread bets) to 'gear' (magnify) their returns. Thus, there is no chance that these investors can suffer more than a 100% loss and end up owing more than they invested.

On the other hand, most homebuyers buy a property with a mortgage. For example, they may hand over a deposit of a tenth (10%) of a purchase price of £100,000 and fund the remaining £90,000 with a home loan. When house prices are rising, this gearing produces terrific returns. In the above example, a 20% rise in property prices would triple the buyer's deposit from £10,000 to £30,000.

However, gearing is a double-edged sword: if prices fell by 20%, the buyer's deposit would be wiped out but s/he would still owe £90,000. Given that his/her house is now worth £80,000, the buyer is £20,000 out of pocket, thanks to this 'negative equity'.

Finally, I intend to continue to steer clear of property in favour of investing in shares to build wealth. As I see it, after eleven years of positive returns, the property market is heading for a nasty fall. On the other hand, the stock-market shakeout of 2000/02 brought share prices down to sensible levels, and rising company earnings make the FTSE 100 reasonably priced even today. Then again, it is very much horses for courses, so do your own research before investing in either asset class!

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