Over the very, very long-term property prices don't beat inflation - and yet the return homeowners get still wallops rising prices. Here's how.
All things being equal, there is no reason for house prices to rise faster than inflation over the very long run.
Looking at data collated by respected Yale economist Robert Schiller for his book, Irrational Exuberance, plus more data since then, we can see that US house prices from 1890 to 2011 rose on average just 0.14% more per year than inflation.
This is practically nothing, and it's worse than the performance of shares by a long, long margin. A bit of a plunge in US house prices now will nullify even that tiny average gain, leaving real prices unchanged after twelve decades. Deduct homebuying and homeowning costs and you're looking at a real loss.
Or are you?
Real prices can fall for a generation
No increase in real prices is great for people who want to get on the ladder, but existing homeowners who are counting on their properties for their retirement might think this news couldn't get any worse. It does (before it gets better).
As I've said, the long run average over more than a century has given practically zero returns, but in between property prices have fallen and risen like crazy, or at least like property markets.
The average person who bought in 1890 might have been horrified to see that the real price of his home 30 years later was 35% lower than when he bought it. So much for the safety of long-term investing.
...If you don't know what I'm talking about when I say “real” prices, don't think it's because I'm worried there are “fake” prices. Read about pie shops and printing presses in What are "real" prices? to get to grips with the “real” price of your property and other purchases...
I've not finished frightening homeowners
To compound the apparently bad situation for homeowners, we can expect to spend twice as much on buying the property than the actual purchase price – and that's due to interest payments alone. Then we have fees, taxes and other costs to add on top.
If the real price of your home has fallen 35% since you bought it 30 years ago, and you've paid more than twice the purchase price in interest and other costs, how on Earth could you possibly ever consider that to have been a good investment?
House prices are not the main issue
It is likely that anyone who bought at a real-prices peak and who could afford all the repayments will be better off 30 years later than if he had kept renting – even if prices are a third lower and even though he has paid so much in costs and interest.
In fact, a conservative homebuyer who knew this might happen could still expect to be in a far better financial position than if he had rented.
It's all about rental inflation
Because one thing a homeowner mustn't do is pay rent, and this is where the profit in owning really exists.
Your mortgage rate might shoot up at times. Imagine in five years it goes up from 3.5% to 12%. Your mortgage payments could then double, and will probably have rocketed in comparison to rents.
[SPOTLIGHT]But eventually they fall. Maybe you'll average 8% over 25 years, or maybe more, we don't know. The important point is that this 8% is not compounded – it is not 8% on top of 8% on top of 8% every year. Rents, on the other hand, might easily rise by 2.5% per year (probably considerably more, on average), and the next year another 2.5% is added on top. And then again. And again.
Even adding just 2.5% per year, 12 or 13 years later a renter will already be paying close to 40% more, and this isn't going to come down.
After 25 years your rent will be up 85% and, unlike mortgage interest rates, the cost will keep rising forever. Yet if you had bought instead, your payments have just ended – forever.
The house price is merely a nice bonus
Less importantly, if you remember, you also now own a property. Yes, by the 30th year the real price of it might be 35% less than you paid, but you own it. If you had rented during these three decades, you'd have nothing at all, and by now your rent has more than doubled – and it is still rising...
Even a cautious homeowner has little to fear
I've been using Schiller's US data because it goes back a lot further than UK statistics. It may be that things are different in the UK and, for all we know, the older data he uses could be uncommonly unreliable.
It may also be that, for whatever reason, things aren't “equal” – as I wrote in my introduction – and that house prices here in the UK will not rise at the same speed as inflation over the next few years and decades.
And they probably won't, but the example I've used merely demonstrates a kind of “worst-case scenario” for homeowners, because we can't really foresee a more shocking scenario than losing 35% after 30 long years.
Yet, even in this dreadful scenario, you'll be better off at the end than if you had rented. That should give peace of mind to even the most cautious homebuyer.
That's not to say that timing the market – if you believe you can do that – can't result in you being even better off. However, that would just be a bonus. Buying low is not essential to beat renting, because the main financial benefit to buying is not house-price increases but alighting from the rising rent wagon.
For homebuyers and owners, by far more important than worrying about market prices is making sure that: 1) you can afford the repayments even if interest rates rise a lot and/or you suffer temporary unemployment, 2) that you could stay in that home during several years of negative equity if necessary, and 3) that anchoring yourself to that location is sensible for your personal circumstances. Now that is the difficult part at today's prices!
For the record, I live permanently overseas and have no property interests in the UK, nor any intention to buy property there, and I have no opinion on the direction of the property market over the next 12 months.
More: Compare mortgages through lovemoney.com | The property market's worst case scenario | What next year holds in store for house prices