Time To Exit The Property Market?
Posted on 31 December 2016
During the 2016 Christmas break I put some time aside to think about whether my strategy still makes sense given the new risks and opportunities that have recently appeared.
My strategy is simple: to grow my net worth at an average rate over a long period of time that exceeds the return I could get from doing nothing. If I cannot do this, then I should not bother running a business – simply investing my funds into a low cost stock market tracker fund, say an ETF, would deliver better results for less risk and no work. Smart investors estimate a long term return from the stock market of 6%-7%. That would turn £100,000 into £1.8-£2.9m over 50 years. A return of 12% would instead result in £28.9m. No wonder Einstein once said “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
Since most people prefer high returns to low, especially in a low interest rate environment, so the competition for deals must increase. This has led to prices for many investments spiralling out of any sensible bounds that a value investor would consider paying given the likely long term return and risks involved. Property prices for example have increased much further and faster than rents suggesting a high level of speculation (people buying because they think market values will continue to increase).
One vivid example… An old Severn Trent water pumping station near me recently went to auction. The property had the potential for conversion and extension to form a block of flats. Severn Trent sold the property on the basis that the buyer would give ST a range of pretty restrictive rights, for example the permission to dig anywhere around the perimeter at any time they wished. They also wanted a share of any planning permission uplift for a long period of time, over 30 years I believe.
I figured there could be an investment here at the right price, having taken the challenges into account. I valued the property at only £45k to account for the risks involved. The eventual buyer went to the auction expecting to buy something else, missed out, then blindly bidded for this and wound up paying £92k. The story doesn’t finish there… Having realised his mistake, he then put the property straight back into a different auction and sold it to someone else for £128,500! Another friend recently put a property on the market expecting £250k, maybe £300k at a push… He sold it for £450k – way over it’s investment value. I can think of many other examples – we went for a property and it sold for way more than we thought it was worth.
This disconnect between risk and return, must indicate that inexperienced investors are actively buying, since they are less likely to understand what can go wrong and account for that by insisting on a margin of safety. Low interest rates are pushing them into risky assets that will perform poorly should market conditions deteriorate. This phenomenon is not just limited to property – it is pervasive.
Recent changes affecting investors – 3% stamp duty surcharge, loss of mortgage interest relief, wear and tear allowance changes etc.
There are around 2m landlords in the UK, who own around 5m properties. About 65% of all these properties are owned entirely mortgage free. The remaining 1.75m are mortgaged at only around 46% on average. So, overall, the changes to mortgage interest relief are going to disproportionately affect the small subset of property investors who are entering the market at high LTV’s, purchased relatively recently with a high LTV mortgage, or refinanced to the same position. Newer entrants are much more likely to be on interest only loans, which are a new invention, and since they are not paying down the debt over time they are going to be doubly hit.
The 3% stamp duty surcharge will only affect those entering the market or adding to their existing portfolios. True long term investors will simply factor the 3% into their calculations and try to negotiate a discount on the purchase price, or swallow it since the long term return, which includes all net rental income received and capital gains, is hardly affected. New entrants to the market are more likely to be put off.
These changes discourage entry to the market which helps not hinders long term investors.
These legislative changes can only be good news for experienced investors who leverage their investments sensibly and manage their properties intensively. Since just 1% of the UK’s housing stock is owned by institutions, compared to 13% in the US, 17% in Germany and 37% in the Netherlands, it seems likely these are the types of investors these Government interventions have been designed to encourage.
Should property investors get out of the market?
An uncomfortable fact: the vast majority of renters would prefer to own a house than rent one. However, out of control property prices have resulted in their ability to buy becoming greatly diminished, impossible in many cases. This does not make landlords as a whole particularly popular (only 2% of the population owns more than one property). This is why we are vulnerable to changes in government policy – nobody really cares about us (did your tenants send you Christmas cards?)
By reading Internet comments related to property articles, it is clear that (rightly or wrongly) some people resent how investors are making it hard for them to get on the ladder. I think the issue could be deserved vs undeserved wealth. I do not think people generally have a problem with deserved wealth (nobody seems to mind when an Olympic cyclist makes a packet for example), but wealth generated by people who do not seem to have worked very hard for it angers people.
Let’s face it, many property investors have been lucky. I do not recall speaking to anybody or reading anywhere, that properties purchased in London in 2011 in London were going to skyrocket in value over the next 5 years but that is pretty much what happened. Those who had the ability to buy, and did so, did very well.
Lucky we have been, but will it continue? The current property price trends do not look sustainable – prices can diverge away from average income for only so long and the UK is way out in front for expensive property on this measure:
An adjustment in prices, assuming people who currently rent and have deposits to buy could buy, would be good for everybody and what we should be hoping for. And lets not forget, there is the side benefit of long term investors being able to buy a few more investment properties.
In the meantime, I will continue to buy and sell.
P.S. Housebuilders are finding this a good time to buy and sell judging by their profit margins – they are back to where they were when the market last crashed.. Food for thought:
Source: Annual reports, Persimmon & Barratt
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