Ten years ago the average price of a house in the UK was just over £179k. Today it stands at just over £214k, which is a rise of 19.6%. This equates to an annualised return of 1.8%, which may come as something of a surprise to a lot of readers. That’s because it’s the popular view that house prices have soared in recent years and that anyone who bought a flat or a house back then is now a millionaire.
Clearly, the truth is somewhat different, since growth of 1.8% per annum is rather modest. However, it’s better than the FTSE 100 has managed over the same time, with the UK’s leading index being up just 3% during the entire period. That works out as a capital gain of less than 0.3% per annum, which is clearly hugely disappointing. However, with the FTSE 250 rising by 64% in the last 10 years (or 5.1% per annum), shares do still appear to have been the better overall option.
Of course, the past is never a useful guide to the future. That’s because the factors that affected house prices and shares during the last decade won’t be repeated in the next 10 years. For example, interest rates are almost certainly going to rise during the period and while this could cause some disappointment for investors in shares, the real problems could arise for investors in bricks and mortar.
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That’s because of debt levels. When an individual buys shares, it’s with cold, hard cash but when property is purchased, investors often leverage their investment in order to try and improve on their returns. While this works well when interest rates are low and house prices are rising, as interest rates start to increase it could put major pressure on the UK housing market. That’s because while people may have been able to afford the repayments on a mortgage while the interest due was relatively low, as it rises their profitability and cash flow will be squeezed. This could cause house prices to come under pressure and lead to lower overall returns.
Realistic valuations
Although a rising interest rate can also hurt share prices, the reality is that valuations in the stock market are much more realistic than in the property sector. For example, the FTSE 100 yields 4%, which is the highest it has been since the credit crunch and this indicates that the index is cheap.
Meanwhile, the house price-to-income ratio is now at 5.6, which is only slightly behind its highest-ever level of 5.8 in 2007. And with house prices having fallen by 20% following the highest ever price-to-income ratio, there’s the potential for a decline in valuations moving forward.
So, while property has been the darling of the UK investment world for the last decade, its returns weren’t as high as many investors perhaps believed and looking ahead, rising interest rates could act as a major brake on them. Although the FTSE 100 has performed poorly in the last 10 years, the FTSE 250 has been a highly profitable place to invest. And with both indices offering excellent value for money and growth potential, they seem to be the most likely assets to make you a million, rather than borrowing to speculate on property.
