FOOL'S EYE VIEW
Sell Your House and Buy Shares? (Part Two)

By James Carlisle
February 25, 2002

In light of the fact that property is 50% more expensive than shares than it was two years ago, last Friday's Fool's Eye View kicked off a two parter comparing shares and property as investments. That first article looked at how the two asset types had performed relative to each other over the years. Today's article will looks at the risks and costs involved in the different assets.

Risks

We can imagine a situation where we have a house worth £100,000, a mortgage of £75,000 and a share portfolio of £25,000 (you'd also have an emergency reserve of cash and a few other things, like perhaps a pension, but we'll leave all that aside). You might think of this as £25,000 of equity in your house and £25,000 of shares, giving you a 50:50 split between the two, but you'd be wrong.

Really what you have is £100,000 invested in your house compared to £25,000 invested in shares: four times as much. Of course, you also have £75,000 of mortgage, but there's no reason to think of this as tied to the property investment, despite the fact that it's secured on the property. It is a debt that you owe and that you will need to repay, whether the money comes from shares or property. If you don't like thinking of it this way, then you can think of your £25,000 as having gearing that makes it four times as risky. However you look at it, your exposure to property prices is four times as great as to share prices.

Looking at it this way, most homeowners will see that they have a very large slug of their wealth tied up in just one asset. How risky is that? After all, we're often told, quite rightly, that we shouldn't have all our eggs in one basket. The thing about property is that it's an unusual sort of a basket. Firstly because there's very little that can go permanently wrong with it, but secondly because those things that might go wrong should be insured against with some form of building insurance. Houses just don't go bust in the way that companies do, so it's not so dangerous to hold one house for the long term as it is to hold just one company.

Property does carry plenty of risk, though. In some areas of eastern Manchester, for example, homes bought for around £30,000 in the early 1990's had become virtually worthless by the end of the decade, because a collapse in the local economy had put so many people in the area out of work. As we saw in Friday's article, the value of a property is a product of its rental value (that is, the desirability of it as a place to live), and long-term interest rates. If the employment disappears from an area, then it can have a major effect on the desirability of an area. Over the long-term, affected areas may receive the benefit of grants and regeneration projects, but that's not going to be much consolation if you're sitting on a slab of negative equity and you've lost your job.

Even if we look at the UK regions more generally, there can be a wide disparity in performance. The following chart shows the performance of the average home in different regions over the last 10 years and since 1983.

Region            Value    Value   annual    Value   annual
                  in Q4    in Q4   growth    in Q4   growth
                   2001     1991    since     1983    since
                    £'k      £'k     1991      £'k     1983
                                        %                  %

Scotland             64       56      1.3       30      4.8
N Ireland            78       38      7.4       26      6.5
North                62       55      1.1       26      5.3
Yorks & Humberside   63       55      1.3       24      5.9
North West           67       60      1.1       26      5.7
East Midlands        79       59      3.0       27      6.6
West Midlands        87       67      2.6       28      6.6
East Anglia         105       63      5.2       31      7.4
Wales                69       56      2.0       26      5.7
South West          115       68      5.4       34      7.3
South East          150       83      6.1       42      7.7
Greater London      180       87      7.6       41      8.9

United Kingdom       96       67      3.6       32      6.7

The UK average price rise since 1983 has been 6.7% per year, but the different regions have ranged between 4.8% (Scotland) and 8.9% (Greater London). Over the last ten years, the different performances have been much more varied, from 1.1% to 7.6% per year. So, although property doesn't generally have the individual risks of shares, you can still have a bad experience from being caught up in the wrong area, in a more general sense.

It's similar to being heavily tied to one sector in the stock market. You'd want to be very confident of that sector's long-term economic importance. In the same way, if you're going to have a large amount of money tied up in a house, then you'd want to be confident about the long-term desirability of the particular area that it's in.

The trouble is that if you want to reduce your overall exposure to property, you only really have the options of moving to a smaller property or renting. Moving to a smaller property would save you money (reducing the amount of 'rent' you're paying yourself - see Friday's article) and reduce risks (subject to what you do with the money), but it may not be feasible.

Renting, over the long term, can be expected to cost money overall because landlords need to make enough money for it to be attractive to them. So, you'd have to think about when to buy back in. As with shares, price rises can take place very quickly and dipping in and out of the market will just increase the chances that you'll miss out on these rises, thereby increasing your long-term risks.

All in all, the value of your home may well have gone up a lot in value a lot over the last few years, increasing the proportion of your money that's in property, but there's not very much you can usefully do about it. The most important thing is to be confident about the about the long-term future of the wealth of the particular area that you live in, but the time for thinking about that is before buying in the first place.

Costs

The other main factor that counts against trading in and out of property, is the cost of doing it. Just as trading in and out of shares will increase your costs and tend to decrease your returns over the long term, so will trading in and out of property.

The cost of buying and selling houses can be astronomical. You've got estate agents, lawyers and surveyors that need to be paid, plus and a host of bits and bobs like fees to the Land Registry and others. Then there's stamp duty ranging from 0% for houses below £60,000 in value, to a whopping 4% for houses worth more than £500,000. On top of all this, you'll need to pay the removal firm that actually moves all your stuff. Putting it all together, buying and selling houses too often is very counter-productive.

Long-term buy and hold

In many senses, property is the classic 'long-term buy and hold' investment: in terms of costs, even more so than shares, though perhaps a little less so in terms of risk. Trading in and out of the market is likely to increase your risks and cost you money over the long-term. To justify doing it, you'd need to have more confidence about the future direction of house prices than is really possible.

The best you can do is buy carefully in the first place. You need to be as confident you can be of the long-term economic prospects for the area and, most importantly, you need make very sure that you stay well within yourself financially. For property to work as an investment, you need to be able to do it for the very long term. That means having a mortgage that you can live with, for decade after decade, even if interest rates double.