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Why Shares Will Trump House Prices Over 5 Years!

Rewind the clock five years back to 2010 and the financial world felt like a very different place. Back then, there was genuine fear regarding the future of the UK economy. A coalition government had just been elected, Britain’s debt to GDP ratio was constantly in the news, and the UK economy was only beginning to show some sign of recovery after a savage recession.

Rewind the clock five years prior, to 2005 and, again, the situation was very different. The UK Chancellor was talking of ridding the economy of the boom/bust cycle, house prices were seemingly on a never-ending upward trajectory, and the FTSE 100 was beginning to make an improved comeback following its 2003 lows.

The point, then, is that a lot can change in five years.

That’s why the current outlook for house prices and for shares may prove to be somewhat unreliable. Certainly, the Eurozone is a major concern for investors and, with the FTSE 100 falling by almost 700 points in less than three months, the future looks to be highly challenging for the stock market.

Meanwhile, the housing market – especially in London and the south east – seems unaffected by almost anything, with prices apparently only able to go one way and making property investors considerable capital gains.

Interest Rates

However, during the next five years there are set to be changes that turn the tables in favour of shares and against property. For starters, interest rates are likely to dampen demand for loans. The full extent of this is not known, but the Bank of England has stated that interest rates of around 3% by the end of the decade would not be unreasonable. This would hugely increase the cost of mortgages, but also cause a change in sentiment in the property market. That’s because markets tend to extrapolate the recent past into the future when making predictions and, if interest rates are on the up, then further interest rate rises will probably be forecast, which further hurts sentiment.

In addition, a rising interest rate will also make UK property less appealing to foreign investors. A stronger sterling will mean that UK house prices are not as cheap as they have been and, for those foreign investors who have already purchased property in the UK, a currency gain plus higher house price may lead to greater sales and a partial correction of the demand/supply imbalance that currently exists.

Of course, a rising interest rate is historically bad news for shares, too. But, if it coincides with an improving macroeconomic outlook which, Greece aside, seems to be the case then increases in corporate earnings should help to offset reduced demand for shares by investors. Therefore, shares could be less affected by higher interest rates than property.

Valuation

According to the Halifax House Price Index, the average cost of a house is 5.2 times the average salary in the UK. Although that is not as high as it was in 2007, when it reached 5.8, it indicates that houses are relatively unaffordable. In fact, house prices fell by 22.5% after the house price to earnings ratio reached its all-time high of 5.8 in 2007 and, while they may not fall by a similar amount (or at all) over the next five years, the point is that upside is limited. In other words, if people simply cannot afford to buy a house, then houses will not be bought until they reach an affordable level.

Shares, meanwhile, appear to be inexpensive at the present time. In fact, the FTSE 100 is trading at a lower level than it was 15 years ago and, in that time, corporate earnings have increased significantly. And, while the global financial crisis still endures in the Eurozone, the outlook for the emerging world and the US in particular remains strong, with many of the companies listed on the FTSE 100 being more dependent upon the global outlook rather than the UK outlook.

So, while most people would probably rather buy a house than a portfolio of shares today, fast forward five years and you may find that the majority feel a degree of regret. After all, the economic situation in 2020 may be a known unknown, but it will definitely be a lot different than it is today.

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