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Buy-to-let could damage your wealth in 2019. Here’s where I’d invest instead

I think it only really makes sense to start an investment in a buy-to-let property when prices seem to be low compared to historical norms. There’s no doubt that property prices tend to fluctuate in a cycle, and that cycle can seem random. But one thing we do tend to expect from cycles is a change in direction every so often – so, what goes down tends to climb back up, and what goes up tends to come back down again.

Why property prices look high

I reckon property prices are sitting close to their highs, and my favourite measure to judge that is the affordability of homes compared to the average wage in the UK. For some time, the average house price for first-time buyers has been sitting close to five times the average wage in some of the cheapest regions of the UK, and way above that level in other areas.

That’s high, and historically the multiple has been much lower. For example, I went into buy-to-let property in the mid-1990s at a time when the average house price for first-time buyers in my region was flirting with figures between two and three times the average wage. House prices seemed cheap back then and it did, indeed, prove to be a cyclical bottom for the cost of a home.

Just as property seemed cheap in the nineties, it seems expensive now, in my view. That matters because the cycle will likely change direction at some point and prices will fall compared to the average wage. Indeed, falling property prices and rising interest rates have been in the news during 2018, and there seems to be a lot of pressure building that could push property prices lower. We don’t know for sure if property prices will fall, or simply sit still for years while affordability catches up, or even whether property prices will rise further to form a bubble.

Too much risk

But I see property investing as risky right now. Because if a property falls in price by around 40%, say, after you’ve bought it, you will need a gain of around 67% from rent, or rising prices later, just to get back to breakeven. And that’s without even considering all the costs and inconvenience you’ll face getting in and out of a property investment. Those kinds of gains could take decades to achieve in the property market and that’s why I wouldn’t buy property now when prices look high.

The same principle works with shares. If share prices are high and the valuations of the firms underlying the shares have become stretched, it’s probably a good idea not to plunge into the stock market. This is because the pressure is on shares in general to fall, so that valuations return to more affordable levels.

But when there’s been a stock market correction – as recently – valuations can be much more reasonable and dividend yields can be higher, which bodes well for good investor returns in the years ahead. So I’d avoid expensive-looking property and invest in cheaper-looking shares, or share-backed investments, for 2019. My investment vehicle of choice would be a low-cost, diversified index tracker fund that follows an index such as the FTSE 100 or, perhaps, the FTSE 250.

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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.