house
house prices, bubbles, and investment returns
WSA adsense code -->I was tidying up my desk the other day and found some old work-related magazines. In the April 2007 edition of Mathematics Today (I know, I’m a geek - I swear it’s going to end up on Have I Got News for You one day) there was an article about investing. It was mostly about the Markowitz model, but covers a bunch of other interesting stuff.
One of the things is something that’s quite well known. Average house prices in the UK oscillate, regularly going through boom and bust cycles and are mean reverting to between 3 and 3.5 times average earnings. This makes excellent sense, because most houses are still bought by home owners and mortgage companies have historically offered mortgages of about 3 times salaries, and then most people have a deposit as well.
According to this article, which had figures up to 2005, house prices are at a 55 year high compared to earnings, with the average house price in 2005 being more than 6 times average earnings.
It’s possible that this is a genuine shift in the underlying housing market caused by many more people using two incomes rather than one to get a mortgage. And of course, if you use twice the average earnings, and multiply that by 3, then you get 6 times the average earnings. Maybe the price/earnings ratio has fundamentally shifted.
On the other hand, the general rule in investments is that when someone suggests that the underlying rules of business have changed they’re usually wrong and we’ve reached the peak of a bubble. And maybe in 2007 (when I bought a house 
) we did.
But, the house that I bought was valued at just under 3.6 times my earnings. Does that mean that I am in a better position? Maybe when it comes to keeping my house, but not otherwise.
I normally assume that the long term average is about right, so this means that house prices will revert to 3 to 3.5 times average salaries, but this means that my house is *really* worth only about 1.7 times average salaries. That’s the value that I should expect it to hold in the long term - my house is not as nice as average.
If we assume that inflation will average 3% and earnings 5%, then over the next 30 years - the length of my mortgage - then the actual expected return on my house is about 2.5%.
I can really only expect to do better if:
- there really has been an underlying shift
- I can sell at the top of another peak, and not need to buy
or
Neither of these is looking exceptionally likely to me. All in all, it’s a good job that I like my house 
.
Similar Posts:
If you like what you're reading, why not leave a comment below, subscribe to my feed, or check out some of my best posts.
Tags: Discussion
7 comments for “house prices, bubbles, and investment returns”
Post a comment
subscribe
use a reader
Plonkee, what a remarkably level-headed and rational analysis. Very well done. Most people would (do) just bury their heads in the sand refusing to sell for a realistic price and thereby inflict more economic damage on themselves.
This is the type of post I enjoy reading on your blog. Thanks.
@Shadox:
Wishing that my house would grow in price massively isn’t the same as it actually happening. Unfortuntately.
I think with the house that you live in, you’re only going to really do well if you happen to buy for the first time at the bottom of a cycle.
I bought in 2007 too. I think we did the right thing though, Plonkee: I know that even though house prices have gone down and our household earnings have gone up, my husband and I would never get a mortgage now. Buying a house in 07 was probably the last-gasp chance to jump on the ladder.
Plonkee, if you bought in 2007 I’m afraid you’ll definitely not have made the optimal investment in housing from a returns point of view - this isn’t me being a sage, it’s self-evident because prices have fallen 15% by then according to Nationwide. Add in inflation of 5% and you could have saved 20% on the price if you bought today.
*However* you didn’t just buy to invest, did you? You wanted a place to live that you were in control of, I’m sure, and after 25 years you’ll have a home, rather than have just paid for a landlord’s investment.
If you’re really down about it, how about saving up a cash fund and watching the price to earnings ratio for houses. When it gets cheap again, you could invest in a buy-to-let? This may prove more of a bargain, if it reverts to the average as you suggest trends do (and I agree).
Just my two pence as I catch up on a couple of months posts.
All excellent points. Last year was definitely a good time to buy from a personal point of view - my house makes me happy in a way that my last rented flat never did. It’s just a pity about the financial hit. In my immeidiate, prices haven’t dropped that much if at all, but I thinks that’s a lot more because sales are very, very slow.
Investing in a buy to let is not a bad idea, although I’m not sure about the hassle of having another property - maybe if I went in partnership with someone else.
[b]Dreamhealer[/b]
Adam has always focused on understanding the science behind [url=http://dreamhealer.wordpress.com/]Dreamhealer[/url] with
the hope of encouraging the medical establishment to take a more
integrative approach to healing. With this focus in mind he will be
pursuing post-graduate research focusing on epigenetics and in the long run
he will be able to help more people worldwide.
Adam’s books and DVD are designed to assist people with their own
healing. Regardless of the modality of healing you choose, the material in
his books will complement the healing process. Adam intends to work toward
scientifically proving that our intentions play a major role in our genetic
expression and consequently our healing.
Visit: http://dreamhealer.wordpress.com/