My Opinion
The other day I did a poll on Instagram asking whether buying a house was really worth it. The poll concluded with 72% of people saying it was worth it and 28% of people saying it wasn’t worth it.
If you know me, you’ll know that when the majority of people think in a certain way, I become reluctant to be the extra person that agrees. The poll is a clear indication that a lot of people believe homeownership is a good idea. But regardless of whether buying your own property is or isn’t a good idea you shouldn’t be one of those people who thinks it is because everybody else does. You must evaluate your own personal circumstances and see if ownership aligns with your personal goals.
Okay. So now, in my own personal opinion when I started the poll I was entirely against homeownership. While there are many benefits to owning your own home, from my perspective property ownership solely for investment purposes is not worth it. Hear me out.
Opportunity Cost
Suppose we are talking solely returns on investment and not taking into account the social prestige elements that come with homeownership. In that case, you need to consider the opportunity cost of owning a home.
The opportunity cost for those of you who didn’t study economics is the cost of the next best alternative forgone when making an economic decision. In layman terms, it is what you miss out on when you pick one option over another.
So, when evaluating homeownership, we must take into account what we are missing out on when we purchase a house.
The biggest hurdle when it comes to buying your own property is getting together a deposit. Assuming that the average house price in London is £500,000 and that you need a 10% deposit, you will need to have £50,000 ready to get a mortgage. For most people, this is a large amount of money. But let’s even assume that you have a well-paying graduate job and have the £50,000 ready to go. The opportunity cost in this instance is what could you have used that £50,000 to do?
I am a massive sucker for ETF and mutual funds. For those who do not understand anything about the stock market, an ETF is a collection of multiple stocks. When you invest in an ETF, you are investing in a basket of stock and thus spread the risk. So, for me, the opportunity cost of buying a house is the gains that could have been achieved by investing £50,000 in the stock market.
For others, the opportunity cost could be funding for a start-up or business idea they had.
The Stock Market VS The Property Market
To determine which is better, I will compare the past performance of both assets.
From my own research, I discovered long-term equities generally produced returns of 10.99% per year. This is determined by look at the average FTSE All-Share Total Return from 1986 to 2017. To add to this, ETFs can be held in a tax-free ISA and thus profits are 100% yours.
Property on the other hand, cannot be held in an ISA to shelter it from tax, and upon research, the average property in the UK increases at 6.18% a year between 1986 to 2017. As you can see, investing passively in ETF is much better than investing in property in the long-term.
There are 2 instances where buying a property is much better than investing in the stock market:
If your mortgage payments are cheaper than rent payments.
If the rent you pay every month could be reduced by buying the property for a reasonable deposit, then buying a property could work out well in the long term.
For example:
Assuming the rental cost of a 1-bedroom apartment is £1,500. And this £1500 could be reduced to £1,000 by taking out a mortgage on the property, the money you save monthly by taking out a mortgage is £500. This is a 33% save rate. So, to beat this in the stock market, you would need to be making a 25% – 35% return every year – something which is very difficult to do.
These assumptions aren’t prevalent, especially in London, as you are unlikely to purchase a property you wouldn’t mind renting.
If you know how to find undervalued properties with high rent yields.
Those with an excellent financial education and understanding of the property market will be able to find great deals that can beat returns from ETFs. This knowledge however is time-consuming to acquire; looking for a great property deal will also take a significant amount of time and energy that could be spent elsewhere.
To conclude, as an investment, property will almost always underperform when it is compared to the stock market. So, for the average person not too fussed about the social prestige that comes with owning your own home, learning how to invest in ETF will yield a much better return on investment.