Why is property sometimes seen as a bad investment?

In the wrong set of circumstances a poor investment in property can lead to the destruction of substantial wealth. Below is a list of the factors which make property investment risky.


1. Investment in an Depreciating Asset

Over the long term property prices tend to rise. However, get the timing wrong and your returns can be catastrophic. If you had invested in the average house price at the peak of the market in 1989 you would have to wait 9 years before you even broke even. In terms of “real” house prices you would have to wait 13 years before you broke even. A very poor investment indeed.

The value of £1 invested from 1989 to 1999 is £1.17 with an equivalent annual rate of 1.6%, lower than almost any savings account and not even keeping up with inflation.


2. The Ability to Leverage

If the average person walked up to their bank manager, explained that he had £5,000 to invest in the stock market and asked if the bank could lend him a further £95,000 to boost his profits, the bank manager would either have a heart attack or burst out laughing. And yet if that same person walked up to that same bank manager and asked to borrow £95,000 as a mortgage to invest in a £100,000 property he would be given preferential treatment.

However, this ability to leverage is one of the most worrisome reasons to invest in property – the possibility that falling house prices cause you to lose significantly more than the equity you started with. For example, in the above situation house prices only need to fall 5% to wipe out your deposit. If they fall 20%, you have not only wiped out your initial £5k deposit but a further £15k. In this situation you would not be able to sell the house without finding £15k to repay your mortgage lender.


3. The Combination of Depreciating Assets and Leverage

In the situation where property prices fall, the property you own loses value but the debt behind it stays exactly the same. This has the effect of destroying wealth for the owner, plunging them into negative equity. The more prices fall, the bigger the hole homeowners find themselves in.


4. Negative Equity

Negative Equity exists when at a particular point in time the value of a property is less than the amount outstanding on the mortgage. Put simply, the owner of the property owes more to the mortgage lender than the property is worth. This is a BIG problem for the unfortunate homeowners who find themselves in this situation. If you want to sell up, perhaps to move to a bigger house, or to a different area YOU CAN’T! You are simply stuck. There are only two ways out of negative equity:

(i) Wait until prices recover
The last house price crash which began in 1989 can be used as a demonstration of what can happen. If you purchased a house at the top of the market in 1989 and fell into negative equity as the market crashed it would have taken 9 years before the value of your house reached the price you bought it for. 9 years! That’s a long wait! Especially if your family is growing and you need more bedrooms or a proper garden.

(ii) Save as much as possible to pay off the negative equity
It probably took many years to save up the original deposit. It will take just as long or maybe even longer to save enough money to dig yourself out of negative equity. Even once this goal is accomplished and you have paid back the mortgage lender, you then have to start over again and save a deposit for the next property you purchase. In all, the average buyer is probably faced with years of conservative spending and diligent saving. Not an enviable state of affairs!


5. You Own An Illiquid Asset

When nobody wants to buy you simply cannot sell. As buyers price more risk and uncertainty into their offers, the few houses which manage to find buyers are exchanged at values significantly below their peaks. In an illiquid market, the sale of a handful of properties at lower values is enough to change the buyers’ perception of market price. In effect, a few transactions are enough to re-price the entire market. The result of the above is ownership of an asset which is falling in value, and due to the scarcity of buyers, one you cannot get rid of.