By Bengt Saelensminde
17 May 2010
House prices in my area
House prices in my area have been going up - and probably in yours too. Now I know why.
I've just been talking to a friend in the property auction business. He's noticed a lot of silver-haired investors buying investment property. Now why would they be doing that? Two simple reasons.
Firstly, fear of stock markets, which have been yo-yoing violently for the last few years. And secondly, terrible annuity rates – that is the return retirees receive when they convert their pension into a regular income stream. Many are deciding to put their retirement savings into buy-to-let instead.
House prices in your area are being driven up
Rental yields for the buy to let investors are around 5%. This compares favourably to an annuity. Low interest rates mean that an annuity for a sixty year old only pays about 6% a year until death. And that's the other problem, the investment dies when the holder dies. Houses, on the other hand, can be left to the next generation.
The problems with annuities don't end there. There's also what's known as counter party risk. That is, if the provider (usually large insurance companies) goes bust, your funds could be at risk. At least with a house you've got the security of 'bricks and mortar' and the land upon which it sits.
Despite the advantages I've just outlined, I'm not keen on housing as an investment. But there are reasons why people are choosing a buy-to-let (BTL) over an annuity. Let's look at the figures to see why property mightn't be as good as it sounds.
Buy to let: the figures just don't stack up
To value any investment, it's essential to look at the price to earnings ratio (P/E). And I'm not talking about the 'price to earnings' figure quoted in the media. When the media talk about property, the price to earnings figure you'll hear about is a so-called 'affordability indicator'. That is simply a ratio of average house price to average earnings (wages).
When we're looking at buy to let, the P/E that we want is the house price ('price' or P) divided by the after-tax rental income (the 'earnings', or E). A BTL rental yield is about 5%. But after tax, rental voids (the time lost while you're looking for tenants) and maintenance, that 5% yield drops down to nearer 3%. And a 3% yield gives us a P/E of 33 times!
Now, we know that cheap investments have a P/E of ten or less. There are blue chip firms like Vodafone or GlaxoSmithKline, trading on multiples of less than ten, and these firms have the ability to grow earnings over the coming years.
Buying a house with a p/e in the thirties is too expensive. Rental yields are unlikely to rise quickly enough to justify such a high valuation.
With a house, you're paying a very large premium for security and the ability to bequeath the asset. There have to be better investments that share property's security, but can be bought at a reasonable price.
Why investing in German property looks promising
German property offers a higher yield than UK property as the residential market hasn't had the extraordinary boom that we've seen in the UK. I've been reading reports that you can get 10 to 14% yields in Germany.
Investing in German property could be a great idea. Of course there's the currency risk. That is the risk that if the euro falls (against the pound), then the rent you collect will be worth less in sterling terms.
Given the problems with sterling, I really don't think we should be too nervous about the euro. Anyway, even if there's some calamity with the euro, I still have faith that whatever currency the Germans end up with, it's likely to be stronger than the pound over time.
