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Sand-Papered to Death by House Prices

I sometimes follow the writings of Merryn Somerset Webb. She recently voiced her opinions on the apparent rise in house prices in the UK, and her opinion was that it was no help to the economy, and probably quite the opposite. Several other commentators pointed out that any apparent rise in wealth due to an increase in debt, which is what it amounts to, is illusory.

There are still idiots who think house price rises are good for people, and that it only goes to show that we should all be piling in and buying.

Here's my own answer to one of these idiots, who accuses Merryn of not being very good at maths, and claims that buying a house now is a great way to cope with the future.

You could buy one of the houses I manage right now for £250,000. I currently get £18,000 a year rent for it. If I chose to buy it tomorrow with an 80% mortgage I would have to put up £50,000. That would mean selling my income producing stocks, and losing a very nice income, plus the prospect of compounding it. I could get round about 10% at current prices. I'm looking at two options right now, one at 9.7% and one I already own currently 11.2%. That's £5,000 a year income lost. (I actually bought it when it was producing 17%, but let's leave that aside for a minute.) That loss is called Opportunity Cost. Dont forget to add it in, virtually everybody does forget. Carrying that forward for 25 years would give you a total opportunity cost of £125,000 (without compounding). That's some loss! With compounding that loss will grow to £710,542. That's what your investment pot would be in 25 years time if you hadn't cashed it in for a deposit on a house. You could then start to live on the income, which will be a smidgeon under £80,000 a year. Sounds like a reasonable pension to me.

Let's cost the mortgage at 5% interest (always assuming rates stay there, which is highly unlikely - remember they hit 15% back in the seventies). The long term average is about 7%, but let's pretend they will remain the lowest in all recorded history, why not? Your payback is about £13,000 a year. Remember to add in that £5,000 a year opportunity cost. That gives you £18,000. If you use the real long term average rate of 7% then your yearly costs are likely to be much higher: £20,000. More than the cost of the rent.

So far this century house prices have not risen at all, but do you seriously expect them to rise more than 11.2% a year every year for the next 25 years? If not, then you have made a big mistake by putting that £50,000 into a house. I'm leaving my money where it is, way away from real estate.

Buy a house if you want to lose money. It's an easy way, but it is also rather painful. It's called being sand-papered to death.


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