There are lots of good reasons to own investment property. But it is worth looking at some common reasons that might not stand up to scrutiny.
People often hold instinctive views about investment property as an asset class which feel true but may not always stand up to scrutiny. Upon realising significant wealth from a business, often one of the first things entrepreneurs do is to consider buying an individual investment property directly.
Here we examine three of the most common reasons we hear for doing so:
Property is stable, compared to volatile and risky shares;
Property has always done well even in tough economic times;
Property is a safe asset of last resort.
Is property really “stable”?
On the face of it, yes. Property as an asset class is generally less volatile than equities. Property prices (at least in the UK) tend to move steadily. You certainly would not expect changes of 3% or 4% in a day, which can happen with stocks and shares.
However, this stability may be misleading. If somebody stood outside my house from 8am until 4.30pm every day, shouting their opinion of its value every minute, the price would appear to be highly volatile, due to all sorts of factors, often nothing to do with the property itself.
This is exactly what happens with shares listed on the stock market, which can then seem “risky”. Individual properties are revalued infrequently and so can give the appearance of stability even if their true value fluctuates much more than this.
Does property do well in tough times?
The infrequency with which property is valued has another potentially misleading effect: property may appear to do better during economic downturns than other asset classes, not because of inherent value but due to a lack of price discovery. Measures of UK house prices dipped during the Great Financial Crisis and began recovering steadily soon afterwards; equities, on the other hand, endured a sickening 40% slide and a much steeper and more volatile rebound.
However, this relatively strong performance by property does not tell the full story. Properties that fail to achieve asking price are often withdrawn from the market (1).
Unless there are a lot of forced sellers, we do not always discover the true price of investment property in difficult times. By contrast, second by second, I can always see what the market thinks about listed shares. Both property and shares may have fallen in value by 40%, but only one of them can scream about it from my smartphone all day, every day.
Is property safer than other asset classes?
Finally, people often see property as inherently safer than other assets: “If it all goes to pot, at least my property will still be there.” Bricks and mortar give property a sense of solidity and tangibility.
But what truly makes ownership of investment property “safe”? Ownership is only granted and secured by an entry in an electronic register, which states your right to the asset.
Even if it feels vastly different, this is, in practice, no different to ownership of shares which is also secured via an entry in an electronic register. Without this system of registration governed by rule of law, the fact that you can touch and feel the investment property does not make it any more safe than the shares which you cannot hold in your hands.
Questioning the validity of these common reasons for direct ownership of investment property should not be taken as rejection of the asset class. There are lots of good reasons to own property in an investment portfolio (whether directly or indirectly) and a variety of ways in which it can be done, which we will explore further.
Notes
“Most of the homes for sale in Central London currently end up being pulled from the market” (Financial Times, 14th July 2017, https://www.ft.com/content/2d3318ac-67b2-11e7-8526-7b38dcaef614).