The money illusion

The world is divided between those that own a house  - who want prices to rise, and those who don’t - who are waiting impatiently for the day the market tanks. For the haves, price rises are seen as an unalloyed ‘good thing’ – an increase in their wealth that is theirs to enjoy and use into their old age. How many times have you heard people say ‘my house is my pension’? It can be, of course, but they will have to get used to living in much smaller houses if they are to get their hands on any money.

What this ‘pension’ argument neatly illustrates is that there is a confusion in most peoples’ minds between property as an investment and property as the place where you live. Take the scenario of a young couple buying their first flat for £250,000 with a large mortgage of £200,000. The market doubles and so does their family – and they are delighted with both. They now have an asset worth £500,000 and their net worth has increased from £50,000 to £300,000. The only problem is that the next rung on the ‘property ladder’, which was worth £400,000 is now worth £800,000. They now have to borrow £500,000 to buy the house when before, if the market had not doubled, they would have only had to borrow £350,000.  They are in an interesting situation where their net worth has gone up six times – but they can’t access it unless they move to a smaller house (not possible with two children) or decide to rent. If they go ahead they will double the their annual interest bill when, in a stationary market it would have gone up by only a third.

Under which scenario are they better off? Most people would instinctively plump for doubling the price of their house – but in terms of cash flow out of the family budget (which is already under pressure from the two children) they will be putting themselves (and the wider economy they live in) in a worse state where they have much less to spend on anything other than interest payments.

In inflationary times, where wages are rising in tandem with retail and asset prices (this is not happening now as far as wages are concerned) the answer is less equivocal as inflation eats away at the debt and it is the lender who loses out by being repaid, eventually, in eroded cash. Before any house-buyers wish for this sort of inflation to help them out, it is as well to remember that the corollary of high inflation is high interest rates - and the inability to pay those rates could lead to insolvency before having a chance to benefit from the rise in house prices – as many found in the 1970s.

Having said all this, many of the baby-boom rode this tiger and are now sitting on houses with most, if not all, of their mortgage paid off and the option to sell, move to a smaller house and pocket the difference as their pension. This was the basis of many a move to the ‘good life’ of the Dordogne. They are the ones sitting on a chair when the music stopped having taken all the sweets as well. Those forced to join the party too late and in parts of the country where prices are now falling are the losers with the grim prospect of negative equity to look forward to. In America the losers are in a fundamentally different situation as they have that ability to post the keys back to the bank with only the loss of their equity in the property to shoulder. In the UK the prospect is bankruptcy – where the lender can come after all your assets. This is a rather different risk profile.

But even for the winners there is a price to pay as the high cost of housing leeches its way into the cost of living that everyone has to confront. If housing takes the lion’s share of household budgets then it must squeeze out other spending and economic activity: the cost of becoming a nation of rentiers is that the shopkeepers pay that price – unless they are estate agents, of course.

The winners are also now having to confront another cost of their good fortune. Their children are increasingly excluded from the ‘housing ladder’ by lending criteria that require deposits that can only be provided by indulgent parents. So in order to help their children afford the prices on which their prosperity depends they have to sell that property in order to release the equity to help them.

Whatever else it is, property is not a free lunch.