Let’s say I make the following statement: “Property prices only increase 2-3% per year”. People in London are probably going to think I’m an idiot. London properties have appreciated 3.5 times in the last 20 years.
People in Greece are also going to call me an idiot. Property prices in Athens are at the same level they were in 2001 and are falling for the past 10 years.
So will people from the 1960s. UK property didn’t appreciate at all from 1900 to 1960.
Which makes property one of the most controversial topics with lots of emotions involved.
I’m sure you know real estate is a fantastic way to invest because of its unique nature. Unique nature meaning two things: leverage and negotiating power. Very few institutions are going to lend you money to invest in the stock market. But property? They will happily do so.
You cannot negotiate the price of gold but you will probably push the house price in a certain direction. Negotiations when buying or selling real estate are critical to your success.
There are certainly managed investment opportunities if you don’t want to do all the legwork – FJP Investments, for example. Of course, as with anything investment related, you’ll have to do your own research.
But let’s talk about how to assess the real estate environment and take advantage of it if possible.
Property markets go through cycles. They depend on various factors like the economy, the demand for location, inflation, future prospects etc.
House prices compared to people’s salaries
One very important factor in knowing whether house prices are expensive or not is looking at the house price compared to the average salary.
The fact that you could have paid 3 times your salary to buy a home in the past sounds like a lie. But today, you would need 14.5 times your salary to buy a home in London!
As the fantastic How to Own the World book states: “It is worth knowing that the average ratio of house prices to salaries over the last several decades is actually between 3:1 and 4:1“.
House prices tend to go back to their average price-to-salaries, a process also known as mean reversion. This makes the current London environment insanely expensive and likely to fall, whereas Glasgow properties look like a good deal to me.
House prices to salaries is a metric I use to quickly grasp the feel of the environment.
Cashflow, Rental Yield – How much money in my pocket?
Talking about buy-to-let property investments here, rental yield is something I always use to find out the actual return. In other words, if I purchase a property for £500,000 and rent it out for £1500 a month, how much money will be left in my pocket per month?
This will give you the net return on investment which is probably the most important thing to consider. Although on paper, the return may look high, I always take into account void periods, maintenance (broken boiler anyone?), interest-rates rise and last but not least, taxes!
You will be surprised how easy you can do your research nowadays with online tools such as Rightmove and Zoopla.
A real-world example #1
The flat I live in here in London costs around £350,000 and I pay £1,275 for rent. £1275*12 = £15,300 which is my landlord’s gross income.
It has certainly crossed my mind to buy the flat I live in because rent is just throwing money away.
My landlord bought the flat many years ago and now owns the property, so no mortgage which also simplifies our calculations. Because I’m a good tenant and take care of the property, he only had to pay £500 per year for some minor repairs. But someone else may not be as careful as we are, and you can certainly not be sure before renting it. So let’s account for 10% maintenance costs and another 10% for voids for when moving out in the summer.
Gross rental yield: £15,300 / £400,000 = 3.8%
Gross income after maintenance and voids = £12,644.
Net rental yield = £12,644 / £400,000 = 3.16%
I have not accounted for any taxes to simplify things and because each person’s tax situation is different. But a mindful reader would notice that I haven’t accounted for capital appreciation either! That’s how much the property will go up in value over time. But will capital appreciation beat 3% inflation?
With prices to salaries at an all-time high, I’m quite sceptical about buying the flat I’m currently renting.
Conclusion? The property market is not on sale here. In fact, it’s selling at a high premium.
A real-world example #2
Let’s have a look at Manchester that according to the graph above, the average price to salaries ratio has stayed about the same. That’s a good starting point.
It’s worth pointing out I’ve never been to Manchester so I’d go for areas around the city centre. I would focus on good fundamentals such as location, good transportation, universities, business development, schools, etc. If you have knowledge of the area then I’m sure that helps spot better investment opportunities (future plans, current trends, things to avoid etc).
Having a quick look on Rightmove and without spending much time there I found this flat selling for £160,000.
Google Maps told me that Salford Quays is 17 mins drive to city centre and 20 mins by train which is alright.
Reading through the description I found out that the property is 9 years old, so relatively new and the current tenants will stay until August 2018 at the current rent of £775 per month.
Let’s say I put an offer to buy this property at the asking price and make no negotiations at all, even though I buy cash!
Gross yield: £775 * 12/ £160,000 = 5.81%
Net yield after maintenance and voids = 4.8%
Manchester properties appreciated 7.9% last year and the numbers don’t look overvalued. If I can get a 4.8% searching on Rightmove at a glance, then I’m sure I can get a 6-7% net rental yield if I do some proper research and price negotiation. I’m buying cash after all 🙂
Interest-only mortgages are an option too, so I can take more risk and go for 2 properties instead of buying one in cash.
The Manchester property market is definitely not on sale, but it offers a decent return and a promising future! Much better than the London equivalent of example #1.
Interest rates and Inflation
When buying to let or just to live in, the concept of interest rates kicks in pretty quickly.
Interest rates are, in other words, the price of money. It’s how much will it cost me to borrow money. We currently live in times where the average interest rates are at an all-time low. It’s the lowest that has ever been in the past 100 years. Going back to the concept of mean reversion and you will see that there is only one way to go: upwards.
I don’t want to be pessimistic here, just trying to be pragmatic about it. Maybe the interest rates will remain low for 10 years, maybe not. But if interest rates rise then the cost of your mortgage will increase. As a result, your net rental yield will go south.
I briefly mentioned inflation when deducting it from capital growth of the property. In fact, inflation is our worst enemy because it lowers our real returns. It doesn’t matter if my house price goes up if my bread, milk and petrol rise higher!
Is the property market on sale?
If you’ve read so far, congratulations! You probably learned more about how to assess a property environment. Interest rates, average house price to wages, and metrics like the above apply across cities and why not, countries.
This means that you can look abroad if the current environment doesn’t suit you, although there are good opportunities if you look north of London right now.
What is your take? Are you buying, selling or still thinking about it?
Disclaimer: This is not investment advice and you should always do your own research. Also, this post may contain affiliate links.