Equity investing presents us with known unknowns. The risk of a well-diversified equity portfolio can be pretty accurately described by a cubic power law with a standard deviation of around 20 percentage points. However, the risks of investing in buy-to-let are rather less quantifiable.
The first question is: what price volatility do you face? We know the volatility of house price indices. But these are irrelevant. Nobody owns a house price index. They own particular properties instead. And just as individual shares are more volatile that the All-Share index, so we would expect individual houses and flats to be more volatile than house price indices. How much more volatile? Surprisingly little research has been done on this. Some US research has found the volatility to be around 15 per cent per year on average - implying they are almost as risky as equities - but with higher volatility for both low- and high-priced properties and for more unusual ones.
Some other risks are even less quantifiable. What's the danger of the place needing emergency repairs? Or of tenants trashing the place? Or that you'll go one or two months without a tenant? And then there's liquidity risk. Buying and selling a house is stressful, time consuming and expensive at the best of times. At other times, it is even worse.
Yet another problem is correlation risk. If you own a property near where you work you face a double risk - the danger that a big local employer will close down, which would depress house prices at the same time as possibly costing you your job. Again, this risk is hard to quantify.
All this suggests that property investors face lots of uncertainty whereas equity investors face risk. If people hated uncertainty more than risk, they would therefore prefer equity investing over property. But very many people don't. Why not?
It's not because property is guaranteed to offer better returns. Yes, it has done so since the late 90s, and it did so in the 70s. But there have been many periods - such as from the late 70s to 90s or since the mid-00s - when shares did better.
Some reasons for the preference for property are entirely valid. One is diversification. The correlation between house prices and equities is quite low - minus 0.06 for annual changes since 1967. This means that, on some time horizons, property diversifies against equity risk.
Another possibility is that you get non-pecuniary returns on housing. However, while this might be true for the country mansion, I doubt it's true for the pokey buy-to-let flat above a kebab shop.
There are, though, perhaps less rational reasons for preferring property, which lie in the paradox that property is both familiar to us and yet also hidden.
On the one hand, just as everyone thinks he is an expert on education because he once went to school, so people think they are experts on housing because they are surrounded by it. What psychologists call the 'mere exposure effect' biases us towards property investing.
On the other hand, though, the risks of equity investing are more salient than those of property. Newsreaders tell us every night about moves in the FTSE 100, but not about daily changes in the price of 23 Acacia Avenue, Cheam. And while a moderately bad week for the Footsie will give us Robert Peston doing his horseman of the apocalypse schtick, the failure of 23 Acacia Avenue to sell quickly will not invite such doom-mongering. In this sense, the risks of equity investing are more salient than those of property investing. But just because something is more obvious does not mean it is bigger.
I don't say all this to mean 'shares good, property bad'. I only mean that it is easy to underestimate the dangers of the latter. Some forms of uncertainty can be easily overlooked.
