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Four portfolio hints for housing investors

Investors who are exposed to house price risk need different financial assets from other investors
April 13, 2021
  • Liquid assets can help housing investors minimise risks 
  • Look overseas for better returns 
  • Beware of interest rate risk

Many of you regard housing as an investment either because you are a buy-to-let investor or because you hope to trade down your house to release cash when you retire. This is not without risks, because house prices are expensive relative to both equities and wages: the Nationwide Building Society estimates that the ratio of prices to the wages of first-time buyers is at its highest since 2007. Which poses the question: what can we do to mitigate such risks? Here are four suggestions.

Favour liquid assets

The risk with housing isn’t just that it will fall in price. It’s also risky because it is difficult to sell quickly in bad times at a decent price. This makes it a terrible asset for anybody who might need to raise cash suddenly: being a forced seller is one of the worst economic fates that can befall us.

If you are long of housing, therefore, be wary of other liquid assets such as VCTs. Favour more liquid assets, not least of which is cash.

Avoid interest rate risk

Since the mid-1990s the ratio of house prices to the wages of first-time buyers has more than doubled, from 2.2 to 5.3, according to the Nationwide. Many economists, such as Oxford University’s Simon Wren-Lewis, Ian Mulheirn at the Tony Blair Institute and researchers at the Bank of England agree that this has happened because interest rates have fallen. In fact, since 1984 the correlation between this ratio and the five-year gilt yield has been a whopping minus 0.73.

One reason for this is simply that cheaper mortgages raise demand for housing and hence its price. Also, a lower interest rate means that the future benefits of house ownership (rents if you are a landlord or rent saved if you are an owner-occupier) are discounted less heavily. Which means the value of houses is greater.

This points to an obvious risk – that house prices will fall if or when interest rates rise. Which is nasty because most other assets can be hurt by rising rates as well. One of the few exceptions is cash.

Be wary of equities

Historic correlations suggest that equities are a nice way of diversifying house price risk, as the correlation between the two is low.

But we cannot rely upon this continuing.

Yes, house and share prices have sometimes moved in opposite directions. In the early 1990s, for example, equities did okay while house prices fell and in the early 2000s house prices rose as share fell. In both cases, the negative correlation was the result of previous overvaluations; in 1990 houses were overvalued but shares weren’t whereas shares were overvalued in 2000 but houses weren’t.

At other times, though, house and share prices can fall together. This happens in recessions, such as in 2007-09. It could also happen if or when interest rates rise. Not only would this hit house prices, but it could also hurt shares if it causes a reversal of the reach for yield.

On balance, if you are long of housing you should be cautious about your holdings of equities.

Favour overseas assets

There have been two significant falls in house prices in the last 30 years – in the early 1990s and in 2007-09. On both occasions sterling fell, giving UK investors decent profits on some foreign currency-denominated assets.

This is no accident. The circumstances in which house prices fall are ones in which we see recession, pessimism about medium-term UK growth, uncertainty and investors’ reluctance to take risk. All of these are bad for sterling.

Whether this is a case for overseas equities is, however, ambiguous. On the one hand, it isn’t. A global recession of the sort we saw in 2007-09 would see house prices and overseas equities fall even in sterling terms: this is especially likely with those stocks (such as emerging markets) that are most sensitive to swings in investor sentiment. On the other hand, though, it is possible that house prices will fall because of purely UK economic weakness or because UK interest rates rise. These risks might be small, but overseas equities protect against it better than UK ones.

On balance, if I were exposed to housing risk, I would have more overseas equities and fewer UK ones than I would if I were not.

The point here is simple, but often forgotten. One of the basic principles of investing is that what matters is your portfolio as a whole. How much of one asset you should own depends upon what else you own; owning cyclical stocks, for example, is risky if you own a small business that’s vulnerable to recession but less so if you are retired on a big safe pension. If you have lots of housing, therefore, you need to recalibrate your holdings of financial assets accordingly. And this should mean holding fewer illiquid assets and more cash and overseas assets than you would ordinarily have.