The financial crisis has naturally rocked many people’s confidence in financial institutions. Some of our clients have been asking us about the merits of property as an investment (as opposed to somewhere to live) – thinking that a tangible asset likes a house or apartment might be a better bet than stocks or shares. This article considers the pros and cons of property versus what we might call “financial assets” – Shares, Bonds and Funds. In particular, we focus on France, as Kentingtons advises clients on investments in France and/or for French residents.
The first point to make about property is that, although there is something comfortingly tangible about a “bricks and mortar” asset, the value of a house may not be as solid as the house itself. Property markets can down as well as up, and in extreme circumstances, a house can become almost worthless – for example if an area suffers a major economic upheaval like the closure of a dominant employer. More broadly, house prices are strongly linked to the wider economy, and such factors as general confidence, interest rates and lending policies can have a big impact.
But what about the investment performance? With the usual caveat that “past performance may not necessarily be a guide to the future”, we can at least look historically how the different investment classes have fared. Typically in articles in the financial pages of the popular press, you will see a comparison of the rise in average house prices with an index, such as the FTSE100, or an equivalent index for bonds. Generally, these will show property to be a good investment, better than bonds, although less good over the long term (20 years+) than shares. However, in my view these theoretical returns are far removed from what a real investor would experience.
With property, there are many additional issues to consider. Firstly, a property requires maintenance – “fixing the roof” and so on. Also, it needs to be insured, and local taxes paid, and possibly service charges for an apartment, or similar a house is part of a private domaine. A more subtle cost not accounted for when looking at “average house” price trends is the general improvement in housing stock. If you bought an “average house” in say, 1980, then in 2010 it would be distinctly “below average” if you hadn’t invested a significant sum of money in bringing the property up to date – replacing kitchens and bathrooms, and maybe fitting air-conditioning in certain French regions, and so on.
Transaction costs are another big factor – in France in particular. (I have never understood why French Estate agents charge a whopping 5% or more to sell a house, when their English counterparts can do it for as low as 1% – but they do!). Adding in Notaires fees, you can count on around 7-8% to buy a house, and 5-6% to sell it. Not so significant if you hold the property for twenty years – but enough to make a big dent in your gains over five.
On the more positive side, nobody in their right minds buys a house and then just leaves it empty for a decade. Houses can be rented, either permanently, or as holiday homes, which provides an income. Clearly this must be taken into account in the total return on housing as an investment. The problem in trying to do this is that it is a very variable number – whether it is permanent or holiday rental, how long the season is in the case of holiday rentals, and the owner’s skill in marketing their property.
Looking at Shares, some of the same issues come into play. There are transaction costs to buy and sell shares, and nobody can replicate the performance of an “index” at no cost, because transactions are required to track an index. If you are buying a fund, then there are management costs. In total however, these are much smaller effects overall than property.
Another aspect to consider is risk and volatility. As we have seen in the last couple of years, property prices can drop as well as rise. However, at the height of the financial crisis, share prices dropped further than house prices, even though the crisis had its origins in an overheated property market! The ideal strategy over the last couple of years of course would have been to have all your money in a guaranteed investment like “Fonds en Euros” (easy to say in hindsight!). As a general rule, shares would be consider more volatile that property, with fixed income investments like bonds being lower risk still.
In analysing risk, however, you have to account for the fact that you can’t go a buy an “average house” – you buy a particular one. Therefore your return depends on how good you are at analysing the market, choosing a property, and negotiating the price at purchase and sale. You also have to account for the possibility that some unforeseen circumstance devalues your property – a new road or construction, or simply the area you have chosen falling out of favour (of course these factors can go in your favour).
Liquidity is the final point to consider. Here financial based investments win hands down. Selling a house is time-consuming and expensive, whereas most financial investments can be sold rapidly and at low cost. You also have the advantage that you can make partial withdrawals, whereas you can’t easily sell a quarter of your house!
Of course, buying property is an emotional as well as a calculated decision. Many people buy a French holiday home, with the idea of renting it part of the time and using themselves, and gain a great deal of pleasure from doing so – you can’t take a short break in your share portfolio! What we would advise though is treating a property investment like a small business; in other words
- Analyse ALL the costs carefully – taxes, insurance, service charges, a realistic maintenance allowance, and the transaction costs to buy and sell.
- Have a realistic plan of how much income you can get from the property – you won’t keep it occupied 100% of the time
- Decide out how you will handle the work associated with managing the property – maintenance, change-overs for a holiday property, marketing and promotion etc. If it is not nearby, then this should not be underestimated.
- Work out all the tax consequences – income, capital gain, ISF.
This way, you will avoid your property dream becoming a nightmare.
Returning to the original point of this somewhat lengthy analysis – which is the best investment? Unfortunately, there isn’t an easy answer. Past performance would tell you that over the long term, shares have performed best, with property next, and fixed income investments slightly less. However the usual correlation between risk and return applies – shares have also been the most volatile. The only caveat we would apply is that housing is perhaps more risky than most analyses would suggest – purely because of the way in which individuals invest in the property market, buying a single house (somewhat analogous to investing in a single company rather than a basket of shares).
The most important thing is to ensure your investment strategy suits you, taking into the account the following main factors.
- Your appetite for risk
- Your objectives – income, or capital growth
- The amount of time you are willing to put into looking after your investment.
- The degree to which you are happy to have your wealth tied up, or easily accessible.
- Your timescales for investment
- The Tax consequences of different investments given your personal circumstances
Helping you with this kind of financial planning is what Kentingtons specialises in, for French residents, or those with property in France. Our broad conclusion would be that property is an important asset class, and one that has shown historically good returns. At the same time, it is a type of investment with its own particular characteristics, and you need to consider if it suits your investment needs. We would generally advice clients to have a balance of different types of assets, or which property may well be an important one – but excessive trust in “bricks and mortar” is probably not the best financial plan.