UK property buyers should be wary of selective memory

Property in the UK has done well in recent years, but you should invest in it along with stocks and bonds.

Contrary to what you might have expected from the perilous state of the UK economy, house prices appear to be stabilising. Despite increasing unemployment and little effort by the UK banks to increase lending activity, the Halifax House Price index showed a rise of 1.1 per cent in July, and through the end of that month it was only 1 per cent down. Halifax is forecasting a modest increase by year's end, baffling many economists who had predicted continued gloom and doom in the UK residential property market.

The reasons for this increase are not clear, but I am certain they will be seized upon by property-obsessed investors. In spite of the sector's wretched performance over the last few years, these people still hang on to the belief that real estate is the be-all and end-all of investment strategy. The truth is that there have been short periods in which UK property has outperformed UK equities - especially in the recent past - but over longer periods it has always competed badly.

London's FTSE 100 index has jumped 35 per cent since its low in March, and in July had its best monthly performance in six years. Property prices, on the other hand, have barely changed according to the Halifax. Despite these figures, research from Mintel shows that one-third of adults still believe this is a good time to invest in bricks and mortar, and one-half believe that property is a good long-term investment.

In my experience, most investors who have such a rosy view of property markets have been investing there only since the late 1990s, when prices in the UK and elsewhere started to climb rapidly - fuelled by cheap credit from banks that were falling over themselves to lend to any Tom, Dick or Harry. But investors with longer memories may recall the early 90s, when house prices in the UK dropped by 20 per cent and many investors fell into negative equity.

Data compiled by Nationwide for the Sunday Times shows that the average house price in the UK rose from £2,105 in 1959 to the present-day value of £153,871 (about Dh939,300). After allowing for inflation, this corresponds to a real, annual growth rate of 3.1 per cent over 50 years. By comparison, shares over the same period, according to Barclays Capital, have returned 5.7 per cent annually after inflation, assuming that annual dividends are reinvested.

Over 40 years, the annual growth rates are 4.4 per cent for shares and 3 per cent for property. And over 30 years, shares have grown at 7.1 per cent annually and property at 2.5 per cent a year, after allowing for inflation. To put this last set of figures in perspective, the effect of these growth rates compounded over 30 years means that shares outstripped property nearly seven times over, with a growth of 692 per cent versus 108 per cent for property. This puts shares in the Usain Bolt category when compared with the opposition - no contest!

Over the last decade, however, property has been the clear winner. Shares have lost 14.4 per cent, having suffered badly from the dual effects of the dot-com crisis and the subprime mortgage debacle, but property over the same period rose by 71 per cent. Property has also outperformed shares over three years and over the last 12 months. But the recent surge in UK equities means that shares have now beaten property over five years. Shares are up 1.2 per cent in that period while average property prices are down 9.2 per cent.

But what about the future? With respect to share prices, Fidelity believes that the FTSE 100 will reach 5100 by the end of the year - slightly higher than its value at press time. This forecast is based on research into the performance of stock markets after a bear market such as the one we have experienced since November 2007. The average rebound is 71 per cent over a 17-month period. So far, European markets are up 42 per cent over five months, while US stocks have risen 49 per cent over the same period. This optimistic view of short-term growth is not shared by all experts, notably Warren Buffett, who believes that the recent rally in stocks is over.

What about property? During the 1990s price crash, house values in the UK fell around 20 per cent over a period of three and a half years, and it took another five years for them to recover to their 1989 peak levels. Because of this and other fundamental issues, like rising unemployment and lack of credit, most experts are forecasting a zero to small increase during 2009, followed by modest growth.

What should the average investor make of all this? Past evidence suggests that investors should not dismiss shares as an asset class simply because they have performed badly over 10 years. And they should not put all their eggs in the property basket because it has done well over that, but only that, period. The Centre for Economic and Business Research, for example, expects average house prices to rise by only 14.5 per cent by the end of 2013.

Property is an emotive asset class and has an important alternative function - you can live in it - and should always form a significant part of an investment portfolio. My advice to clients is that they should initially think in terms of buying a private residence in the country in which they intend to retire or to spend most of their lives, then start to build a balanced portfolio of bonds, shares, commodities and hedge funds over time, then think about an investment property (usually in their retirement country), then add more esoteric asset classes like overseas property, forestry, private equity and art.

Bill Davey is a financial adviser at Mondial-Financial Partners Dubai. Write to him at [e-mail]