Home Ownership: The Unstable Dream

Why buying a house is a bad investment in the UK

The idea of buying a house as an investment has been a long-standing tradition, but is it really a good idea? In the UK, there are several reasons why buying a house may not be the best investment option. Firstly, a house serves a primary purpose of providing shelter and a place to live, which means that its sale is often dictated by lifestyle choices rather than investment returns. This was evident during the 2008 financial crisis when many people were forced to sell their homes at a loss due to a collapse in the market.

Secondly, the only way to profit from a house is by selling it, which then requires finding another place to live. This often results in the equity gained from the sale being used to fund the new purchase, trapping the money and preventing any profit. Additionally, borrowing against the equity in a house through a home equity line of credit (HELOC) or cash-out refinance can create a liability and put the house at risk, as seen during the financial crisis when many homeowners found themselves underwater on their mortgages.

Carrying costs, such as mortgage payments, real estate taxes, insurance, and maintenance, are also high and ongoing, making it difficult to generate cash flow from a house unless it is rented out. Over time, these costs can add up and may even exceed any potential gains from appreciation.

Finally, appreciation is not guaranteed, and there is a possibility of a flat or declining housing market. Therefore, buying a house in the UK may not always be a wise investment decision, and it is important to carefully consider the financial implications and run the numbers before making a purchase.

High transaction costs

When buying a house, there are a number of high transaction costs to consider. These costs can add up quickly and eat away at the money you have available for the house purchase. Here are some of the key transaction costs to be aware of when buying a house in the UK:

• Electronic transfer fee: This is a cost associated with transferring mortgage money to the solicitor, and while it usually doesn't exceed £100, it's important to include it in your budget.
• Land Registry changes: If you make changes to the title documents held at the Land Registry when completing the purchase of your home, you will need to pay a fee. The cost depends on the method you choose and the value of the property. Currently, it costs between £45 and £1,105 to make changes to the Land Registry, with properties valued between £100,001 and £200,000 incurring fees of £230 per change.
• Mortgage advisor fees: Working with a mortgage advisor can help you find the best mortgage deals for your income level, but their services come at a cost. Mortgage advisors may charge a fixed rate or an hourly rate for their services, and you can expect to pay around £500 if you're a first-time buyer.
• Survey costs: While not a legal requirement, a property survey will give you a better idea of the condition of the property and any maintenance or repairs it may require. The cost of a survey depends on the size and scope of the survey, but you can expect to pay anywhere between £250 and £600 for a comprehensive RICS Home Survey Level 3.
• Solicitor or conveyancer fees: You will need to hire a solicitor or licensed conveyancer to handle the legal side of the transaction when buying a house. These fees can vary depending on the size, location, and value of the property, as well as the conveyancer you choose. For a freehold property, the average solicitor fees are £1,320, including 20% VAT. Conveyancing fees for a leasehold property will typically be higher, costing around £1,490 on average. In addition to legal costs, you'll also need to pay conveyancing disbursements, which are fees to third parties paid on your behalf by your conveyancer.
• Stamp Duty: Stamp Duty Land Tax is paid when purchasing a home worth more than £250,000 in England and Northern Ireland. First-time buyers are exempt from Stamp Duty on properties costing up to £425,000, and eligible first-time buyers can claim relief on properties valued up to £625,000. In Scotland, Stamp Duty is replaced by the Land and Buildings Transaction Tax (LBTT), while in Wales, it is replaced by the Land Transaction Tax (LTT).

Lack of liquidity

Liquidity is a complex concept that reflects the trading speed of a given market or asset. In general, an illiquid market is one in which assets cannot be sold efficiently or quickly due to search frictions, larger ask-bid spreads, and asymmetric information between potential buyers and sellers.

Real estate is one of the most illiquid assets because it requires more capital to buy than securities or precious metals, for example. It also takes longer to sell a property, both to find a buyer and complete the transaction process. Property assets are also limited to their current location (immobile) and affected by changes to the local market.

Liquidity is an important aspect of any real estate investment. It determines whether assets will be sold quickly or slowly and if the price will be above or below market value. Property that is easy to sell and purchased at market value is considered liquid. Conversely, assets that are harder to sell and transact for a discounted price are considered illiquid.

In the UK, the housing market has been in a boom, with house prices soaring over the past two decades. However, rising interest rates are leading to higher mortgage rates, putting downward pressure on house prices. While house prices have fallen in recent months, they appear to be stabilising due to supply constraints and a tight labour market.

The illiquidity of the UK housing market means that it may take longer to sell a property, and there is a risk of having to accept a discounted price. This lack of liquidity can make buying a house a bad investment, especially if there is a need to sell quickly or in the event of a market downturn.

High maintenance costs

Maintenance costs are a key factor to consider when buying a house. On average, home maintenance costs 1% to 4% of your home value per year. However, this can vary depending on the age, size, condition, and location of the house. Older properties, particularly those built before the 1900s, tend to have higher annual maintenance expenses. According to a 2021 study, UK homeowners spent an average of £2,800 per year on home maintenance for houses over 100 years old, while maintenance costs for homes less than 20 years old averaged £1,500 per year.

The age of the house is not the only factor that affects maintenance costs. The location of your home also plays a significant role. Houses in areas with high humidity require a larger budget for pest control and mould and mildew control. Additionally, properties exposed to harsh weather conditions, such as heavy snow and continuous rainfall, need to prepare for potential repairs and more frequent clean-up projects. The cost of living in a particular area also impacts maintenance costs, as services tend to be pricier in big cities.

The size of the house is another factor to consider, as larger homes require more resources for cleaning, pest control, and repairs. Upon purchase, the condition of the house will also influence future maintenance costs. If the previous owner neglected indoor cleaning, lawn mowing, and gutter cleaning, you can expect higher maintenance costs in the future.

To estimate maintenance costs, you can use methods such as setting aside 1% of the value of homes less than 10 years old or 4% for homes over 30 years old. The square footage method is another approach, where each square foot equals one pound, depending on labour and materials. However, this method does not consider the age and condition of the house.

To avoid surprises, it is essential to include maintenance and repair costs in your annual budget. Routine house maintenance tasks, such as cleaning, checking for leaks, treating mould and mildew, and changing air filters, are crucial to preserving the value of your house and preventing costly repairs in the future.

Low returns

The returns on buying a house are low compared to other investment options. The average house price in the United States is around $355,000, with a required 20% down payment of $71,000. With a 30-year fixed mortgage at a 3.5% interest rate, the monthly payment would be approximately $1,700. Over the course of the mortgage, the total principal and interest paid would be $612,000, which is $257,000 more than the original amount. When you factor in property taxes, maintenance fees, and opportunity costs, the total out-of-pocket costs over 30 years could exceed $841,000.

In contrast, if you rented a similar home for 75% of the monthly mortgage payment, you would pay around $459,000 in housing over 30 years, saving yourself $382,000 by not owning a home. This calculation assumes that you invest the money you would have spent on a down payment and the monthly savings into something that offers a higher rate of return.

Additionally, the opportunity cost of owning a home is significant. The money spent on a house could be invested in other assets that offer higher returns. For example, if you took the money you were going to put into a down payment and invested it in something that gave you a higher return, you could end up with a substantial sum of money over time.

Furthermore, the appreciation of house prices is often overstated. While land prices in desirable areas can trade at a premium, the numbers often don't reflect the true value of the property. In reality, house prices may only appreciate by around 1% more than inflation over the long term.

Moreover, the transaction costs of buying and selling a house are very high, typically around 5% of the deal. These costs include real estate agent fees, legal fees, and other associated expenses. The complexity of buying or selling a house also adds to the overall cost, as there are many documents, reports, and fees involved in the process.

Finally, a house is an illiquid asset, meaning it can take a significant amount of time and effort to buy or sell. This lack of liquidity further reduces the potential returns on investing in a house.

In summary, while buying a house can provide a place to live and establish roots, it is not a good investment option due to its low returns, high transaction costs, illiquidity, and opportunity costs.

Lack of flexibility

When buying a house, you are tied to a long-term financial commitment that will also impact your lifestyle, happiness, and perhaps even your identity. It is a complex process with a myriad of details and emotional pitfalls on both sides of the transaction.

High Transaction Costs

The transaction costs of buying and selling a house are very high, often reaching 5% of the deal. These costs include estate agent fees, advertising, VAT, and more.

Illiquid Asset

A house is an illiquid asset, meaning it takes a long time and effort to buy or sell. The process of buying a house can take weeks or even months.

Geographical Constraints

A house is immobile and fixed to one geographical spot, limiting the potential pool of buyers to a tiny group in one specific location. This lack of flexibility can be problematic if you need to move for work or personal reasons.

High Maintenance Costs

Owning a house comes with endless maintenance and repair costs. Systems like plumbing, electricity, and roofing will require regular upkeep and occasional replacement. These costs can add up quickly and eat into your savings.

Opportunity Costs

When you buy a house, your money is tied up in the property, and you lose the opportunity to invest it elsewhere. The money spent on a house could have been invested in stocks, bonds, or other assets with potentially higher returns.

Restricted Mobility

Homeownership can restrict your mobility and limit your options. It may be challenging to relocate for work or personal reasons, as selling a house and buying a new one in a different location can be a lengthy and costly process.

Emotional Attachment

Emotional attachment to a house can cloud your judgment and lead to poor financial decisions. You may be tempted to overspend on renovations or improvements that may not provide a good return on investment.

Tax Implications

In some countries, property taxes can be high, and they are often subject to annual increases. Additionally, there may be tax implications when selling a house, such as capital gains taxes.

Lack of Diversification

Buying a house can result in a disproportionate percentage of your net worth being tied up in a single asset. This lack of diversification increases your risk and exposure to the real estate market.

Impact on Employment

Homeownership can limit your employment options and keep you "docile for your employers." You may feel less inclined to take risks, change jobs, or relocate for a better opportunity due to the constraints of owning a house.

Impact on Relationships

The financial strain and commitment of owning a house can impact your relationships. It may lead to increased stress and even contribute to divorces, as highlighted by a commenter on JL Collin's blog:

> "It should increase stress, lead to more divorces, but then be impossible to divide."

Summary

While homeownership has its benefits, it is essential to recognise the lack of flexibility it brings. Buying a house is a significant financial commitment that can impact your mobility, relationships, and investment opportunities. It is crucial to carefully consider your circumstances and run the numbers before making such a substantial decision.

Frequently asked questions