The Fallacy of Home Ownership

I’m a big fan of turning negatives and set-backs in life into positives. It’s a handy skill which I’ve developed over the years. So when our landlord called us one Sunday to inform us that he had hit rocky times and was selling some of his properties, it felt as though we had the rug pulled from under us. Especially as we’ve finally got our new puppy ‘Pips’ all settled in the house and also that we had 2 months to get out!  So it was time again to try and spin things into a positive again. Well long story short, after a couple of days of searching for new houses, applying for one and getting rejected (so demoralising), Ellie and I finally found our dream home. A massive converted barn on the outskirts of Norwich.

Now upon posting a pic of our new house on Facebook, conversations and debates erupted between the merits of buying and selling. Now for those of you who follow me, you’ll know my stance regarding UK property right now, but for those who don’t, (I’m not going to mince my words), buying a house or even worse a ‘Buy To Let’ right now is the dumbest thing you could do right now. This isn’t just my opinion, it’s also the opinion of many skilled property investors I know and also pretty much every millionaire/billionaire who predicted the 2007 Sub Prime Mortgage collapse which led to house prices plummeting across the globe. And it pains me to see so many of my friends jumping into this bear trap right now. There are many facets to this debate, some of which I covered in last month’s issue, so I’m going to address the angles I didn’t cover last time. But first of all you need to understand WHY UK house prices are soaring right now.

‘LET’S WIN SOME VOTES’

Our obsession with home ownership started in the Thatcher and Reagan Era where they started the ‘Right To Buy’ campaign on both sides of the Atlantic. This sparked the culture of everyone aiming to own their own home. One of the aims of this was to spark a property price rise in order to boost the construction industry. But the key thing to remember here is that the sole aim really was to win more votes for the next election. Therefore since the 1970s, the urge to buy your own home has just exploded. Don’t forget, it’s really just the US and UK that are obsessed with ownership. Our neighbours like France and Germany are net-renters! So fast forward to now, the Coalition led by ‘Cleggeron’ need to win votes in order to be re-elected in 2015.

So how are they going to do it? Well they know that the public are completely naïve when it comes to investing/economics and they also know that people feel happier when their house is rising in price. People also feel that the economy is prospering. (Please read www.linkedin.com/pulse/article/your-familys-wealth-shrinking-you-dont-even-know-siam-kidd because this ‘Wealth Increase’ is fake). So the Government have been working studiously over the past 3 years in order to make UK property grow in price, which they’ve succeeded. They did this through the 2 Help To Buy schemes which enabled over 1.1 million young couples to get their foot on the ladder which has been the main driving force and also the wily use of media. However what people don’t understand is that rising house prices actually HURT the economy and lower GDP. For instance, if property prices increase and you have to spend more of your income on your mortgage or rent, you’ll then have less money to spend into the economy. So the crux of all this is that this explosion in house prices that we’re currently seeing is completely premeditated and false.

‘PAYING RENT MONEY IS SIMPLY THROWING MONEY AWAY’

Rent money is not dead...it's a myth! In fact, Germany and Sweden credits its predominant renting market to making their citizens wealthier and happier. The ratio of renters compared to homeowners that are far better off for renting is grossly on the renting side. When you look at the huge swathes of people in negative equity because they bought at completely the wrong time and are paying a mortgage for a house worth far below their mortgage, it's crazy... Also, how many homeowners get back their mortgage interest payments? Or their property taxes? Or their monthly maintenance expenses?

I hear this argument all too often, but 9 times out of 10, the people that say this have next to no knowledge of how the markets and money work. So they default to the standard belief of their peer group and parents! Most of which are in the same boat and probably don’t understand interest rates. And believe me, interest rates dictate everything these days! The Global Bond Market holds nations and Central Banks to ransom through interest rates.

Also upon purchasing the ‘average home’, you’re not only paying a massive amount of TAX to the government, you’re also forking over a significant amount in fees for your mortgage, deeds and a bunch of other miscellaneous fees easily overlooked. Never mind the commission that goes to the estate agent. Property tax, commission and other fees can easily add up to over 10% of the purchase price of a house. This makes residential property one of the most expensive asset classes to invest in, at least as far as up-front costs are concerned. Then, once you are the proud owner of your new home, you’ll be paying interest to a bank, every month, until your mortgage is paid off.

And don’t forget about maintenance! When the paint starts peeling, roof starts leaking, toilets stop flushing and other such things, the costs add up! Especially for the hordes of families now discovering that their swanky ‘new-build’ is starting to crumble due to having the worst/cheapest labour and parts. These are costs renters don’t contend with. And if the market were to fall, renters don’t have to worry about negative equity and being stuck which so many people have found themselves in.

 ‘BUT OWNING YOUR HOME IS A GOOD WAY TO BEAT INFLATION’

The flaw in this theory is the fact that the interest rates commercial banks charge their customers have always been higher than the inflation rate. Always. It’s how banks make a large portion of their money and it’s for this reason that the banks have also been complicit with the Government over the last 40 years of getting everyone to buy. If you get a mortgage, your interest repayments will dwarf the ‘gain’ you’ll get through devaluation of the amount outstanding on your mortgage due to the effects of inflation. But having said that, I know a guy who owns 367 residential properties in Peterborough who has every property (including his home) on interest only mortgages. The theory being in 30 years’ time, he’s hoping that inflation will devour his mortgages and he’ll be able to pay off all of his properties with perhaps a years’ worth of salary. Only time will tell though. And his stance 100% relies upon the world continuing in an inflationary manner…but if there’s even a sniff of deflation, he’ll go bust…The only real winner in this equation is the bank who was kind enough to grant you a loan to buy your property.

THIS IS WHERE THE BANKS REALLY PROFIT…

And they profit in a colossal manner. Not only is the bank earning an above inflation return on the money they lend to you, they also create the money they lend to you, right there on the spot, out of thin air. Poof! Hard to believe isn’t it. Put it this way, if I were a bank and you were a customer to whom I was granting a home loan, it would be pretty much the same as if I had a printing press in my attic, where I would quickly print up £500k in counterfeit currency to lend to you. You then sign a contract with dire consequences to yourself should you ever miss a loan payment and then, to make sure I get the best deal possible, charge you an above inflation interest rate currency which I just created out of thin air! It’s the perfect scam, yet the public are oblivious to this all. And yes, it is a scam which would be illegal if you or I did it! But when the banks behave like this, it is called fractional reserve lending and, whether you like it or not, it is perfectly legal.

 ‘OWNING YOUR HOME IS PART OF A WELL DIVERSIFIED PORTFOLIO’

These were pretty much the exact words that came out of an IFA from St. James’s Place not so long ago. You’ve probably heard of similar rhetoric like ‘You need to spread your investments’ and ‘don’t put all of your eggs in 1 basket’. And in some cases, this is sound advice.

Well, for the typical person, buying a house is akin to gathering up all of your eggs, borrowing another 9-10 times as many, and putting them all together into one basket. Not only are you over-invested in exactly ONE asset class (residential property), but you’re also completely undiversified within that asset class, since you’ll own exactly ONE property, in exactly ONE area, based in exactly ONE town, located in exactly ONE country. This is just about as undiversified as you could ever get yourself into! If you have lots of other investments then yeah sure, go for it. Splash out on a house, but for most people, they have next to no investments and then they go and lever up whatever savings they have to end up as I just described – super-uber-every-egg-in-one-tiny-basket susceptible to multiple factors like Central Banks, Gov policies and interest rates! You’re also extremely illiquid! If you needed to sell up, you’re at the mercy of whatever market conditions are at the time and if you’re in a desperate rush to get some cash due to unforeseen emergencies (like my old landlord), you’ll get a sub optimal price for your beloved house.

In fact, let’s say you’ve got £15k saved up, your life savings. Would you then use that £15k to lever up and buy £200k worth of Stocks? OF COURSE NOT! Then why would you use your £15k to put down on a deposit for a house!? And as much as I dislike the Stock Market, it’s far outpaced property over the last 100 years and even the last 30 years!

MY STANCE ON ‘BUYING’ WILL CHANGE, BUT NOT YET…

Don't get me wrong, my long term goal is to own as much land as possible. Mainly farmland as it's also a cash flowing asset as well as a capital appreciating asset. And with population in exponential growth on a tiny island, land can only rise in the long run. But don't be fooled into thinking that this rise is in a straight line! The UK is currently following an identical path to Japan in the 1980s. Back then they had a booming stock market, a booming banking sector, a booming property market and the world thought they would soon be one of the richest nations on the planet along with the highest property prices. In many ways, Japan was in a far better situation than we're in right now. But what happened is that their currency creation and debt levels got out of hand and so they experienced one of the worst depressions ever. Their stock market and property market more than halved. 25 years later, their stock market is still less than half of what it was. And their property market bottomed out for FIFTEEN YEARS! Everyone who had similar comments to you were left devastated and lost pretty much half of their wealth, cash flow, savings and those with buy to lets got hammered as rents fell below their mortgage commitments. We are doing exactly what Japan is doing and no one in power is learning from their mistakes. Please watch this: www.ProfitFromTheNextCrash.com

Also, what most people suffer from is called 'complacency bias' which means most people only have a 4-5 year memory of things. So right now people think that 0-1% interest rates is the norm. When it's not. It's at 300 year LOWS! And due to a thing called 'mean reversion' there's an extremely strong chance that rates will overshoot back into double digits like we've seen in the 70s, 80s and 90s. At each juncture hordes of uninformed people said it couldn't happen because the BoE and government wouldn't let rates rise. They were wrong. This time is no different. The 300 year UK average is 7%. So WHEN rates rise another 7%, if you've got a £200k mortgage, and on a tracker rate (which is the WORST THING YOU COULD HAVE RIGHT NOW) you're going to have to fork out another £840 per month! Most families can't scrape together even another £84 per month let alone £840. So expect a wave of foreclosures and repossessions. This is what will spark a house price crash - a rise of rates.

‘BUT THE GOVERNMENT AND BANK OF ENGLAND WILL NEVER LET RATES RISE’

Again don't be fooled into this line of thought. They don’t have any say in the matter! It's the global bond market which dictates rates and our tiny Gov and central bank are just pawns in this huge market. The Bond market is the most powerful and politically influential market on the planet. Global Stock Market ‘Turnover’ is about $62 Trillion whereas the global Bond Market is almost double the Stock Market size.

‘HOUSE PRICES ALWAYS RISE THOUGH’

No they don’t. From 1900-1965 house prices did not rise one bit! The only reason people have been indoctrinated into thinking it always goes up is due to our parents thinking and preaching it. But it's only been down to the advent of colossal currency printing and 30 years of falling rates. As a result every nation has just been gorging on cheap credit and it tends to end up predominantly in the property and stock market.

MARKETS ARE CYCLICAL

You also need to be aware of the Kondratiev Cycles which have proven throughout time that here in the UK the property and stock market compared to Gold and Silver go up for 20 years and then go down for 20 years. We're currently entering a Kondratiev winter and people are going to get themselves burned because people spend next to no time in enhancing their own financial education/knowledge. You simply don't know what you don't know, which is why people are blissfully aware. So combined with the info in that video and a few other things I don't have time to explain, I will definitely NOT be buying anytime soon. I'm just waiting for the inevitable panic and then I'll just buy up Norwich for a song using my Silver. Plus buying a house is a HUGE capital investment which will unnecessarily tie up my money. Nominal inflation is 1.5% but real inflation is around 10% right now, so why would you accept anything that returns you less than 12-15%? I don't get out of bed for anything that doesn't make me at least 20% per year and my trading more than does that, so tying up money in something as unstable as a house right now is just silly for me. Granted...If this was to be the place that houses my family for a long period of time, all of this is irrelevant. But I'm not. Our next house is just a stop gap to when we buy our final dream home in a few years. Also don't forget that the Duke of Westminster, one of the biggest property owners in the UK has just sold all of his residential properties. And also the Wilsons, the UKs biggest buy to let owners have just sold ALL 2000 of their homes in one go. The writing is on the wall…

LET’S CRUNCH SOME NUMBERS THEN…

I’m going to use real figures here from someone I know but masking his true name. So meet Mr. Dave Housebuy. He’s a 30 year old professional, married, 1 dog and between him and his missus, they have £24k saved up for a house deposit. After all, he had spent his entire 20s “throwing money away” in the form of monthly rent. After scouring the market, he found a nice three bedroom home for £240,000. He decided to use his £24,000 savings as a down payment on the house, and take out a 30 year fixed rate mortgage for the remaining £216,000. Mortgage rates were still close to record lows, and with his good credit he was able to secure a rate of 4.5%. His monthly payment would be £1115. He has to pay £2000 in Stamp Duty Tax, £2000 in estate agent fees and would also have to pay £2000 a year in council tax. In addition, there would be other monthly fees including homeowner’s insurance, gardening, and repairs that Dave was previously unaccustomed to as a renter. However, these seemed like a small price to pay for Dave to have his own place.

The beauty of homeownership to him was that he would be building equity in his home over time. Sure, it would start slowly, but over time John would continue to pay down the principal in his mortgage until after 30 years he would own the home outright. Even after factoring in the estate agent’s costs upon closing (approx. 5% when he realized he pays both the buyer and seller’s agent’s costs), he would still be making money. The housing market had historically appreciated in value by 2-3% per year, so Dave felt good about that equity he’d be building in his home. He was pleased that that after 30 years, he would own his home outright with £240k worth of equity.

 Having £240k in 30 years was a pleasing figure for Dave…but what Dave is blissfully unaware of is that after spending 30 years paying off his mortgage and ending up with £240k, he’s had to spend £401k in total – mainly bank interest fees! So in real terms, he’s lost £161k over 30 years…

Now Sarah, a good friend of mine who I’ve taught to trade and invest is in a similar situation and has £15k worth of savings. But Sarah’s a little bit more switched on than Dave. You see, she knew that house prices don’t just always go up, she knew that the best time to buy a house is after a few solid years of rising interest rates (not at 300 year lows) and that she could make far more money by actively investing her money. She knew that even if she was pretty laid back, she could average at least 10% per year on her Stock, Commodity and Currency investments.

After doing all of the calculations of the monthly running costs of a mortgage, she realised that she could easily rent a same spec house as Dave’s but for about £4000 per year cheaper. She did understand that on the other hand, while a mortgage would remain fixed, her rent would likely keep going up. However, Sarah realized that repair and maintenance expenses (such as those for new appliances, new roofing, carpets, furnace, paint and insulation over a 30 year period) would likely offset the cost of those rent increases.

So Sarah came to a firm conclusion that for her, renting was the better option as she couldn’t get stuck in a negative equity house for when rates start to rise and she could make far more money with just 5 minutes of investing per month. So after some Maths, what she worked out amazed her. Sarah discovered that starting with her £24k and growing that by just 10% per year (which is only 0.83% per month):

- After 5 years, she would have £38652.

- After 10 years, she would have £62250.

- After 20 years, she would have £161 460

- After 30 years, Sarah would have £418 786

So not only could Sarah go and buy a same spec house as Dave’s on the same street for £240k outright with cash, but she’d then have about £175k left to play with after fees. Whereas Dave would have nothing spare.

CONCLUSION

So why does Sarah’s path result in so much more wealth formation than Dave’s? The main difference was that instead of paying interest on a large amount of debt (mortgage), she would be generating dividends and capital gains from her investments which was invested in the Markets. Remember, she didn’t have to pay the Banks over £401k in repayments! Over time, the returns would be much greater than the 2.5% a year that could be expected from the housing market.

So with this realization that renting (combined with investing) predominantly leads to faster wealth accumulation than owning a home, then why does the vast majority of the public (including investors) argue the opposite? The simple answer is because the banks have been extremely effective at convincing the public of “the dream of home ownership”. In reality, home ownership is quite a bad investment (assuming it is done using a traditional 30 year mortgage). However the mortgage is an extremely profitable product for the banks – it offers steady coupons over long time horizons with very little downside risk, since it is secured by the home itself (which very rarely declines in value, 2008 notwithstanding). The more people the banking industry and Government can convince to “lever up” to purchase a home, the more money flows into their pockets in the form of interest payments and the Government gets the Stamp Duty and Capital Gains Tax. So the next time a friend of yours buys a house, just ask them if they know how much they’re going to be paying the Bank in repayments over 30 years! A rough rule of thumb is that you’ll be paying back around £370k for a £200k mortgage! Bonkers!!!

SO HERE’S MY TAKE ON ALL OF THIS…

Right now, I believe buying a residential property is the worst thing you can do right now. There has been no worse a time to buy one than now due to all of the reasons I mentioned before. Yes I do want to own a house, but I will build my money up through Trading/Business/Investing first, then buy my dream home outright and then buy other rental properties/land using sensible leverage.

So I’ll part with a few tell-tail signs of when a good time to buy a house is:

• When interest rates are starting to stabilize at a high rate, after rising steadily for two to three years in a row.
• When there is mass hysteria and panic and many people are trying to sell their properties, because they are struggling to make their monthly mortgage repayment. (Most likely sparked by rising rates).
• You hear many tales of properties being foreclosed on, also in neighbourhoods where people are considered to be wealthy.
• People around you are generally feeling quite negative about owning property.

 Also, as I say in my Trading workshops, the BEST time to buy assets is when there is blood in the streets. That is the time to buy…..and right now in the UK Property market, there’s potpourri and a party raving on…