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We’ve not one but two of our favourite bloggers guest posting today. What’s more they’re going at each other head-to-head! Roll up, roll up, for a bare knuckle cage fight – personal finance style! Okay, not really, Mr YFG and Fire v London are too polite for that. But we hope you enjoy their gentle jousting nonetheless.

There’s a divisive issue that has been tearing the nation apart forever. Bloggers are at odds over it. Family members squabble over it. Maybe you’ve even put off retiring because of it.

No, we’re not talking about Brexit. This is a far more ancient disagreement than that mere whippersnapper!

We’re thinking of the age-old question as to whether your home is an asset and an investment. And even if it is, whether you should count it as part of ‘the number’ you need in order to declare yourself financially-free and able to retire early, should that float your boat.

Parliament isn’t getting a great rap at the moment, but we see merit in a serious debate. So let’s have at it!

At the end you’ll even get to give your (indicative) vote.

  • Proposing the motion “This house believes it deserves to be included in your net worth” is FIRE v London, who is here to make the argument FOR including your home in your Financial Independence (FI) net worth figure.
  • Opposing the motion is Mr YFG, who will make the argument AGAINST.

And are you sitting down, dear reader? Because there’s a twist…

Warren Buffett’s wise sidekick Charlie Munger once said:

“It’s bad to have an opinion you’re proud of if you can’t state the arguments for the other side better than your opponents.”

We’re going to put this to the test: Each debater is arguing the opposite of what they believe.

Let’s see if we change anybody’s mind. (Maybe even our own?)

We now call upon FIRE v London to get proceedings underway.

FIRE v London: Property should be counted in your net worth

Gentle readers, the argument I am putting forward today is nothing short of simple common sense.

Property is big!

Property is the biggest type of asset out there. In the UK it is 51% of our net worth, dwarfing all other types of asset.

Why would retail investors like us FIRE1 types ignore the biggest asset class?

Of course not all properties are residential properties. And not all residential properties are your home. But what we are discussing in this debate is your primary home – where the FIREr lives – and whether this home, and any associated mortgage, counts in the Net Worth calculation you tend to do for FIRE.

The average home in the UK is worth around £250k. In London it’s more than £480k.

For most people, the savings needed for Financial Independence are around £1m. So in that context, the house you live in is an important number – potentially half of the total assets required.

Why would we possibly exclude the most important asset from the calculation?

Big as an asset but also big as an expense

Of course, property is also the biggest cost for most households. It is around 22% of disposable income in the UK on average, and a lot more for #GenerationRent – who in London pay on average more than £1,600 per month to rent a home.

From the point of view on somebody on the FIRE path, this is important. To be Financially Independent one needs to be able to meet all your living expenses, and this obviously includes housing costs. If you own your own house outright, with no mortgage, you’ll have a significantly lower cost of living.

So, in fact, this house believes not only that your primary home, as an asset, should be included in your net worth, but that your housing costs should be included in your assessment of FIRE. You can no more disentangle your primary home, as an asset, than you can forget about paying for electricity and broadband.

So far, so much common sense.

Rent vs buy? An important side question

In fact once you move beyond common sense, there are good practical arguments for considering both your asset and your housing costs in your FIRE deliberations.

It may even be that – counter-intuitively – renting rather than owning turns out to make FIRE more achievable.

Certainly in parts of London with low rental yields, renting may prove significantly cheaper, especially if you can obtain decent investment returns on the freed up capital.

This house might be better off sold! But you won’t know if you don’t consider it in your net worth.

UK property has important tax benefits

But never mind the size of it, look at the quality. Property is not just a large asset, it is also – especially as your primary home – one of the best assets. Particularly here in the UK.

In the UK property holds a special place in the heart and mind of everybody – not just those Englishmen whose ‘home is their castle’.  In Britain, property investment is ‘safe as houses’. Property is a ‘one way bet’. Stocks and shares? That’s ‘gambling on the stock market’, whereas you can put your trust in ‘bricks and mortar’.

As you can see almost every week in the Sunday Times’ Fame & Fortune column, where successful people make these arguments all the time. And they are successful people, so their arguments must be right, right?

In the UK, the taxman agrees with Fame & Fortune. Property is taxed differently to other types of asset. Crucially, there is no capital gains to pay on your primary home. If you pay off your mortgage, live in your home rent-free, and ultimately have no capital gains to pay, your primary home – the single biggest chunk of wealth for most of us – attracts no tax.

As in most places, here in the UK property is also arguably the key asset that it makes sense to borrow to buy. This means that you can get leveraged returns on it. This means you’d be crazy not to – especially for your own home, where mortgage rates are particularly low.

So, property is different. It is a large and obvious asset for retail investors to buy. In owning it you eliminate rent as a housing cost. There is no tax to pay, and you can leverage up your returns. You’d be foolish not to invest in it.

Let’s hear no more nonsense about excluding it from your net worth. Property is too big to exclude, and too attractive to exclude. That’s why this house believes it deserves to be included in your net worth!

But now I turn to Mr YFG, who is going to oppose the motion.

My YFG: Does my asset look big in this?

Whilst my honourable friend is right to call our home big, the case for it being an asset is less clear.

That’s because our homely abodes don’t generate any income or cash towards our FIRE target.

As Robert Kiyosaki of Rich Dad, Poor Dad fame points out, a home creates a negative cash outflow. For example, a mortgage, maintenance costs, bills and taxes. That makes it a liability!

My friend and rival also correctly points out that whether you should rent versus own your own home is a serious question to ask. This follows from the above. A bigger, more valuable house means you need to hold greater and greater amounts of other assets to balance out the cash outflow.

It also means leaving money on the table. The research shows that in the UK, investing in the stock market has beaten investing in property.  Money in your house is money out of the market. Money out of the market is the lost returns needed to finance FIRE.

Overall, the bigger your house, the harder it is to reach FIRE!

Alternative facts

Putting aside whether a house is an asset or not – can we even claim it’s big?

Valuing a home is very difficult. Unlike shares in an ETF (or FIRE bloggers), no two houses are alike. Sure, we can get a valuation from our local slick-backed-hair estate agent. But the ‘true’ value is only known when you come to sell.

Those mansions in Florida were quite valuable until they weren’t. Likewise the owners of former homes in Dunwich thought little was safer than houses… until the North Sea developed a taste for bricks and mortar.

This means that if you include your own home in your assets column the number is a little bit ‘fake news’.  It’s not a ‘real’ number like the cash in your bank account. It may never be realised.

Liquidity

The main point of our FIRE stash is to fund our living costs. All those craft beers and avocado on toast won’t pay for themselves! And this is very difficult with a house.

As mentioned above, a home generates negative cash flow. But even thinking in capital terms, it’s tricky to realise capital amounts, too.

Unlike stocks and shares, we can’t just sell piecemeal amounts of our own home into the market as needed. Nobody would be interested in buying a quarter of my guest bedroom, and not only because of the mound of bric-a-brac I’ve stored in there.

To realise money from our own house we have to sell it all or else take out big remortgages. That makes your own home a really bad investment for funding living costs.

Mums and their sons

My honourable friend is quite right: An Englishman’s home is his castle. I love my home. And this level of emotion makes it very difficult to stay rational.

My home is the best home. Just like my mum’s son is the best son in the world.

So when it comes to my home, I have a huge blind spot. I’ll always be tempted to bump the value of my home up in a way that I can’t with my index fund investments.

My home is more than a number in a spreadsheet. As a rational accountant I must guard against that, and discount whatever value I magic up for my home.

In summary my case is this: we can’t categorically say a home is an asset as it loses money. Whilst it’s a big expense, it’s hard to put a real number on it. Any number we do conjure up is contingent on a future star-crossed home we’re in love with making it rain in our bank account. And even that number is probably unrealistically high because who doesn’t love their home?

My case rests.

Who is right? You decide

Well, there you have it. Two opposing points of view on a key question facing any ambitious seeker of Financial Independence.

What do you think?  If you rent, is buying your own home part of your financial plan? If you own already, what will your financial independence look like in the future? What arguments are we missing?

Please vote in the poll and expand your thoughts in the comments below!

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I last wrote in detail about commercial property as an asset class in 2009. In the aftermath of the financial crisis, half-finished towers and moribund building sites dotted London like the LEGO play of a child interrupted.

The towel had been thrown in. I saw an opportunity.

Over the next few years, property investments – stock market-listed Real Estate Investment Trusts (REITs) as well as old-style property investment trusts and funds – did better than anyone expected.

Helped by persistently low interest rates, property assets doubled or even tripled your money over the next few years, thanks to rising prices and generous yields. Skyscrapers soared.

Some property shares lagged the recovery, giving a chance to buy again in 2011 – especially as the recovery was slower to reach small cap property firms

However certain parts of the sector are now well down from those highs.

Industrial property companies are doing well thanks to the weak pound juicing manufacturing, and there’s a boom in the warehouses that support online shopping and other logistical operations.

But companies that own lot of office space in London trade at big discounts to their net asset value – due mostly, I think, to the ongoing Brexit fiasco.

The market also seems wary of second-tier retail exposure. That’s understandable in light of the many store and restaurant closures we’ve seen since we voted to shoot ourselves in the foot in 2016.

Bailing on Brexit

Long-time readers will know I think Brexit is our biggest unforced error since the Hundred Years War.

However everything has its price.

If I can buy prime London office space at 70p in the pound via the stock market, I have a good margin of safety. If property developers have curbed speculative ventures because they fear bankers will decamp to Frankfurt and start-ups to Lisbon, at least new supply will be limited. That should help the incumbents.

Also, I don’t think we’ve condemned ourselves to penury with Brexit. I just believe we’ll be poorer than we would have been, for the foreseeable decades to come, for little gain. (That’s bad enough!)

Jeremy Corbyn notwithstanding, the rich will still get richer, and London will remain the base of operations for most of them.

You can shake your fist from the provinces, but you can’t make an oligarch or a tech entrepreneur move their company to the middle of nowhere. (Movers and shakers are even more aghast at that idea in light of the social divisions revealed by Brexit.)

But before anyone sells their Facebook shares and plows it all into UK real estate, know three things.

Firstly, Monevator is not about share tips. At most, posts like this are just suggestions of areas worth exploring. Do your own research – and on your head be the results.

Secondly, you should know I’ve had this view about commercial property since quite soon after the Brexit vote, when traders dumped UK property faster than Boris Johnson shedding his principles.

As global money began fleeing UK PLC, property funds had to be gated so investors didn’t ask to withdraw money that the funds didn’t have. I thought this was a sign the panic was overdone, and flagged up the potential opportunity.

Since then some companies I mentioned have done okay, but others have fallen further.

Again, do your own research – because you will have to live with the consequences.

This time it’s different

The third thing to note is that back in 2009, property prices really had plunged.

If you wanted to go out and buy a London office following the financial crisis, it was cheaper than a few years before. Same with a new lease, too. Prime property was going cheap.

The falls in property investments on the stock market then reflected this gloomy reality.

That’s the standard cycle in commercial property. Boom years – in which money is easy to find and development rampant – followed by lean years where over-extended developers go bust.

Sell when the fat blokes in suits and hard hats in the business pages look smug and contented, that’s my rule of thumb. Consider buying when those CEOs have been shuffled away for wiry upstarts who appear in the same pages talking up the forgotten sector again.

This time – so far – it’s different.

London office space is holding its value, and rents remain high, too. Brexit fear has not yet dinged the hard bricks and mortar assets themselves, just their stock market proxies.

Those discounts to net asset value we see with certain REITs may reflect an irrational disconnect with reality on the ground. Perhaps some of the beefy property blokes will be proved right to be more confident about Brexit than the flighty liberal elite fund managers selling down REITs?

Alternatively – more technically – it may be that hedge funds and the like who are very pessimistic about Brexit have turned to shorting the shares of listed property giants as an easy way to express that view. (The funds are unlikely to own physical offices to dump).

Does this make the big London office REITs more of an opportunity this time – because it’s a phony war – or less so – because the usual cycle hasn’t yet played out from peak-to-trough?

It’s something to think about.

Commercial property and your portfolio

In my next post I’ll recap the broader investment case for commercial property, whether you’re an active or a passive investor.

Why do some model portfolios include specific commercial property exposure, and how does the asset class differ from equities and bonds? What if you already own your own home?

The exciting bit is over, but the important stuff is to come. Subscribe to catch it.

Disclosure: I have various beneficial interests related to London property.

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Prices for prime properties in some global cities are softening. Commentators tend to put their weak local market down to local conditions – tweaked tax laws, or regional political concerns – but are they missing the big picture?

Bears have lost – or at least not made – untold billions by betting on the end of the bubbly market for assets we’ve seen since the boom began in 2009.

And I’ve been pretty optimistic throughout what’s still being called a “recovery”.

But nothing lasts forever.

Crucially, US interest rates are already well off the bottom.

Continuing low rates in Europe, Japan, and the UK curb will restrict how fast and how far US market interest rates will go. Perhaps the US President will too, with his random Tweets driving fearful money back into Treasury bonds, in turn pushing yields back down.

But with North America’s unemployment now very low and its economy boosted by a late-cycle tax-cut bonanza, it’s hard to see why the Federal Reserve won’t continue to hike its benchmark interest rates in the months and years ahead – a complete contrast to the easy money regime that has prevailed since 2009.

The end to that near-limitless cheap money will surely be felt around the world, one way or another, in time.

Is prime property already rolling over?

Global gains

The Financial Times has detailed how global cities have boomed since the crash:

Over the past 10 years, the life-cycles of global cities such as London, New York and Sydney start to look very similar.

They begin with central banks cutting rates; then foreign buyers are welcomed in, prices go up, high-end homes are built, capital appreciation drops and then cities are left with a lot of stock which is too expensive to sell.

The FT also featured a snapshot of how the cream of the global cities had prospered over the past decade:

(Click to enlarge)

It’s quite remarkable really.

True, most of these cities had seen high house prices long before the financial crisis.

But few (if any) pundits predicted the house price growth we’ve seen in these global cities in the subsequent 10 years.

The financial crisis involved an excess of debt and speculation in property – albeit more sub-prime properties than Manhattan penthouses.

Property therefore didn’t seem the obvious place to look for a new boom.

But in retrospect, it looks obvious what happened.

By successfully (re)inflating asset prices, quantitative easing (QE) made the rich, richer. And the rich tend to live in global cities.

In the fearful years that followed the near-collapse of the financial system, few wealthy people fancied a move to a far-flung rural town…

London falling

The FT article explains this dynamic in the context of London.

Waves of capital washed into London’s housing market – first from bog standard rich people seeking safety, then from sovereign wealth funds lured in by the fall in the pound, then Russian and Middle Eastern investors fearful of disruption in their part of the world, and finally with a wall of money from Asia.

Already high prices for prime London property hit levels that seemed fantastical. (£140m for a penthouse, anyone?)

When did this start to reverse?

The collapse in commodity prices in 2014 didn’t help. That squished the spending power of Russian oligarchs and Middle Eastern royalty.

Stamp duty changes the same year also increased the cost of buying the priciest homes.

The price of visas were raised. From April 2015, tougher anti-money laundering measures were introduced, too.

All told, the Home Office recorded an 80% fall in the number of foreign investors moving to Britain in the year to 2016.

Then there’s the ugly white elephant – Brexit – which has turned UK assets into the most unloved in the world for global fund managers.

The result? A malaise that has spread beyond Mayfair and Belgravia. London house prices just posted their first annual fall since 2009.

The FT argues London property simply got too expensive. And sure, if London homes were cheaper then perhaps they could have shrugged off some of these headwinds.

Stamp duty might never have been raised so high if the Government hadn’t seen a cash cow to be milked, too. There’s an element of reflexivity to this.

But look at other big global cities. Many of those also seem to be losing their footing. Can it be a coincidence?

Here, there, nearly everywhere

Let’s whip around the world, montage-style:

Toronto:

Re-sale home prices in the Toronto region dropped 12.4 per cent, or about $110,000, year over year in February.

[…] the Ontario government took cooling action by introducing its Fair Housing Policy, including a foreign buyers tax, said Jason Mercer, TREB director of market analysis.

Sydney:

Cracks are showing in the Sydney property market, with prices now falling for the first time over a 12-month period since the boom began.

New York:

Manhattan real estate sales and prices took a fall in the fourth quarter, and they’re likely to slide even further this year after the new tax rules take effect.

Total sales volume fell 12 percent compared with the fourth quarter of last year — the lowest quarterly level in six years, according to a report from Douglas Elliman Real Estate and Miller Samuel, the appraisal firm.

The average sales price in Manhattan fell below $2 million for the first time in nearly two years.

China:

Out of the 70 cities tracked, prices dropped in 16 cities month on month including first-tier cities Beijing, Shanghai, Guangzhou and Shenzhen.

It was these top-tier cities which saw the most significant decline in prices.

Shenzhen had its biggest drop in three quarters as prices slid 0.6 percent from the previous year. Prices fell 0.4 percent in Guangzhou, 0.3 percent in Beijing and 0.2 percent in Shanghai, compared to the same period last year.

Granted, these are tiny falls so far. Not much more than noise.

It’s also not universal – Paris and Singapore for example appear to be bucking the trend. Perhaps it’s because they missed out on the prior boom, but anyway if some global cities continue to do well it does slightly scupper my thesis that cheap money is beginning to ebb away, exposing the priciest assets.

Perhaps it is just a matter of froth being blown off. The masses had their Bitcoin frenzy in late 2017. Maybe global property was the same mania for the 1%.

Yet it’s still odd to see prime property falling even as the global economy does better than it has done for years.

Property is typically a lagging indicator, not a leading indicator like the stock market. House prices tend to react, rather than predict.

But when it comes to the end of super low interest rates, perhaps prime property does have something to say about the future?

Prime property is very often bought with cash, not a mortgage. To some extent that might soften the link between property prices and rates – certainly compared to the mass market.

However investment is everywhere and always a relative game.

If the rich can now get nearly 3% from a ten-year US government bond, maybe they no longer want to bother with taxes, estate agents, and getting the windows cleaned twice a month?

It will be interesting to see who reaches a similar conclusion next. The share prices of so-called ‘bond proxies’ like consumer goods giants have already softened a little, but they could have much further to fall if investor appetites truly change, for instance.

In contrast, maybe the cheap-ish, cheer-less UK stock market might finally get some love, stuffed as it is with cyclical miners and banks.

Your next local house price crash: Made in China?

I began writing this article in the snowy miserableness of March, but got distracted by new flat nonsense and never finished it.

And that’s convenient, because this month the IMF came out with research stating that global cities are indeed increasingly moving in sync.

In its latest Global Financial Stability report it found:

…an increase in house price synchronization, on balance, for 40 advanced and emerging market economies and 44 major cities.

Countries’ and cities’ exposure to global financial conditions may explain rising house price synchronization.

Moreover, cities in advanced economies may be particularly exposed to global financial conditions, perhaps because they are integrated with global financial markets or are attractive to global investors searching for yield or safe assets.

I have no firm conclusions to draw about all this right now. My track record of predicting property prices is poor!

Also, before anyone (rightly) pipes up and says that potential house price falls in New York shouldn’t derail your passive investing strategy – I obviously fully agree.

This post is filed in the Commentary section. Most readers own property, too, so the asset class is hardly irrelevant. But acting on the end of the QE-era should probably be left to those of us silly enough to muck about in active investing waters.

To that end, I am Watching This Space.

One of the (less important) reasons why I finally bought a flat in London this year was I could see the market was soggy, and I put much of that down to Brexit uncertainty. Given that Brexit uncertainty should pass, one way or another, it seemed a potentially opportune window to buy.

But synchronized falls for global property could indicate I was mistaken about the role of Brexit. Perhaps the property cycle has turned. We’ll see!

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The following guest post on the reasons to rent a house instead of buying is from Graeme Pietersz, the man behind Moneyterms.

That it’s better to buy a house rather than rent is deeply ingrained in the British psyche. But the argument as to whether it is better to rent a house or buy is far from one-sided.

The core of the argument against renting is that rent is wasted money that you could instead save and invest in a house.

The flaw in this argument is that your entire mortgage payment is not an investment.

A mortgage payment is two payments combined:

  • One is the repayment of the amount you borrowed: this is an investment.

If paying rent to your landlord is a waste, then so is paying interest.

Rent a house or buy? The true cost comparison

You need to compare the cost of rent to the cost of paying mortgage interest. You cannot just compare rental yields to mortgage interest rates. You need to look at where both are likely to go over the lifetime of the mortgage.

For future interest rates (beyond any period for which mortgage rates are fixed) you look at a yield curve and add the spread over it that you expect to pay.

The amount you need to add is obvious for tracker mortgages, but the principle is the same for any variable rate because banks approximately follow market rates.

The Bank of England provides some nice graphs for UK rates. Similar data is available in other countries.

Model behaviour

The bad news for buyers is that it looks like we can expect yields to go up. Your mortgage payments will probably be a lot higher in five years.

To forecast future rents, the safest assumption is that they will, like house prices, roughly follow income growth over the long term.

By now you may be feeling that you are being asked to do a lot of financial modeling to decide whether to rent a house or buy. Sorry, but this is an important decision that does not have an obvious answer. It demands at least as much analysis as buying a share.

And we have not finished yet! There are more costs to be taken into account – and we have not even talked about risk.

Other costs of owning a house

Mortgage interest is not the only cost of owning a house:

  • If you own a house, you have to maintain, insure, and furnish it. Doing this costs you not only money, but time as well.
  • You need to take care to ensure that you maintain valid insurance (I know people who have happily paid for policies they did not realise were not valid).
  • You have to find plumbers and builders when needed — and pay them.
  • You have to replace old furniture, even if it has only suffered ‘fair wear and tear’.

So you need to add an estimate for all this to the cost of owning a house, and compare that number to your rent. Buying a house is probably looking a lot less attractive by now.

It looks worse when you consider the risks.

The risks of buying a house

The most obvious risk is that house prices will fall. In the long term, this risk is ameliorated by economic growth, as house prices have had a fairly stable long term correlation with incomes. The question is whether you have the will and means to last through crashes.

Also, the risks of owning a property are not just the risks to the property market in general. There are risks specific to the area you buy your house in, and to the particular property itself.

House prices do not follow the same trends all over a country. There can be huge divergences between regions. In addition, there are risks attached to your local area. It may become more or less desirable as an address.

Local facilities (schools, transport, shops) may improve or deteriorate. Changes to rivers or flood defences may make your house prone to flooding. Similar risks exist in areas vulnerable to erosion.

We touched on one of the risks peculiar to a particular property: the cost of repairs. There are a whole range of risks that can leave you badly out of pocket, from dry rot to fire. Some will be covered by your insurance, some will not be covered at all, and a good many will be inadequately covered. Regardless of who pays, it still costs you time and worry.

The price risk is far worse than similar volatility in any other investment, because most people borrow to buy a house — very few borrow to buy shares. Buying a house with a mortgage is therefore a massive margin trade

Buying a house also ties you down. If you rent a house and you are offered a job in another city, or even another country, you can be there in a few weeks. It may cost you a few months rent, but it is quick and easy, and the cost is predictable.

So, rent a house or buy?

There are times when it is obvious that buying a house is a good decision, often in the wake of a crash.

When house prices are low enough that you can pay the mortgage and also other costs with the equivalent in rent, you can’t really lose. Such high rental yields are a strong sign that prices are too low.

Most of the time it is much less clear that you are likely to benefit financially.

If house prices rise rapidly it may turn out to be a mistake to rent a house – but so would buying if they fall or stagnate. So why not keep your options open and your expenses predictable?

Note: I have updated this post from the archives because the core reasons to rent a house versus buying haven’t changed, even as various parameters have arguably become more stretched. Be aware that some of the older reader comments might now be dated, however. On the other hand, that does provide interesting context to this timeless back-and-forth!

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Good reads from around the Web.

Once I’d finished kicking myself, I allowed myself a wry smile on reading the latest house price survey by UK Value Investor. It brought back a lot of memories.

John entitled his post UK house price forecast: It’s not looking good.

But I was thinking that for me it might have been called A little knowledge is a dangerous thing.

The source of my dark mirth was the following graph. It shows how the average house price moves through bands of apparent over and under-evaluation over time, as defined by a deviation from the longer-term norm of property prices to average earnings:

Prices are cheaper in the greener band and most expensive in the red.

Source: UK Value Investor / Halifax

When I look at that graph, I’m taken through the story of my adult life.

In the mid-1990s, fresh out of University and already with an eye to a bargain, I was urging friends to buy their own home. I can vividly remember reading an article in The Sunday Times showing how the price-to-earnings ratio for London property had hit an all-time low in the wake of the early 1990s house price crash. (Yes kids. Really).

It’s hard even for me to believe now, but the meme back then was that buying was so over, and that Generation X would usher in an era of renting. (Which has eventually happened with the Millenials, but not exactly out of choice.)

As you can see in the graph, I got ‘anchored’ in 1995, as the behavioural economists say, to very low prices. Unfortunate.

I wanted to buy, but for various reasons I didn’t – I’d only had a job for six months and I knew it was the wrong one, the £5,000 or so I’d saved as a student (!) didn’t go far, and I was greedy and wanted to buy in gentrifying Clapham Old Town, not Brixton where I actually lived.

What was the rush? Nobody wanted to buy. A couple of years of frugal living and hard saving and I’d swoop in like Hetty Green.

When I moved out of London for a couple of years to a new job, I urged my new friends in the provinces to buy there, too, as the infamous ripple rumbled beyond the M25.

Incidentally, these friends have finally stopped thanking me for first putting this idea into their heads, either because they have forgotten, they are too-embarrassed by my ongoing property penury, or they’re too busy going on holiday with all the money they save from paying £200 a month for a four-bed house in the best part of town.

Which is fair enough, obviously, but being remembered as the kindly savant did soften the sting a little…

Trees that grow to the sky

Back in London in the early 2000s – and with a combination of nearly 10 years of savings and access at last to sufficient self-employment records to please the bank manager – I put in an offer on a two-bed in 2003.

And then there was a snag with the paperwork. The mortgage agent suggested, in essence, that I make something up.

I dithered.

Truth is I dithered not only for moral reasons. I was now telling my friends that I thought property was becoming truly over-valued in London, and I was risking ten years of savings from a very ordinary basic rate taxpayer level income in the face of a potential crash.

If my London friends who heeded this terrible call still remember it, they are kind in (generally) not mentioning it. Swings and roundabouts, I suppose.

Look at the graph above and you can see my fears. Prices are moving into the orange zone. My gut call was right. But my crystal ball was murky, and history had other ideas.

Remember, we couldn’t know then what would actually happen next.

Here’s what happened next:

How price to earnings ratios have moved into the stratosphere.

Source: The Guardian

This graph – from The Guardian – shows that average London prices are now more than 14 times earnings, according to the property specialist Hometrack.

The unprecedented eight-times peak that had me quailing back in 2003 looks positively pedestrian.

Non-buyer’s remorse

What a palaver. For the record I did look at a few properties in 2010 (partly as a result of helping a friend who didn’t want to view them on her own) and thought prices now looked a tad more sane.

I wondered if it was time to stop the bleeding.

Alas, that mini-crash lasted about six weeks and my firepower had been smashed to smithereens roughly halved by the financial crash. Which left me feeling guilty as well as keeping me renting.

Some readers have told me over the years to stop complaining, and just move and buy. I am complaining to some extent I suppose, but it’s a sort of rueful self-knowing complaint.

It is what it is, as my younger friends say. But that doesn’t make it “right”. (Substitute rational, fair, sustainable, predictable, a good bet, or whatever other word you like – I’m just using it to cover the waterfront, not to imply a deep moral injustice).

I can buy, even in London, albeit because I’ve basically turned myself into West London’s answer to the early Warren Buffett.

But that doesn’t mean I will, or even should.

Bailed out by the bond bubble and the BOE

I understand anonymous commentators on the Internet are all geniuses. Their property purchases were wise, prescient, and it’s entirely in the proper order of things that their homes now cost 10 times what they paid for them, and that they couldn’t afford a shed at the bottom of their garden if they had to buy today.

That’s nothing – you should see them at the races!

But let’s be honest, if you were told in 2007 that the world was about to face a once in five generations financial crisis, would you honestly have thought London property prices would be trading at more than 14-times earnings some six or seven years later?

I sold most of my bank shares before the worst of the crash hit because I was convinced high debt was part of the problem, although I didn’t in any way understand exactly how in the way we all do now.

It was also part of the reason why I was nervous back in 2003 – I saw ill omens all around, particular with spendthrift friends buying flats via credit cards and parental handouts.

Ho hum. Moral hazard has been on holiday for a decade.

Other people say “of course property prices are very high, bond yields are very low.”

To which I say: Unconvinced. Prices are not at anything like such high levels in the US, which had a bigger crash and for a long-time as low or lower bond yields. Nor the big cities in Germany and Spain where ten-year yields are from time to time negative.

Oh, and anyway I’m not going to condemn myself too harshly for not to have anticipated the property bubble would be bailed out by 5,000-year lows for interest rates.

Brexiteers to the rescue?

Clearly all property markets are local to both time and place, which it took me too long to fully understand. The UK economy – and more particularly London – has been doing very well in a world that’s been doing rather poorly.

The brilliant Brexit may now burst the London property bubble, but then again it may not.

I’ve seen the thing stagger back onto its feet too many times to stomach the confident soundings of a new recruit. I’m more like one of those hardened zombie-fighters that the prettier and younger movie stars find holed-up in the top-floor of a crumbling tower block.

They think the worse is over. I’ve seen it all before.

A little knowledge is a dangerous thing. On the other hand, my experiences (and that housing deposit I never deposited, but instead put into the market) has helped make me the investor I am today. And I’m pretty content with that guy’s record.

Still, I can’t deny it’d be nice to be able to knock a wall down now and then.

Have a great weekend.

From the blogs

Making good use of the things that we find…

Passive investing
  • Don’t bother reading this – Jonathan Clements
  • Good summary by SCM of last week’s FCA report [Embedded doc] – T.E.B.I.
  • Low-vol investing “is not worth the brain damage” for most – Alpha Architect
  • What fraction of international smart beta is dumb beta? [Research] – ABWorks
Active investing Other articles

Product of the week: The new 2.2% NS&I savings bond announced by Phillip Hammond in the Autumn Statement is getting short thrift. ThisIsMoney quotes one pundit who says the Chancellor is “papering over the cracks”. The 2.2% three-year fixed rate isn’t the problem – depressingly it’s a table-topper, even though after rising inflation it’s likely to deliver a negative real return. Much worse is that you can only save £3,000 a year into the bonds, which will net you £66! You’ll have to wait until next Spring for this particular dream to come true.

Mainstream media money

Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1

Brexit still looking a great idea update
  • Britain’s Autumn Statement hints at how painful Brexit is going to be – Economist
  • Britons face a “dreadful decade” of wage stagnation, IFS warns – Bloomberg
  • Reality check: How much will Brexit cost? – BBC
  • Martin Wolf: Brexiters choose to target the messenger [Search result] – FT
  • Ex-Prime Ministers warn of Brexit buyer’s remorse – Bloomberg
Passive investing
  • Investors turn towards evidence – Morningstar
  • Hedge fund vet Steve Cohen is putting money into a passive startup – Bloomberg
  • Jack Bogle Q&A: “We’re in the middle of a revolution” – Bloomberg
  • Interview with Larry Swedroe about his new factor investing book – ETF.com
Active investing A word from a broker Other stuff worth reading
  • Autumn Statement 2016: At-a-glance – ThisIsMoney
  • Autumn Statement: What it means for your money [Search result] – FT
  • Buy into a pension while tax reliefs last [Search result] – FT
  • How to earn £27,000 a year tax-free – ThisIsMoney
  • Will banning letting fees push up rents? – Guardian
  • One writer’s year of not spending anything is over – Guardian
  • How much is enough? – The New York Times
  • 33 million millionaires own nearly half the world’s wealth – Business Insider
  • The signs that civilization is about to collapse [Excellent podcast] – Bloomberg

Book of the week: Investing Caffeine this week looked back to the fall of the Long-Term Capital Management hedge fund in the late 1990s. If I knew then what I know now, I’d have been a lot more worried than I was. Curious to learn more? The Kindle version of Roger Lowenstein’s classic account – When Genius Failed – is just £5.49 at Amazon.

Like these links? Subscribe to get them every week!

  1. Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”.
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You pay stamp duty on UK property when you buy a home that costs more than £125,000.

There is no stamp duty payable if you’re the seller of the property.

Stamp duty is a transaction tax (the long name is Stamp Duty Land Tax), which you need to take into account when working out your budget for moving or buying a home for the first time.

Buying a property in Scotland? From April 2015 stamp duty is replaced by a levy called the Land and Buildings Transaction Tax.

Stamp duty on UK property rates

The stamp duty rate paid by home buyers varies depending on the purchase price of the property.

There are five stamp duty rate bands. You pay stamp duty at the indicated rate on the portion of the price lying within each band.

The stamp duty rate bands are as follows:

Purchase price band Stamp duty rate
£0 – £125,000 0%
£125,001 – £250,000 2%
£250,001 – £925,000 5%
£925,001 – £1.5 million 10%
Over £1.5 million 12%

Source: GOV.UK

For instance, if you were buying a home for £400,000 you’d pay:

No stamp duty on the first £125,000 of the total £400,000.

A 2% stamp duty rate on the next £125,000 up to £250,000.

The 5% rate on the final £150,000 of your £400,0o0 purchase.

This works out as:

£0 (up to £125,000) + £2,500 (2% of £125,000) + £7,500 (on £150,000)

= £10,000 in total stamp duty.

Incredible! An improvement to the tax system

Under the old stamp duty system, stamp duty was payable at the highest applicable rate on the total purchase price of a property.

That was a really stupid way of doing things.

Stamp duty inevitably adds friction to the home buying process by making it much more expensive to move house, and it doesn’t do much to restrain prices.

But the old system also distorted asking prices.

For instance, there was a 3% band that kicked in if you bought a property worth more than £250,000. Stamp duty on a £250,000 property was £2,500, but were you to pay just £1 more you’d face a stamp duty tax bill of £7,500.

You’d pay an extra £5,000 in stamp duty because of that measly £1!

In reality few people would do that, so house prices were distorted around the different bands by sellers trying to take into account these warping effects when setting their asking price.

Similar one-bedroom Zone 3 London flats stayed priced at £250,000 for many months even in the rising market, for instance, before leaping up to £275,000 as a group. Very few people ever paid £255,000 in the meantime.

Buyers also resorted to ruses to reduce stamp duty.

The new stamp duty rates introduced in December 2014 did away with the distortions of the old ‘slab’ stamp duty system, because the higher rates are only chargeable on the portion of the property price that falls within each rate band. (It’s similar to what happens with your salary and income taxes).

In addition, the total stamp duty you’ll pay on a particular property price is lower in the vast majority of cases under the new system.

Chancellor George Osborne says you’d have to spend more than £937,000 to see your bill go up under the new system.

The £10,000 payable in my example above would have been a £12,000 stamp duty bill before – that’s a saving of £2,000 under the new stamp duty rules.

But put the Aldi prosecco back on ice – I’d expect any such savings in the cost of buying a home to be quickly reflected in house prices moving higher.

The main benefit of the 2014 overhaul of stamp duty will therefore be the removal of those cliff-edge distortions, which may make the market a tad more liquid, too.

Stamp duty on UK property calculator:

That calculator also shows you what was payable under the old rules, which may be handy to know if you’re in the midst of a move.

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I have explained before how a mortgage is money rented from a bank.

When you buy your first property with a mortgage, you don’t leave the renting classes behind – you simply do your business at the more respectable end of the High Street, and rent the money needed to buy the house from Natwest or Nationwide.

Instead of giving brown envelopes stuffed with tenners to a bloke called Trevor every Thursday for the honor of living in his dive in New Cross (in spirit, I appreciate we all use bank transfers nowadays), as a newly indebted homeowner you pay ‘money rent’ every month to the bank on the lump sum it lent you to buy your home.

It’s a different way of thinking about home buying and mortgages. It doesn’t mean in itself that renting or buying is better or worse.

By the same token, this article is also not about whether you should own a home or not (or whether prices will go up or down or whether the younger generation is shafted or whether the market will crash next Tuesday or any of the usual).

It’s a thought experiment.

Let’s imagine we’re dressed in white togas eating grapes like Greek philosophers, and have ponder.

A house? For me? How kind!

So, a mortgage is money rented from a bank. Sort of.

But what about when you rent a property from a landlord?

Is that just, well, renting a property?

Of course.

But there is another way of looking at what’s going on, which adds another financial jui jitsu move to your mental arsenal.

Instead of thinking of your landlord as someone who owns the house or flat they rent to you, you might think of your landlord as someone who borrows £250,000 or £500,000 or whatever to buy the property on your behalf.

He or she borrows the money, and as a result you don’t need to do so.

You pay him rent for the privilege of him borrowing this money. The cost is usually marked up for his trouble, so your rent is higher than if you’d rented the money from the bank yourself.

In addition, your decision to rent hands the option to make money from rises in the property’s price to your landlord.

Then again, you’re also insulated from the risk of falling house prices.

The interesting thing about landlords and mortgages

This is in fact very close to what happens in practice.

Let’s say you’re renting 29 Acacia Avenue from your lovely landlord, a Mr E. Wimp Esq.

You pay him £1,000 a month to rent his house, and when you see him in the street you tug your forelock (whatever a forelock is) and generally feel like one of the oppressed classes.

You presume Mr Wimp owns the house – and legally he does.

However he doesn’t own it outright.

Instead, like any financially savvy landlord, Wimp bought the house with an interest-only mortgage. He repays no capital, and in fact as house prices go up he remortgages every few years, increasing his debt on the house and rolling the equity released into new deals to buy more houses.

Buying, growing, releasing equity, and re-investing capital that’s leveraged through Other People’s Money – i.e. mortgages – is the heart of most property enrichment schemes. It gives Mr Wimp access to financial firepower that he could probably never have amassed in his lifetime from saving alone.

And Mr Wimp enjoys another great benefit from using interest-only mortgages to finance his properties.

The interest he pays on a mortgage can be offset against the rental income you pay him, in order to reduce his taxable profits.

For this reason, a landlord will typically try to keep his or her interest-only mortgage payments at about the same level as rental income. This way they can effectively reduce their tax liability on the rental income to zero. (Especially as he also gets to make deductions for wear and tear and the like).

When the mortgage – and hence the capital owed – comes due after 25 years or so, a landlord would usually aim to either sell-up the property and repay the mortgage, pocketing the difference, or else refinance the property with a new mortgage.

The alternative strategy – steadily amassing equity in a property by gradually buying it outright with capital repayments – would over time reduce the mortgage interest bill. This would therefore increase taxable profits – and taxes paid – as there’s less interest paid to offset against the rental income.

Of course a landlord might choose to own a property outright for other reasons – such as avoiding having to sell or re-finance in 25 years – but from a near-term tax efficiency perspective, a big interest-only mortgage is the way to go.

(Capital gains tax is another matter altogether. Whereas an owner-occupier can sell her home free of capital gains tax, a landlord is liable for taxes on capital gains).

It’ll cost you extra

As a renter, instead of you using a big mortgage to buy your property, your landlord has taken out a big mortgage to own the same property and to rent it to you.1

However in both cases you – the occupier – is servicing the mortgage.

  • If you own the property, you’re repaying your mortgage to the bank, likely over 25 years, and probably repaying capital as as well as interest.
  • If you rent the property, you’re paying your landlord’s mortgage, which is likely interest-only, via your rental payments.

Typically the rent paid to your landlord will cost you more than if you bought the same property via an interest-only mortgage.

This is because landlords aren’t in it for charity, and they want to make a profit.

Note: An interest-only mortgage is the correct kind to use for like-for-like comparisons between the different options, because it ignores capital repayments. Such repayment of capital is a separate issue (really it’s a form of saving).

Consider a two-bed property that costs £200,000 to buy:

  • A 4% interest-only mortgage costs £666 a month over 25 years.
  • Your landlord might charge say £750 rent a month– which is an effective rate on £200,000 of 4.5%.

By renting, it’s as if you’re paying a slightly more expensive interest-only mortgage than the landlord, and in addition you’ve hedged out house price gains and falls.

You’ve given up security of tenure in the deal, too.

On the other hand, you didn’t have to put in a deposit, so your free capital can be earning money elsewhere.

In addition, your landlord has to account for wear and tear to the property, whereas you can call him up for a new boiler. There’s also a risk that if you move out he won’t immediately find new tenants, forcing him to cover the gap in payments from his savings.

But you can’t bang nails into his walls.

However he paid all the transaction costs of buying the property. You just paid a month’s rent as a deposit.

And around and around we go…

The point is there’s a mix of pros and cons.

Lording it up

The key idea I wanted to get across today is the relationship between your rental payments and the landlord’s mortgage.

But here’s a few consequences to think about.

One very strong case for home ownership is to be your own landlord

If someone wants to rent you a property, then clearly they think it’s worth at least the monthly interest-only bill to do so, plus profit coming from either the surplus over the mortgage from the rent or gains in house prices, or both.

But as I mentioned, as well as any profit margin and an allowance for wear and tear, a landlord also has to charge a higher rent to cover the risk that a tenant doesn’t pay up or of a gap between tenancies.

As a homeowner you are effectively letting the property to yourself and these things are under your control. So unless you’re a member of a 1970s heavy metal band with a penchant for throwing TVs out of windows, you’re your own ideal tenant. By buying and renting the property to yourself, you get a better deal, because you pocket the profit margin, and you’re not paying extra to cover those overheads and unknowns.

Owning a home is more tax efficient than renting one

It’s true that UK home buyers no longer get mortgage interest tax relief, and that does put the landlord at a slight advantage from that perspective. However on the portion of your home that you own you’re effectively paying monthly rent (as imputed rent) free of tax issues. In contrast if you were renting you’d have to find the money to pay for the whole house each month out of taxed income.

For instance, if you own £100,000 of that £200,000 house, then you might have say £750 of ‘imputed rent’ that you don’t actually pay, and equally that you don’t have to find out of your taxed income. (This is a weird concept I know, so read the Wikipedia page on imputed rent).

Your home is also free of capital gains tax if you sell, so if you downsize to a smaller place or leave the property market, you don’t pay tax on any money that’s released. Landlords gains will be taxed.

Presumably, in a rational market the landlord takes that future tax liability into account when setting rents. So as a homeowner you should be able to make the maths work more comfortably than the landlord can.

Money NOT in property is NOT automatically dead money

I hope this post is another way of seeing that money spent on rent is not ‘dead money’.

Whether you rent or have a mortgage, you’re still paying an interest bill.

Equally, even if you’ve paid off your mortgage, the capital locked up in your home is not being invested elsewhere. And that has an opportunity cost.

Now I happen to believe most people do much better owning their own home than with shares, which is the only asset class likely to keep up with UK house price inflation over the long-term.

But if you’re a skilled investor who can earn, say, 10-15% a year from investing on average, then it might be worth renting from a landlord, even at an effectively higher interest rate, in order to avoid having to sink a big deposit into a property. You’d invest instead of paying off a mortgage. You’d have to be investing in an ISA or a SIPP to match the CGT-free nature of owning your own home.

Keep in mind though that a home bought with a mortgage is a geared investment, and those are very hard to beat with ungeared investments – presuming house prices keep going up at historical rates, of course. (If house prices fall for 20 years you’ll be laughing).

You might not be ready or able to buy yet

The reality is that not everyone can buy, even if monthly mortgage payments would be lower than their landlord’s monthly payments plus their mark-up (aka their rent). They may not have a deposit, or they may not be considered a good credit risk by a bank.

This has always been true for many 20-somethings – the controversy today is that it’s true of many people in their 30s and 40s, too.

A lot of it comes down to house prices

I have danced on a pinhead above discussing how a landlord may make a few more quid from rent after costs and so on. In reality, most landlords who got into the game in the 1990s have made out like bandits from house price appreciation, compared to any profits they made from rent.

Most old-time landlords say price appreciation should always the eventual goal, but when buy-to-let mortgages and legislation changes first democratized being a property mogul, it was also common wisdom that you should get at least a 10% yield on your purchase price.

Today yields are far smaller – more like 4-7% – but then mortgage rates are also far lower. Ultimately, winners and losers will likely be decided by the trajectory of the UK property market over the next 10-20 years – the ‘option on house prices’ I mentioned that a renter gives up to a landlord.

None of this is rocket science, but I hope it’s revealed a few of the semi-hidden dynamics of renting versus buying a home.

Please note: Constructive discussion about the mechanics of the UK property market in the comments would be great. Tirades about greedy landlords / young renters who spend all their deposit on iPhones / how the UK is going down the toilet unless we vote UKIP will probably be deleted.

  1. As I said before, we will leave any rights and wrongs of this for another day… Head to HousePriceCrash if you can’t wait, rather than arguing it here please.
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I last wrote in detail about commercial property as an asset class in 2009. In the aftermath of the financial crisis, half-finished towers and moribund building sites dotted London like the LEGO play of a child interrupted.

The towel had been thrown in. I saw an opportunity.

Over the next few years, property investments – stock market-listed Real Estate Investment Trusts (REITs) as well as old-style property investment trusts and funds – did better than anyone expected.

Helped by persistently low interest rates, property assets doubled or even tripled your money over the next few years, thanks to rising prices and generous yields. Skyscrapers soared.

Some property shares lagged the recovery, giving a chance to buy again in 2011 – especially as the recovery was slower to reach small cap property firms

However certain parts of the sector are now well down from those highs.

Industrial property companies are doing well thanks to the weak pound juicing manufacturing, and there’s a boom in the warehouses that support online shopping and other logistical operations.

But companies that own lot of office space in London trade at big discounts to their net asset value – due mostly, I think, to the ongoing Brexit fiasco.

The market also seems wary of second-tier retail exposure. That’s understandable in light of the many store and restaurant closures we’ve seen since we voted to shoot ourselves in the foot in 2016.

Bailing on Brexit

Long-time readers will know I think Brexit is our biggest unforced error since the Hundred Years War.

However everything has its price.

If I can buy prime London office space at 70p in the pound via the stock market, I have a good margin of safety. If property developers have curbed speculative ventures because they fear bankers will decamp to Frankfurt and start-ups to Lisbon, at least new supply will be limited. That should help the incumbents.

Also, I don’t think we’ve condemned ourselves to penury with Brexit. I just believe we’ll be poorer than we would have been, for the foreseeable decades to come, for little gain. (That’s bad enough!)

Jeremy Corbyn notwithstanding, the rich will still get richer, and London will remain the base of operations for most of them.

You can shake your fist from the provinces, but you can’t make an oligarch or a tech entrepreneur move their company to the middle of nowhere. (Movers and shakers are even more aghast at that idea in light of the social divisions revealed by Brexit.)

But before anyone sells their Facebook shares and plows it all into UK real estate, know three things.

Firstly, Monevator is not about share tips. At most, posts like this are just suggestions of areas worth exploring. Do your own research – and on your head be the results.

Secondly, you should know I’ve had this view about commercial property since quite soon after the Brexit vote, when traders dumped UK property faster than Boris Johnson shedding his principles.

As global money began fleeing UK PLC, property funds had to be gated so investors didn’t ask to withdraw money that the funds didn’t have. I thought this was a sign the panic was overdone, and flagged up the potential opportunity.

Since then some companies I mentioned have done okay, but others have fallen further.

Again, do your own research – because you will have to live with the consequences.

This time it’s different

The third thing to note is that back in 2009, property prices really had plunged.

If you wanted to go out and buy a London office following the financial crisis, it was cheaper than a few years before. Same with a new lease, too. Prime property was going cheap.

The falls in property investments on the stock market then reflected this gloomy reality.

That’s the standard cycle in commercial property. Boom years – in which money is easy to find and development rampant – followed by lean years where over-extended developers go bust.

Sell when the fat blokes in suits and hard hats in the business pages look smug and contented, that’s my rule of thumb. Consider buying when those CEOs have been shuffled away for wiry upstarts who appear in the same pages talking up the forgotten sector again.

This time – so far – it’s different.

London office space is holding its value, and rents remain high, too. Brexit fear has not yet dinged the hard bricks and mortar assets themselves, just their stock market proxies.

Those discounts to net asset value we see with certain REITs may reflect an irrational disconnect with reality on the ground. Perhaps some of the beefy property blokes will be proved right to be more confident about Brexit than the flighty liberal elite fund managers selling down REITs?

Alternatively – more technically – it may be that hedge funds and the like who are very pessimistic about Brexit have turned to shorting the shares of listed property giants as an easy way to express that view. (The funds are unlikely to own physical offices to dump).

Does this make the big London office REITs more of an opportunity this time – because it’s a phony war – or less so – because the usual cycle hasn’t yet played out from peak-to-trough?

It’s something to think about.

Commercial property and your portfolio

In my next post I’ll recap the broader investment case for commercial property, whether you’re an active or a passive investor.

Why do some model portfolios include specific commercial property exposure, and how does the asset class differ from equities and bonds? What if you already own your own home?

The exciting bit is over, but the important stuff is to come. Subscribe to catch it.

Disclosure: I have various beneficial interests related to London property.

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