Property or pension — which is the better investment?

People in the Anglo-Saxon world — Britain especially — are often obsessed with property investing. For a long time, from around the mid-1990s onwards, the housing market went up and up in most countries. But things have taken a different turn in 2023. According to the latest data from Halifax, UK house prices suffered their sharpest annual drop in 14 years in August, as higher mortgage costs dragged on sales. On average, prices were down 4.6% on August 2022. House prices have recently started to drift lower in the United States too.

The Investing Show, episode 14 Is residential property still a good investment?

Abraham Okusanya: Hello again, Robin. What topic have you in store for our viewers today?

Robin Powell: Well, I thought it was high time we looked at residential property and whether or not it’s still a good financial investment. As you know, Abraham; Brits are obsessed with property and house prices and for a long time, the housing market went up and up. Things have taken a different turn this year though.

Abraham Okusanya: Yes, I keep seeing surveys showing that house prices are falling but, as with equities, nobody really knows where prices are headed next. Who have you been speaking to?

Robin Powell: I’ve been interviewing Norma Cohen. Originally from New York, Norma worked at the Financial Times in London for 26 years. In that time, she specialised in pensions and investing – but also for a long time in property.

Abraham Okusanya: So what’s her take on property and whether or not it’s still a good investment?

Robin Powell: Norma’s view is that houses are primarily homes and not investments. She strongly favours investing in equities over property, and she’s concerned that many young people in particular underestimate the disadvantages of property. For example, she dislikes what she calls “lumpy investments” and says houses are the lumpiest investment you can buy.

Norma Cohen: Transaction costs in Britain, just for example. When you add in stamp duty, solicitor’s costs, exchange of contracts – costs can be something like five to six percentage points either side of a property, compared with a fraction of a percentage point for, let us say, equities or gilts. So they’re expensive to transact; and moreover, when it’s an illiquid asset, you do not know for certain what that asset is worth until you try to sell it. And looking at a lot of the commentary in recent days about mortgage rates, it’s interesting to see that there are predictions that some house prices may be worth less than the owners thought they were when either they bought them, or perhaps when they borrowed against them. To be fair, thanks to vigilance by regulators, the kind of over-borrowing that we saw in the run up to the great financial crash of 2008-2009 has been greatly, greatly reduced. But people who say things like, “my house is my pension fund,” are really placing themselves in a very, very precarious position. It may be that you can sell your house and buy something to live in, which is smaller and less expensive and be able to take some cash to live on – but a house is not an income.

Robin Powell: Another factor, which Norma Cohen says people often fail to consider, is that when the time comes to downsize and to free up capital to fund their retirement, leaving the family home can be much harder than you think. Many people end up leaving it too late.

Norma Cohen: One of the things to look at is the reluctance of older adults, particularly in this country, to downsize and try to move into a smaller property. Some staggering percentage of houses in this country are occupied by one or two people who are over the age of 65. It’s certainly under-occupation big time. And part of the reason that there is this reluctance to downsize – yes, there is this a comfort factor remaining in your own home – but it’s also hugely difficult, particularly for older adults, to pack up a lifetime of belongings, memories, mementos, and so on, and to move. So the state of California is forming support groups to help older adults move out of their under-occupied properties. And it’s possible there would be some genuine public policy reasons to support creation of similar advisory firms, or help firms, at local authority level in Britain that could help older adults to move out of their under-occupied properties and into smaller, more suitable, easier to manage, and lower cost to maintain properties for older adults. Part of the difficulty in this country is the ability of retirement living to extract excessive charges – service charges – from residents who do not actually own the flat they are living in in their retirement facility. They are only leasing it, which is just being a renter. And the fees that are charged to these people are exorbitant. You never sell a retirement property at anything like the price you paid for it.

Robin Powell: UK property prices have fallen in the spring and summer of 2023, making houses more affordable. But Norma Cohen still urges first-time buyers to be cautious, and certainly not to consider renting as a waste of money.

Norma Cohen: I had this argument with my son, who with his girlfriend wants to buy a property; and he said to me, “I’m just wasting my money by renting.” “No, you’re not,” I said, “you are buying housing services. You’re buying accommodation services.” That’s what rent is. A house is a functional asset: it serves a purpose. It allows you to live in it, to occupy it. It’s not the same thing as providing you with an income. It only becomes your pension fund if you can sell it, crystallise all the gains that you’ve made in capital value over the years, and use those gains to live on in old age. In only the narrowest sense is your

house your pension fund. And unless you have thought clearly, logically and neutrally about how you’re going to downsize; your house is most certainly not your pension fund.

Robin Powell: So what about buy-to-let property investing? Well, tax changes and higher interest rates have made buy-to-let less attractive and, in Norma Cohen’s view, investing in shares via a pension is a much better option.

Norma Cohen: Buy-to-let became attractive when the cost of borrowing to buy the asset in the first place collapsed, and that’s what happened after the great financial crash of 2008 / 09. All of a sudden, the differential between what it costs to buy a house to rent it out, and what you could achieve in rent widened out, and they started to look like very attractive investments relative to what was available from other asset classes – and many people piled in. There are some unique aspects in Britain that make ownership of land particularly attractive. However, there is a big push on now to change underlying land law, which dates back to the feudal era of medieval times. And, to the extent that that is eventually successful, it will diminish the value of the land that buy-to-let houses are built on and it will also diminish the rents that buy-to-let investors are likely to be able to extract. And that’s not a bad thing! If housing becomes more affordable in Britain, that’s a good thing. We keep talking about getting a foot on the property ladder in this country, and that is also the way it’s talked about in many other countries. We assume that the property ladder goes one way. Up. No, it doesn’t. And anyone who has any appreciation for British history, American history, will know that.

Robin Powell: So Abraham: lower prices are a good thing, according to Norma Cohen. Would you agree with that?

Abraham Okusanya: I’m not sure I agree. House prices are falling a bit. But it isn’t really any more affordable to buy or to move than, say, a year ago – no thanks to the fact that mortgage rates are least two to three times what they were a year ago. And – if you are banking on your property as your pension – I am not sure you’d consider falling property prices a good thing.

Robin Powell: To play devil’s advocate for a moment: some people might say that both you and I, Abraham, are bound to advocate investing in equities over property; and there’s no denying that houses have been an excellent investment since the mid-1990s.

Abraham Okusanya: No, absolutely not. And you know, I was looking at some data recently. Apparently, house prices have grown by over 5% a year after inflation over the last 30-odd years. And so, yes, there’s been a massive increase in house prices. And, therefore, if you think of property as an investment – compared to equities, I think in terms of returns, equities are still more attractive, but we can’t take that away from property given the growth that it’s seen in the last couple of years.

Robin Powell: I’m sure there’s a generational aspect to this debate. Norma Cohen can remember several housing downturns over her lifetime. I certainly remember the housing crash of 1989, which left millions of UK homeowners in negative equity. We are nowhere near crash territory today, but perhaps the recent downturn will provide a much needed dose of reality.

Abraham Okusanya: It does. Or, I hope so at least, anyway. I mean, you’re already seeing in the data that there are far less transactions going on. So there’s about 25% less in terms of housing transaction compared to, say, a year ago. And then of course, if you think about some changes in the taxation of buy-to-let properties; there’s a lot of talk about buy-to-let landlords essentially putting their property on the market because it’s not as tax-efficient as it used to be.

Robin Powell: For me, Abraham, one of the main reasons for investing in shares via a pension – as opposed to investing in property – is that there are, at least for now, some very big tax advantages to it. Perhaps not enough is made of those.

Abraham Okusanya: Yes, indeed. When you think about, say, pensions – investing in the stock market through pensions, for instance: you have tax relief on your contributions and that means there’s more money going into the pot. And then of course the investment grows virtually tax-free. And the same applies to ISAs. You don’t get tax relief on ISA contributions, but the investment grows within the ISA wrapper tax-free. If you compare that to, say, holding a buy-to-let investment in your name, for instance, that is not very attractive. There are ways around this where people put these properties in a limited company structure. But the thing I say to people when they’re thinking about property investment, or buy-to-let investment, is that: think about this as a business. Because that’s how the taxman – the HMRC – considers it, as a business. And the work that you have to do is very different than what you do with an ISA. As somebody recently said to me: you don’t get a phone call in the evening from your ISA or your pensions telling you that the boiler has broken down. You do with your buy-to-let investments.