Thoughts on house prices and comparing asset returns

Take a look at this graph relating to the UK housing market:

People fixate with house prices and completely overlook rents. This is strange, because rental yield is an important component of the total returns from investment in housing. (Note that whether you are an owner-occupier or buy-to-let property landlord is irrelevant. An owner-occupier still 'pays rent' the exact same way a tenant does; excluding the tax implications, the fact that he is 'taking money from one pocket and putting it in the other' does not affect the amount of resources he is consuming. This is perhaps a non-obvious point to some readers; tune in later this week for a simple explanation.)

As the graph demonstrates, rental yields have nearly halved between 1993 and 2005 as a result of house price growth dramatically outstripping growth in rents (compound annual growth of 9.7% for house prices but only 4.3% for rents). There are two points that follow from this:

1. Looking at house prices is severely misleading if we are interested in how affordable 'consuming housing' - as compared to 'investing in housing' - is. It is rents, not house prices, that are the best indicators of the real cost of putting a roof over our heads.

2. House prices are an inaccurate indicator of the performance of housing as an investment. As is the case with most assets, capital gains are only one part of the equation; the flow of payments (in this case, rent) is another. In other words, it is impossible to judge how wise your choice to buy a house was simply by looking at how house prices have changed - but house prices seem to be the only thing homeowners (especially owner-occupiers) and the press focus on.

This second point applies more widely: data on historical returns to assets (be it homes or listed companies) are extremely difficult to find; yet this is what people really want to know when they ask, say, how the stock-market fared in the 1990s. We are awash with data on share prices, but what about overall returns taking into account dividend yields (and, as the friend who provided this graph points out, the increasingly important buyback yields)?

In the absence of this information, comparing the past performance of various assets is subject to large errors. Look at stockmarket and house price indices if you have to, but never forget they are far from telling the whole story.