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Robin Powell: You’ll often hear people say they don’t invest in equities because their home is their pension. Some people buy more than one house and rent them out. For many years, from the mid-1990s, house prices rose steadily around the world. But Jens Hagendorff, Professor of Finance at Edinburgh Business School, says you need to exercise caution.
Jens Hagendorff: A lot of people who say their house is a pension - and they shy away from investment in the stock markets - underestimate how risky an investment their house indeed is because it’s very volatile. Around the globe, there’s a long history of property booms and busts, and the price of that particular asset is very volatile indeed. And perhaps more importantly, you cannot diversify. Most people have one home. Maybe they have one home in a buy-to-let investment, but that is not diversification. In terms of stocks, it’s very easy to have a broad portfolio of stocks across a country, across the globe… at minimal expense. And these are all factors that make housing, actually, quite a risky investment; and probably a lot riskier than people who invest in it realise.
Robin Powell: Another problem is that many people under-estimate the expense of maintaining a property. And simply buying the property in the first place incurs considerable expense.
Jens Hagendorff: To use an economist’s term: the transaction costs are just huge. Meaning, your stamp duty, your fees, the time it takes to sell a property outside a boom period is very long. And people who say that they want to downsize also need to see, often, what is it really that any money they release from downsizing buys them in terms of a pension? Because, a few hundred thousand pounds (which may be the difference between the property you occupy and the property you move into when you downsize)… that sounds like a lot of money, but when you turn it into a stable, risk-free pension, it may just translate to a few thousand pounds a year.
Robin Powell: As with equities, the less you pay for property, the less likely you are to have your fingers burned. So, unless you really can afford to, don’t pay over the odds.
Jens Hagendorff: The factors that go into purchasing a house as an investment should be very similar to those that go into purchasing stocks. Meaning there has to be some sort of reference point in terms of value. With houses, I would usually recommend to use the rental income that you can generate from a house as a reference point. And if you’re satisfied that the rental income that you can achieve from that property makes for a good cashflow based on what you’ve invested, it makes for a sound investment.
Robin Powell: And one more thing. Remember, you have to live somewhere in retirement. So, if your home really is your pension, you’re going to have to find another one.