Do the investment sums still stack up?

My job involves speaking to a lot of different people across many diverse segments of the wider
property ecosystem and a common thread lately has been a more conservative view about potential
future long-term capital growth. How likely is that? Would it kill property investment? Or would it
just need to be looked at differently?

What’s the logic for a structural change

First let’s look at why people are expressing a more conservative view. These factors include: interest rates have already trended down to a low level, the shift to two income households has already happened, we now have debt to income ratio limits, the tax system may be more restrictive in future, and housing supply has become more responsive.
Now, I’m always wary of saying ‘this time is different’, because quite often it’s not. That being said, I do find these factors quite compelling, and then if they do become reality you can overlay an extra (self-reinforcing) driver, which would be a more conservative mindset as well.

From long-term growth over the past several decades of 6-7% compounding annual rises in house prices, perhaps the future might be 4-5%. Many are now arguing this would a really good outcome, as we don’t get richer as a society by buying and selling each other’s houses at ever-higher prices, although it’s also true that real estate activity does drive genuine economic activity.

But we still need property investment

Of course, let’s be clear that this is still growth in values over the long term, just a bit less than before. Indeed, there’d still be general inflation in the economy – including for wages and construction costs – and the population will tend to rise too. (It’s also worth noting in the margins that a capital gains tax system needs price growth for any revenue to actually be raised.)

Meanwhile, although better affordability over the long run would allow a greater share of people to buy their own house, it also needs to be accepted that property investment from private households will still be required. After all, there’s always a chunk of the general population that needs or wants to rent their house, and the government can’t cater for all of that demand.

So it may just need a different approach

With all of this in mind, in a world where capital growth isn’t as strong, property investment would also look different. Some investors may just accept a lower total return (or indeed look at other asset classes altogether), but others will approach it differently – aiming for the same return as before but generating more of it from cashflow/net yield. Certainly, this would make sense if interest deductibility was permanently reduced and hence losses didn’t dampen tax bills as much.

One way of doing this would obviously be to reduce costs by putting in larger cash sums (rather than taking out big mortgages), but other approaches could include ‘value add’ in terms of building an extra bedroom or different floor layout to increase the rent, or looking at different properties right from the start. For example, smaller dwellings tend to have higher initial yields anyway.

A balanced view is almost always justified

It’s easy to focus too much on the most bullish or bearish views when it comes to any kind of investment. Property does seem to be changing, but being a landlord can still be a great option.