Sunday, 13 January 2008
The ghost of housing equity
Over the last few days, newspapers have been full of happy talk about the huge appreciation of house values. Supposedly, over the last ten years home owners accumulated £4.0 trillion worth of equity in their homes.
However, the most idiotic comment came from firstrung.com. It claimed that due to rising house prices "UK household balance sheets strengthened again in 2007". So despite that huge increase in personal indebtedness, rising inflation and stagnant incomes, UK household became wealthier last year. And not just a little more wealthier; household net wealth went up a tasty 9 percent.
Lets start with an obvious point; for the vast majority of households, there is just one asset in their balance sheet - their home. Portfolios with just one asset are not exactly diversified. This makes their portfolios vulnerable to sudden changes in price of this one asset. This is not what an accountant would call a position of financial strength.
But what of the household income statement? Households invariably one source of income - their job. Apart from the BTL brigade (and we will come to them in a moment), people are living in their sole asset. Therefore, it is not earning an income stream. On the liabilities side, however, there is debt. This needs to be paid off. Despite their huge price appreciation, from an income perspective, homes are simply an expense. In balance sheet terms, homes are non-performing assets. Houses certainly provide a flow of services, but unless they are sold, houses don't pay off debts. Only jobs do that.
The BTL brigade understand this point better than most. These jokers are out there trying to make a return on their houses via rents. However, all too often, these rents do not cover the mortgage costs. On a cash flow basis, many BTL investments offer extremely low and sometimes negative returns.
This pernicious idea that rising home values generates real wealth has encouraged people to take out more debt, to over consume and under save. It has also encouraged many speculate in the BTL scam. It has served to underpin the housing bubble and offered false hope that debt accumulation has no long term financial consequences.
This year, it is coming to an end. House prices will fall, and as they do, that phantom home equity will disappear. However, those debts taken out on the housing upswing are real. They need to be paid off. Then households will understand the true wealth generating capacity of housing equity.