Property isn’t the money spinner we’re made to think it is

Rooting through the attic recently, a pile of repair and renovation invoices for a former home came to light.

The house was built early last century as a head gardener’s house on a country estate in a style that might be best described as mock Tudor, a pretty house in its country setting nevertheless, but one that required a lot of maintenance to keep in good order.

Repair costs, however, could be seen, alongside mortgage repayments, as a cost of accommodating the family, a consumption choice little different from purchasing food, drink, clothing and everything else that accompanies day-to-day living.

Quite different were bills for upgrading and extending the property, improvements done over the years in the expectation of a decent return on invested money.

Upgrading after all is what millions of owner occupiers do and, in the long term, supported by a number of house price indices, the returns appear to be very good, suggesting that an investment in property is one of the wisest of all investment choices.

But are things quite so? My pile of invoices did set me wondering whether residential property might not be the sparkling asset class it is often said to be.

To see why, let us dig deeper into the way the return on housing is commonly measured, which means looking a little closer at the much touted house price indices. The better known ones are compiled by Nationwide Building Society, Halifax and the Office for National Statistics (ONS).

They track each other fairly closely despite slightly different approaches. Nationwide and Halifax use data from their monthly mortgage books (Lloyds Banking Group in the case of the Halifax), the ONS includes a not insubstantial number of properties that are cash purchases, sold for full market value.

Nationwide and Halifax data are at mortgage approval stage and therefore represent forward indicators of price changes; ONS figures are based on returns to the Land Registry on completion of sale and lag building society figures by a few months.

The raw data is adjusted so that each index represents the price of a “typical” house, bearing in mind that only a very small proportion of the housing stock is sold each month with no guarantee that any month’s sales are a true cross-section.

Adjustments are made for factors such as property type (whether a flat, detached house, etc), whether new build or existing, region of the UK and type of local neighbourhood, number of rooms, bedrooms and so on. This allows for price estimates for every type of property in every region, even if there were no sales.

It also allows for corrections when happenstance means that the number of sales in a particular time period and area have been skewed in favour of a specific dwelling type.

Bearing in mind that elaborate checks on the methodology are undertaken from time to time and fine adjustments made, one can have great confidence that the latest published price indices give an accurate picture of current and past market prices.

On the other hand, as a measure of the true return on invested money there is a major snag with the price indices.

Because of the craze for home improvements, housing quality is continually changing and largely for the better, which means that the compiled price indices are not, strictly speaking, measuring like-with-like.

This year’s housing stock is of a higher standard than it was a year ago and price indices are reflecting in part this higher quality without considering, and offsetting, the upgrading expenditure.

So how might we approach the issue of adjusting indices for that component due to the gradual but steady upgrading of the general stock of existing property?

One approach would be to calculate overall spending on capital improvements to existing dwellings and deduct this sum from the imputed increase in the value of the stock as measured by the price indices.

Annual surveys undertaken by organisations such as Houzz and Home attempt to measure the nation’s spend on home improvements, spending that apparently runs into tens of billions of pounds annually.

Unfortunately, the distinction in these surveys between expenditure on repairs and maintenance (to maintain the property in a steady state) and that on enhancing the overall quality of the property (investment) is fuzzy.

Another, albeit equally inconclusive, insight is provided by the Valuation Office, a branch of HMRC, that advises local authorities on property values for the purposes of levying council taxes.

The Office keeps a close eye on those improvements signalled by the grant of local authority planning permissions.

When permission is granted, what is termed an “improvement indicator” (IC) is listed against a property, so that when next sold, an examination is made of whether the improvements are of such a magnitude to propel the property into a higher council tax band.

We don’t have a time-series of the number of properties with ICs but following a Freedom of Information request some years ago, we know that at the very end of 2018 there were 1.65 million dwellings (at that time over 6pc of the total) in England and Wales with an IC attached.

We also know that as a rule 20pc of such properties merit an increase in council tax banding and, therefore, one can presume are upgraded to a considerable degree.

However, this large number of IC properties possibly scratches the surface. There are numerous other ways of upgrading a property without needing planning permission – upgrades, for example, that fall into the category of Permitted Development Rights.

Owners of houses in England built after 1948 and not in protected areas, can add modest extensions, undertake careful loft and garage conversions, and add garden rooms, without having to seek formal permission of the planning authorities.

And not to be forgotten, although it often is, are monies spent on gardens that surround and enhance many properties.

Too often these more minor, but still costly, adjustments to house quality are forgotten about by industrious owners until, occasionally, a paper pile in the attic comes to light.

Unfortunately, the conclusion is that we do not appear to have reliable estimates of overall capital expenditure on upgrading the national stock of existing homes.

It appears on the surface to be a considerable sum (ignoring, of course, the freely given time spent by owners planning alterations, which sometimes they do themselves).

Clearly house price indices, by not adjusting for enhanced quality brought about by refurbishments, upgrades and extensions, give a false impression of investment returns, but how false is difficult to say without further research.

What is required is an adjusted “constant-quality” index, inflated prices minus investment expenditures, (arguably excluding new build from the modified index). This might turn out to make little difference but that is unlikely.

Either way, and bearing in mind the importance of housing and its price level for perceptions of inflation in general and for taking a measure of the economy’s pulse, there is a strong case for the ONS or Bank of England’s research department undertaking further inquiry.

David Starkie is an economist and senior associate with Case Associates