Don’t bet the house on it
Rathbones’ head of asset allocation research Ed Smith explains why advisers should encourage their younger clients not to rely on property wealth when it comes to funding their retirements.
By Edward Smith
If any of your younger clients, or the children of your clients, are looking to property for funding retirement, it might be wise to consider a plan B. Many look to solve their financial woes by selling the family home and moving into a smaller model, but we question if this option will be sufficient for future generations, if indeed it is available at all, and encourage you to discuss alternative solutions with them.
Left out in the cold
So, why might selling the family home not be a good plan? Firstly, millennials have missed out on some huge property price hikes that are unlikely to be seen again in their lifetimes. UK house prices boomed between 1996 and 2006, as mortgages became increasingly easy to obtain and property was ‘financialised’. When interest rates fell, so too did the primary cost of finance alongside the opportunity cost of holding other assets; prices shot up. The courting of foreign buyers and some generous tax policies provided further support. Prices rose again between 2012 and 2017 in areas which lacked supply.
The general state of the economy hasn’t helped either. Real interest rates cannot fall by another 5% as they did in the housing boom years, and UK households are suffering the most prolonged stagnation of real pay in 150 years. Average house prices have significantly diverged from average pay and rates of home ownership have collapsed. Almost 60% of baby boomers owned their own home by the age of 30. Only 30% of millennials do at this age.
Just renting a home costs this generation a small fortune - their monthly bill accounts for almost a quarter of their post-tax income when baby boomers paid just over 15%.
So, what does this all mean? The huge gains garnered by the older generations have been financed, effectively, by the indebted and rent-locked young. Rising property prices function as a redistribution of wealth to today’s homeowners from today’s non-homeowners who must pay higher rents and/or a higher price to own the same property in the future.
Just a pipe dream?
Their long mortgages won’t help them either. Many millennials that managed to get themselves on to the property ladder will probably still have outstanding mortgage debt as they approach retirement, reducing any ‘income’ they would receive from their home. Mortgage servicing costs may be lower for millennials, but their mortgage terms are longer, so lifetime mortgage costs will be higher. Millennials are likely to be paying off their mortgage well into their 50s and 60s, meaning they’ll have less money to save for their retirement during those prime saving years.
Mortgages aren’t the only challenge. Saving for a deposit takes the younger generations so much longer than it took their predecessors, which delays the house purchase. Later purchases mean less time to benefit from any rise in real house prices and there is a greater risk of being placed in negative equity in retirement because of an economic downturn.
Don’t look at the past
Advisers can help their clients by raising awareness of some of these issues. As we know, past performance is no guide to the future, but when it comes to property, most turn a blind eye to that disclaimer.
What is the biggest worry? We think it’s the trade-off between owning a home and saving for a financially secure retirement. Nearly half of UK workers think that investing in property will deliver among the best returns on offer and only 22% would say that about personal pension schemes. We are concerned that other forms of saving and retirement provisioning are being ignored in favour of home ownership.
In the face of all of this adversity, the dream of home ownership and its use as a retirement asset is absolutely thriving. Research shows the younger generations are even more likely to think they will use property to finance retirement than older ones. This is slightly alarming, given they are far less likely to ever own any.
So, you can help your clients see that property may not be the answer to the younger generations’ financial woes that many might assume it is. As we noted in our first blog in this Too poor to retire series, the only solution seems to lie in some combination of working more, saving more or spending less.
Although it may be bad news for those planning to fund their retirement in this very way, it’s a great opportunity for advisers. Engage the younger generations today by explaining the pitfalls of relying on their house. These discussions could provide a good grounding for successful, long-term advisory relationships.
Our report presents some uncomfortable truths that will confront us all. But there are some steps you can take. We hope Too poor to retire will encourage some helpful intergenerational dialogue about investing for the future. You can read the full report or a summary version on our website.
Photo by Arno Smit on Unsplash.