Sunday 1 December 2013

My Property is My Pension (because of Leverage)

Within this great country of ours we have what appears to be an eye watering level of debt.  We learnt this week that household debt in the UK, including mortgage debt, has now grown to £1.43 trillion or £28,489 for every adult. We however need to be careful when digesting this type of information as what really matters for the Average Joe is actually Wealth which is the market value of all assets minus those debts.

The Office for National Statistics Wealth and Assets Survey, published on the 12 July 2012, tells us that the total Wealth (including private pension wealth but excluding state pension wealth) of all private households in Great Britain was £10.3 trillion.  That’s £373,000 of wealth for the Average Household and even if we switch to Median values, to try and remove some of the extreme Wealth held by the 1%, it’s still £210,000, making the debt seem a little less serious on the average (I acknowledge that the poorest probably have no wealth and a lot of debt with the richest having lots of wealth and little debt but that’s for another day).  32.9% of this wealth is Net Property Wealth which is the value of the property held minus the value of mortgage liabilities and equity release.  Not everyone is lucky enough to own a property but for those that do the Average Net Property Wealth is £195,000 and the Median is £148,000.

With so much Wealth tied up in Property it’s no wonder I still hear and read of people using the My House is My Pension statement.  This is in my humble opinion is a statement from someone who really hasn’t quite understood how they have generated all that housing Wealth they now possess.  Have they really stopped to understand how with average earnings of £474 per week and a property Compound Annual Growth Rate of 5.4% since January 1995 (Land Registry data) so much Wealth has been generated by property.  There are of course a number of ways this has occurred including the more obvious time in the market and riding the rapid rise in property values between the mid 90’s and 2007 but there is also another method that all those with a mortgage are employing which I don’t think the vast majority even understand.  This is Leverage or Gearing which is a financial technique used to increase gains or losses by giving the investor the return on a larger capital base than the investment personally made by the investor.  In home owning speak the investment is the house deposit and the capital base is the purchase price of the house.  The leverage is achieved by taking on a mortgage.

Let’s demonstrate with a simple example that looks at two punters, Average Bob and Average Joe, who each have £10,000 to invest.  Average Bob understands that a mortgage is just money rented from a bank and that the interest portion is then really not much different to just renting from a landlord while the principle portion is an investment made in property.

Average Bob therefore chooses to rent a home for his family and makes a £10,000 investment in the Vanguard LifeStrategy 60% Equity Fund.  A year passes and the Vanguard Fund increases in price by 5%.  Were he to liquidate his Vanguard Fund the return made by Average Bob would be (£10,000 x 5%) / £10,000 = 5%.  Average Bob is using no leverage.

Average Joe goes in a different direction.  He heads over to Yorkshire Building Society and uses his £10,000 to secure a 95% LTV mortgage (as an aside why are people taking on the complexity that comes with a Help to Buy loan when 95% LTV mortgages are once again available...)  on a £200,000 home.  A year passes and our Average Joe’s home has increased in value by 5%.  Were he to then sell his home the return made by Average Joe would be (£200,000 * 5%) / £10,000 = 100%.  Average Joe is using leverage to generate a return that is 20 times larger than Average Joe.

Given the huge rise in property values since the mid 90’s it’s therefore not hard to appreciate how with leverage a lot of UK residents are sitting on big property wealth leading to the My Property is My Pension statements.  It’s however important to remember that past performance is not a guide to future performance.  Turn that 5% rise into a 5% fall and Average Bob still has an investment worth £9,500 while Average Joe has lost the lot.

I should reinforce that I don’t have a problem with leverage or gearing in principle.  I just wish that people had a stronger financial education and understood concepts like Leverage, Compound Interest and even more simple things like how to calculate investment return.

As always DYOR.


  • I understand that the examples presented are extremely simplified and make no account for complexities including inflation, costs, duties and expenses.  I have done this as in this post I wanted to simply demonstrate what leverage is rather than get bogged down in a complicated piece of analysis that would pass over the head of many.


  1. The extra money gained through leverage comes straight out the pocket of the next generation who have to stump up more for exactly the same house in real terms.

    I do have a problem with that. It's f*cking disgusting.

    1. Ben, I can understand how some people resent those who have leveraged to build a property portfolio however I think the resentment should be focused on successive governments who have failed to put in place policies to help maintain a demand-supply balance for housing.

      A little about my background. As a young corporal in the Army I purchased a property at the age of 22 in 1980. As I was posted to various places in Germany I rented out my house. A few years later I realised that this looked like a good investment, mortgage costs covered and being repaid, and a small income on top. I then approached my bank manager and got another mortgage to buy a second property in 1986. I repeated this process and now have 7 buy to let properties, 3 of which have no mortgage outstanding. I also have many happy tenants, one of whom has been with me for over 15 years.

      I am not interested in house price growth and would prefer prices to be more stable. My focus is on income generation for when I retire in a few years time.

      Overall about 50% of my retirement income will come from property, for me is it an essential part of my retirement.

      For me the main issue with property prices comes down to supply and demand. We simply need more properties (or less population growth).

      Just my views

  2. Not necessarily Ben F. What if inflation and wage increases were also 5% in this case. Then the house price would be the same a year later. However, the additional benefit of leverage still holds true for Average Joe.

    I'm a big fan of leverage. Its only risk (and its a big risk if poorly managed) is not understanding the impact if house prices tumble and you are required to liquidate your assets (i.e. sell the house).

  3. Ben F is right - the reality is that house price inflation since the 1990s has screwed the younger generation in the UK (unless they have rich parents/grandparents). Wage rises have nowhere near matched 5% per annum on average since the late 1990s and due to cost of living rises it is now more than twice as expensive for ordinary people to buy a house in southern England.

    Leverage is useful if you are a fund manager or business owner, but in the case of UK house prices it has been a social disaster due to the lax lending policies and credit bubble promoted by our banks from 1997-2008. We are now in a situation where the government has to throw every policy in the book to maintain high house prices in order to avoid widespread negative equity or bank failures.

    Effectively this has resulted in a massive wealth transfer from the poorer under-40s to older generations, since the non-homeowning taxpayer picks up the bill for no benefit, in order to subsidise home-owners and keep mortgage-payers on low interest rates. Meanwhile the richest home-owners continue to hike their rents on their BTL portfolio, making it even more difficult for the have-nots to save and afford to buy.

    It is f*cking disgusting.

    1. I disagree with the "f*cking disgusting" comment.

      I do agree however that prices are too high for many and sadly they are still going up in many areas.

      The best solution would be for Government policies to either increase housing supply or reduce population growth, or combination of both. Easier said than done, there is no quick fix here.

      Historically it seems to me that Governments became concerned about the ageing population and actively encouraged 'working age' population growth (through immigration) without putting in place adequate infrastructure to support the larger population. That combined with the over supply of credit are major factors in the very high house prices we have today.

      As has been inferred, if property prices were to fall now it would create huge negative equity and possibly high levels of defaults. There is no quick fix but in my opinion we need the Government to put the brakes on property prices by cancelling schemes such as help to buy. All this scheme is doing is pushing up prices in the hope that some of the easy credit gets into the wider economy to improve GDP. It is a dangerous strategy.

  4. Those whingeing about the (patchy) good fortune of the previous generation will in turn face the whingeing of their kids ~ who will whine "you were lucky to be able to borrow oodles of cash at the lowest interest rates ever known. Taint fair!"

    Grow up & get on with it.

    1. > "Grow up".

      Says someone posting as "Anonymous".

  5. Is this the same younger generation who drive around in brand new cars, have the latest iPhones and take several foreign holidays a year? Spending less than you earn is a good first step when you're saving for a deposit.

    1. I don't know anyone "young" who is in that position, and I would wager that neither do you.

    2. We must inhabit different worlds. In the office where I work nearly everyone under 30 has all three of those things in their lives (mostly on credit of course) and many more luxuries besides.

      Buying a house is completely possible for a couple earning average salaries:
      - banks will lend 5 times salary
      - a couple each earning the median wage of £25,000 can therefore borrow up to £250,000
      - the same couple will be getting over £3,300 per month net so can easily save a 10% deposit in under 2 years

      I want to sympathise but I just can't understand why people feel so hard done by. What am I missing?
      - Do people think earlier generations had things like cars, central heating, mobile phones and holidays when they were young?
      - Do people think taking on a second job in the evenings and weekends for a couple of years is below them?
      - Are people only looking at the best properties in the trendiest parts of London and expecting those to be their first purchase?

    3. Whatever world you claim to live in (we can all, I think, hazard a guess at a few professions where trust fund babies abound) it certainly does not resemble anywhere that most of us would recognise.

      The real world, populated by facts, is one in which, over the past decade, car ownership amongst under 30s has plunged, as has home ownership, as has, surprise surprise, their disposable income. And unlike their peers in the gilded generation (to which, we might assume, beattheseasons belongs) most young people today start out with tens of thousands of pounds in graduate debt (no free education), face much more expensive pensions (no final salary pensions, nor state pension until at least their 70s), and are burdened with a ballooning national debt which will mean much higher taxation throughout their working lives.

      None of this undermines the laudable principles of a blog such as this one, which teaches that the best personal finance policy is to live frugally within one's means, and to save hard today for financial independence tomorrow. But do expect young people to be angry when, in spite of the goal posts moving ever further away, they are told they should take on several jobs to fund a mortgage 10x median salary, because they have central heating and a mobile phone.

      I'll leave the last word for now to the extremely perceptive scientist Ben Goldacre:

    4. BeatTheSeasons isn't from the gilded generation and nor is he a trust fund baby. He lived without a car, foreign holidays, gym memberships, etc in his 20s and saved up for a deposit on a house from his own earnings.

      I've provided some facts about mortgages and pointed out that an average couple can easily borrow enough money to buy an above average house with just their day jobs after only 2 years of saving for a deposit. Taking a second job is purely optional, but two older people I recently spoke to in their 60s and 80s both did exactly that when they bought their own home so it's hardly a recent phenomenon.

      DJL is right about recent economic changes but it's just too easy to rail against the world and take no personal responsibility. Those who read Mr Money Mustache would recognise that attitude as what he calls Complainypants.

  6. All right, dears, we won't embarrass you by leaving you the house.

  7. To afford my first mortgage I took a second job, the "pay" for which was free accommodation. I also saved money by running a motorbike instead of a car.

    1. Ah, a voice from the "gilded generation", nice to see things weren't as easy back then as some of the other posters seem to think.

      This afternoon all my colleagues have been moaning that today's budget announcements mean they'll have to work until they're 68 years old. I suggested they saved up for a private pension instead of relying on the government and they looked at me blankly. Apparently that's giving money to companies who are going to gamble your money away and you'd be better off buying lottery tickets!

  8. Yes, l took a risky decision to buy a tiny house with no drains, a chemical loo emptied on the allotment, no heating apart from one coal fire and a plastic bath in the kitchen. I had a second-hand 50 cc motorbike to commute 6 miles to the station and my commute was an hour and fifty-four minutes each way. My wife who worked as a teacher didn't complain. We sold it on the plans when drains came to the area.

    So don't give me that crap about how easy it all was, kids. Do you have what it takes, or are you just soft?


  9. Having just heard/read the news about the potentially poor value of annuities, I begin to think twice about investing money in my pension scheme. It makes property look more attractive. Trouble is, when I sell my property, I'm going to be liable to CGT, so how will I avoid that except by dumping a large amount in my pension? I don't have a mortgage (so no 'gearing').

  10. More like My Property is My Care Home Fees (because of The Human Condition).

  11. So Nationwide showing +8.4% for the year today.

    +14% in London.

    +21% in Manchester.

    Plus of course, the 2.1% difference between current average rental yields (5.6%) and current average mortgage rates (3.5%).

    Staying out of the property market at the moment is an incredibly expensive risk.



  12. RIT. Are you on holiday? Hope you come back refreshed.

  13. February 2, 2014, time for a new post!

    Hope, you are ok

  14. It has got to the point where the voting majority benefit from rising house prices.

    We live in a democracy where the voting majority set in place the rules of life.

    The voting majority have set in place "Planning Rules" which have the desired effect of increasing their house prices.

    The voting majority have set in place Taxation Rules and Housing Rent Subsidy Rules that benefit Buy To Let landlords at the expence of their tenants.

    The voting majority care only for themselves and take the attitude that those who are not on this artificial gravy train can go hang themselves.

    Have to publish as Anonymous since I've no idea what the rest of the "Profiles" are (or what a Profile in this context might be).

  15. Hi RIT
    Are you okay? Missing your posts!!

  16. Hi RIT
    I miss your posts and hope all is well :)