If your ability to buy a home is determined by your salary and your salary determines your lifestyle, it follows that there’ll be some relationship between the value of your home and your pension pot at retirement. Assuming you want to keep your home in later life and maintain your usual lifestyle, that is.
The attractions of property investment
There are many attractions to buying your own home beside the emotional benefits. For me, the main one is being allowed to invest with 90% gearing to buy individual houses in the UK.
I’d rather own a slice of the global economy than an individual house, no matter how cosy, but I’m not able to borrow 9 times my stake money to do so. I like my house – but it pays me no income and needs constant, further investment to keep warm and dry. Multi-asset investments are pretty much ‘fire and forget’.
The second attraction on my list is returns - those on property have been very good, at times. The average detached house in England is now worth £480,620 (June 2023). Over the past 10 years the average annual increase in its value has been 5.7%pa – compared to 5.3%pa from a Parmenion Risk Grade 5 Multi Option portfolio (the Risk Grade 10 portfolio has averaged 7.8% growth a year over this decade).
But it's gearing that makes the big difference. Your profits from house price inflation are measured against an amount of investment which you could never afford without the mortgage debt.
Achieving a balance
A common strategy for buying your home is to ‘max out’ on your ability to buy, hopeful that interest rates will behave themselves, your career will progress, climate change isn’t a problem and that your chosen location doesn’t go to the dogs.
This tends to mean that when we kick off on the property ladder we don’t have a penny to spare. The last thing on our minds is making room in the budget for long term investment, having just laid a big bet on somewhere to live.
But as time goes by, and money gets less tight, it’s important to look carefully what that marginal, spare income could be used for. Top of my list is retirement saving. You can’t take advantage of gearing – but you do get tax relief.
Consider a 65 year old’s situation. The average value of a detached house in England when they were 40, 25 years ago, was £107,000 and you’d have needed a £35,000 salary to get a mortgage to cover that. A 100% mortgage would have been available. The equivalent salary today is £80,000, and this assumes no career progression. For that individual to retire on two-thirds salary including £10,000 in State Pension – let’s say, drawing £40,000 in real terms for life – would cost £900,000 if you bought an annuity and you would have a fair chance of a good outcome with £800,000 in drawdown at mid-risk.
In other words, it might be helpful, as a generalisation, to aim for twice the value of your home in pension, if you want to stay put, not take equity release, keep the place looking neat and tidy and keep up with the neighbours’ expectations.
To achieve this means saving twice as much in pension, including tax relief, as you’re paying off your mortgage debt, if property and investment returns go up in lockstep. Of course, if a little more investment risk is an option, taking more risk might be well worth the stress, if it could make retirement more affordable or bring it a little closer.
Patrick Ingram will be debating the main challenges advisers face when giving advice on retirement income with a range of independent experts and thought leaders in a new 3 part Let’s Talk Retirement webinar series. Follow us to keep up to date.
This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity.
Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.