Trouble getting on the housing ladder? There’s an ETF (or several) for that.

Ah, the likely murmurs of stone-faced City workers I pass in the morning: just keep earning the paycheque; have to pay the mortgage.

I’ve written before about my general thoughts on buying a house.  I was burned in the bubble-pop of 2009, so perhaps I’m jaded.  In any case, here are my general thoughts:

  • Pros of buying a house
    • Decorate it as I (or more likely, my wife) see(s) fit
    • A nice feeling
    • A diversifying investment, with the opportunity for very high leverage
    • A real option: if things get very bad, I can try to convince my wife to allow a lodger or two
  • Cons of buying a house
    • Continuous repairs + taxes + insurance
    • Huge capital outlay
    • Extreme illiquidity, such that valuation is very tricky and transaction costs are high. These effects are multiplied by the leverage used
    • Reduced financial and physical flexibility: harder to move for whatever reason

I like the diversifying aspect of housing, so can I get the good without the bad?  The short answer is yes, I can get the investment characteristics of housing without buying a house.  A good example is the iShares Dow Jones Real Estate ETF (IYR), which contains a basket of real estate holding companies, REITs, and developers.  The performance of the fund tracks the Case-Shiller 20-city Housing Price Index quite well:

No need for bricks or mortar.  Source: Quandl and S&P.

No need for bricks or mortar. Source: Quandl and S&P.

The fund is a bit more volatile than the index, which is probably at least part due to the illiquidity of measuring house prices.  In any case, the correlation is reasonable, and the major trends are captured.  The ETF is liquid, with OK-ish liquidity on the options for those wanting a leveraged investment.

As a kicker, the dividend yield for IYR is about 3.5%; that’s probably a bit lower than the net rental yield on a buy-to-let, but at least no one calls in the middle of the night needing a toilet unblocked.

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2 thoughts on “Trouble getting on the housing ladder? There’s an ETF (or several) for that.

  1. Nice Post (Where do you have time to do this..!). Just a couple of points. As you might know this is my specialist subject, so can’t resist:

    I wonder about the diversifying aspect of property generally. The graph you show could equally be Case Shiller but could also be the S&P 500 (albeit that is back to its previous high). Property as an asset class is pretty correlated to stocks and other things that follow the economic cycle, the only difference being because the market is less liquid it can take less time for bad / good news to get impounded into the price (the last crash being an honorable exception).

    An EFT which holds listed equity will also be more correlated to stocks than the underlying asset class, since people will sell property companies when the stock market goes down even if the underlying assets haven’t budged in value.

    A different argument is that you should probably hold property as part of a 1/N asset portfolio anyway. Although most ordinary people have *way* too much house in their portfolio. The average (mean) family in the UK asset breakdown something like 50% of annual income in financial assets, +200% in UK property, -150% mortgage debt. Not very diversified and quite leveraged.

    Finally there are times when property as an asset class looks cheap, and that seems a good reason to buy it, although I don’t think its so much cheaper than equities to justify a big overweight right now.

    Now I can understand it if you are trying to hedge your implicit short on property with an ETF, rather than looking for diversification.

    [You’re short on property until you own your ‘last’ house. Let me explain. If you’re renting, and rents follow house prices, then you have short equal to the NPV of your future rental payments. If you’re rent is 20% of your income then you are short a house worth probably 3 times your income!
    If you buy a starter home you have short equal to the difference between the price of your ‘last’ house and the house you are in now, since you’ve only got a partial hedge on your ‘last’ house.]

    But is this a great hedge? Isn’t the ETF you refer to (which I’ve held myself in the past) mostly tracking commercial property? And given it’s also US based, and you’re currently renting in the UK, there is some basis risk there.

    No easy answer to this. You used to be able to spread bet UK property prices but I can’t seem to find anyone doing it anymore.

    I guess Bob is disappointed:

    http://cowles.econ.yale.edu/P/cd/d16a/d1648.pdf

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  2. Thanks Rob. You’re right to question just how much IYR would track house prices, rather than just overall stock markets. We’d need a longer track for IYR to get more assurance there.

    The holdings of IYR seem pretty diverse. Yes, plenty of commercial (including things like cell phone towers and the like), but around 20% or so based around residential mortgages/housing. So not exactly like buying a house, but definitely more ‘property beta’ than a single residence, I imagine.

    I suppose one option for those bullish on UK property (are there still people like that?) would be a peer to peer lender such as lendinvest.com or landbay.co.uk. Not much of the upside, but interest rates are quite a bit better than bank deposits.

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