Residential property does have an undeserved reputation for being a volatile asset. This is partly due to the fact that house price indices often quoted in the media do only focus on one thing: capital values. Combine this with the fact that there is little consistency between each index. For example:
Estate Agents indices base their data on property asking prices – i.e. vendor sentiment;
Mortgage lenders indices are based on mortgage offers but the sample size is unknown and can contribute to index volatility when lending levels are relatively low
Land Registry indices based on final sale prices – but these typically lag some months due to the time lag between a sale completion and the sale being registered as such with the Land Registry. This factor tends to be exacerbated when transaction levels are high.
It is, therefore, unsurprising that potential investors may mistakenly believe that house prices are swinging wildly on an almost daily basis.
Capital returns are also only one part of the story. When considering residential property as an investment asset, one must consider the rental income return, or ‘yield’. This income can represent a significant input to the total return, and can also serve to mitigate volatility in capital values especially if this income is reinvested.
Go to the next section for actual figures for the volatility of total returns on residential property. This helps dispel the myth that this asset class exhibits extreme volatility.
As well as providing strong returns over the long-term, residential real estate has also been one of the least volatile asset classes. In our view this is as relevant an advantage to many investors as the headline rate of return. Standard deviation of returns for five, ten and twenty years to the end of 2012 shows residential property to be less
volatile than everything except cash and, over ten years, gilts.