All in the mind

If I’m honest I’ve never really understood where the extra money actually comes from when shares and the stock market rises and the same goes for houses. If my house has doubled in value like most homes in this country have since 2002, then has this extra money actually been printed? Has it been taken into account on some great balance sheet somewhere in the Bank of England? Has a note been made of the notional increased net asset value of my house? 

I assume that unless I actually sell my home then any increase is purely a ‘paper profit’. I could borrow against it, I could be taxed on it (if I were to die or pass it to my kids) but unless I actually do something other than just feeling good, the increase is never actually crystallised and therefore not recorded anywhere. I think it’s just invented money. House prices don’t form part of the mythical shopping basket that goes towards calculating inflation – neither by the way do mortgage repayments which you might think were a significant chunk of the average monthly outgoings for Mr & Mrs Joe Average, particularly today.

So, when asset prices like shares and houses rise in value, the increases isn’t physical. It isn’t real unless you decide to sell them. The other thing that I’m often reminded is that for most people, buying and selling in the same market means that prices are all relative. It doesn’t really matter exactly how much it is really worth, if you home is worth five Smarties and the house you might want to buy is eight then if your home goes up in value to say ten Smarties then the house you want to buy will go up in the same proportion. It’s all about the difference between the two – the amount you either have to save or more likely borrow in order to make the move.

We have just witnessed eleven straight years of increasing house prices. All 24 million properties in the UK have nearly tripled in value without anyone having to print a single new note. We are now in what I suspect will be a savage downturn where values could fall by up to 50% for some from their peak last year. (In Japan house prices in their crash fell by up to 80% and didn’t rise for ten years!). The point is that while we will all feel poorer, you never actually had the increased value that the papers told you your house was worth. House prices have fallen notionally but this drop isn’t recorded anywhere. No one is burning £50 notes. 

I hope I’m wrong but if prices were to fall by 50% the those who will suffer most are those who bought in the past four years. Those who borrowed against the value of their home either to finance their business, to buy a second home or possibly just to pay for a trip to DFS. Many of these 5 million will quickly find that they paid more (and in many cases borrowed more) than their home is now worth but as with a rising market this doesn’t matter unless they actually sell.  If you can afford the payments and you don’t have to sell then sit tight. 

So don’t despair, most people will find that whilst their own house is worth a lot less than they had thought it once was, when the time comes the one they want to buy will also be pleasantly less than they had expected it to be.

Think of it this way, the value of your house never really went up – it was always worth what you paid for it (plus whatever you might have subsequently added to the mortgage!). You just felt better because you were told it had gone up. Now you’re being told it is worth less but remember it is still the amount you paid that will establish if and when you have lost money. Until you actually sell it’s all just in your mind.