Is property still a good investment?
Is Property still a good investment?
Let’s start by defining property investment as a property that will be rented out, rather than a property to live in. We will mostly focus on residential property for this article but will also touch on industrial and commercial property.
Let’s examine why you might buy property as an investment. Some of the reasons (not limited to) could be:
- Capital growth. The long term growth in value of the property.
- Passive income. The regular and consistent income you receive from rent
- Ability to add value. An opportunity exists to add significant value to the property you have purchased.
- Tax efficiency. The ability to reduce your taxable income due to costs associated with running property as a business.
Property has historically delivered good returns over the long term. That is about 4% in real terms (after inflation)1 This is in line with other countries in the developed world and data collected in the US takes us back to 1927 (Shiller Home Price Index). So, with almost 100 years of data it is reasonable to expect this may continue.
If you are looking at buying property for capital growth over the long term, property is still a good option.
At the moment according to Barfoot and Thompson, the average sale price of a 3 bedroom property in Auckland is $1,119,667 (December 2022 Auckland suburb report December 2022 | Barfoot & Thompson) and the average yield is 3%. With historically low interest rates 3% was competitive. Now an investor can receive 5.10% for a 9-month term deposit with a bank. If you had $1,000,000 to invest, would you buy a property that delivers $30,000 (before taxes and expenses) or a term investment that delivers $51,000 before tax? We also have bond portfolios delivering over 5% which may also deliver capital gains at the next interest rate reduction.
If you are looking for income, other asset classes such as cash and bonds will provide greater return right now than property.
Ability to add Value
The ability to add value refers to an opportunity to add value to your property by way of creating additional income or selling a portion of it off through subdivision. Putting in a new kitchen or repainting the property is simply upkeep and maintenance. Adding value may include adding a bedroom or granny flat giving you the ability to increase your income. Alternatively, subdividing your property from one title into two or three, giving you the option to sell a piece of your property at market value. You can engage with planners to help you with due diligence and to assist you through the process.
This is a good option if you can find a property that gives you that opportunity. However, this comes with significant risks. Building costs and delays are causing projects to go over budget. That, combined with property prices dropping is causing lenders to take a very conservative approach. Basically, you need a significant amount of capital or equity behind you to make it a viable option.
Due to the increased risks, we are seeing less demand for this type of investment.
Previously, as a property investor, you were able to deduct the interest cost of the mortgage from your rental income. This meant that after a landlord deducted interest cost, rates, insurance, property management and maintenance they were often negatively geared. Yet often the rent would cover the mortgage and the landlord just had to top up for other expenses and they would get a tax refund at the end of the financial year. New regulations prevent this from happening unless you are buying a newly built house. This means that with higher interest costs and the new regulations, not only are landlords having to increase the amount they have to pay, they are also having to pay tax on the rental income. This can be a significant weekly figure.
The new tax regulations don’t apply to residential new builds, industrial and commercial property. You should talk to a tax expert about this, which we are not.
Based on what we have discussed, outside of capital growth and potentially holiday accommodation, there is not a compelling reason to invest in residential property. Property will remain unattractive to invest in until some of these factors change. Conversely, now looks like a good time for first home buyers, or anyone looking at buying their own home.
As an investor what should you do? Well, these factors will change. To really take advantage of them you will need to invest before they change.
Otherwise, it is prudent to have a broadly diversified portfolio of investments that pick up good performance of different asset classes when it occurs.
1 Reserve Bank Bulletin Vol 79 No 1 January 2016
Recognise the unpredictability
The world is filled with major uncertainty about a lot of things at the moment. How will the Russian attacks on Ukraine develop and will there be new upward pressure on energy prices? Are prices now trending down because world growth prospects are worsening? Will China’s overdue abandonment of a zero-Covid strategy lead quickly to a growth boost from Chinese tourists, or will the wildfire spread of the virus dent Chinese growth for much of the first half of this year?
The biggest question of all is about inflation. How quickly will inflation respond to higher interest rates? We never know the answer to this question in any policy-tightening cycle and this time around with the after-effects of the pandemic in play, shortages of labour, and the war, it is anyone’s guess.
Recently, in the United States inflation has come in lower than expected and wages growth has slowed. These are very good signs. But some economic growth numbers in the US and elsewhere have proved stronger than anticipated and that means inflation, whilst falling, may not settle close to the desired 2% rate for some time.
Each week the financial markets will be buffeted by up and down news regarding growth, inflation, and where monetary policies are headed here and offshore. This makes setting one’s interest rate risk management strategy difficult. It also makes it easy. No-one is ever going to be able to look back and say that the reason they choose the optimal cost-minimising strategy is because they knew what was going to happen with inflation and interest rates.
For the people who do end up optimally positioned it will be entirely a matter of good luck. In this environment the best thing to do is concentrate not on minimising cost but on minimising vulnerability to interest rate extremes. That means discussing with your mortgage adviser the degree of certainty you feel about your income for the next two years, your ability and willingness to pick up extra work if needed, the degree of flexibility in your expenses, and your ability to tolerate things going wrong without panicking.
For some borrowers this means the optimal strategy will be to fix short and be able to ride falling rates down if that happens in the next 1-2 years. For others it can mean biting the bullet of fixing three years or longer because a rate surprise upward could risk losing the house.
There is no single optimal answer for what to do – hence the current need to really be honest when discussing things with your adviser.
For additional information on the economy, housing market, and interest rates, you can subscribe to Tony’s free weekly Tony’s View publication at www.tonyalexander.nz
- Posted by Isbister
- On January 15, 2023