Are Our Houses Really Unaffordable?
In this article I will take the plunge and make my forecasts for the year ahead.
So much news has been coming from all quarters of late that forecasting is a dangerous game but not to try is avoiding the issue.
The Actions of the Reserve Bank
I have written several times on the previous actions of the Reserve Bank, and I along with many others just wonder what goes on behind the walls in that hallowed institution.
The LVR restrictions, will drag down some low deposit buyers, but I remain at a loss to see how in the long term these restrictions will be beneficial.
For this year I believe we will see further softening of these restrictions (already some new builds are exempt) but more likely more and more ways will be found to get around the restrictions either by the banks themselves or by potential buyers.
One good thing that may happen if the restrictions do bite, is to cramp the style of the Johnny-come–lately spruikers who promise fabulous wealth, no money down, pay off your mortgage, or free advice deals when all but the totally foolish know that there are no free lunches.
Time and again I have clients come to me with upside down mortgages, negative gearing and serious cash flow problems because they believe the nonsense put out by the spruikers who boast that just owning a property is an absolute guarantee of success.
Recently I had a bank manager (of all things!) who had fallen for this nonsense and then came to see me with a problem. He had borrowed from his own bank over $4 Million at concessionary rates and then he had then gone out and within 6 months had bought half a dozen expensive properties hocking his home, his parents home and anything else that wasn’t tied down. When I had analysed the cash flow the silly fellow was stumping up $8000 a month (!) to hold his portfolio together. I tried to tell him that he would be broke inside 12 months but he wouldn’t listen. Inflation would save him for sure was his belief, and nothing I said would change his mind and face reality. With that sort of block-head thinking I declined to have him as a client.
Stop press: As I write this the reserve bank has announced that personal loans and credit cards no longer have to be taken into account when calculating 20% deposits. This means that effectively the LVR rules have been watered down to almost nothing. Anyone with too smaller deposit can top up with personal loans, second mortgages, or credit cards.
From all sides bleating economists keep calling for the Reserve Bank to increase the cash rate from its current 2.5%.
Their calls are backed by breathless journalists who job is to create a fresh shock-horror headline headline every day of the week without real research.
Be careful what you wish for.
If rates are increased I would imagine it would be by as little as 0.25% to start with and maybe another 0.25% later.
Beyond that would be hard to forecast.
It would be an extraordinary move as NZ would then be the first country in the world to raise interest rates.
With Europe in the doldrums, Australia likely to cut rates and the US just lifting, and Japan and China still very benign, it’s going to get very interesting as the NZ dollar risks going through the roof as a result.
In any event if the cash rate is increases by a quarter or a half percent the banks seem to have priced that into their lending rates all ready .
What with competition and borrower resistance it wouldn’t surprise me at all, if actual mortgage rates stayed more or less where they are at present.
Of course the building industry would take a knock as buyers hesitate so expect some howls from that quarter.
Any interest rate rise will be done more for “shock” value then effectiveness.
It could well force the market to hesitate but I believe given a month or two, it will be business a usual.
Also note that a paper-thin inflation rate as we have at present risks deflation, the ugly brother of inflation.
If you think inflation is bad, deflation is a 100 time worse.
The slightest knock to the economy could spiral into deflation and aggressive interest rate rises could be just be the catalyst needed.
Maybe one good thing will come out of it all.
If interest rates rise, more and more people will choose renting as the cheaper option.
Normally I avoid getting into politics but it can’t be ignored in the present market, especially as the heat and light generated by
the rising market cannot be ignored as it is a very major topic of discussion.
This is election year and for better or worse the next 10 months will be filled with rhetoric, accusations, threats, wild promises, bribes and exaggerations.
This has a destabilising effect on the market- any market in fact- so cool heads are needed.
I have been through at least 20 elections as I recall and it has always been the same.
Who ever gets into power immediately becomes sober, serious and conservative and all the promises, threats and accusations drift away or are watered down.
I do believe the coming election will be more vigorous than many others past, so fireworks will be the order of the day.
Just remember that whatever is said or done, people have to live somewhere, work somewhere, farm somewhere, rent somewhere, and retire somewhere.
Any political party that destroys values, creates burdens, punishes hard work or interferes in free enterprise will be out of the door in a blink of an eye.
It will be business as usual for experienced investors and may indeed, create bargains for the canny as the naïve panic and rush to the exists.
Bearing on mind the above it should be a good year for property.
My developer mates tell me that the prices of materials, approvals, consents, insurance and all the other cost involved in developing have sky rocketed over the last few years. When doing the sums it is still cheaper to buy an existing home (including the extras) then to build the same house next door.
That being the case the pressure on the existing market will remain high especially as “second hand” house don’t carry a 15% GST tax burden on them.
Indeed the call from some quarters for a capital gains tax, will play right into the hands of investors as many people will not sell for fear of attracting any such tax.
This happened in the 1970’s when the then Government brought in a punitive Capital Gains tax. The withdrawal off the market of property raised prices 40% in the following three years so there are always unintended consequences when a market is interfered with.
Investors looking to long term at the residential market should consider buying standard family homes, and not get caught up with the dazzle of numbers.
It is better to buy a two houses at $350,000 for example rather than one at $700,000 simply because rents do not rise in proportion to price. Besides cheaper homes are easier to fund and rent. On the flip side, capital gain on cheaper homes is limited because they are likely to be in working class areas where money is scarcer.
Inner city apartments remain a bargain still selling for less than half their replacement cost and returning well above average yields. If income is all you want then careful investment into that area may be fruitful.
If you want to be a trader in property, then that is certainly the quickest way to make money in this market. A quick renovation and clean up can be very profitable indeed. It is not a game for the faint hearted or for those with no practical skills. Nor should you venture into major redeveloping unless you have deep pockets as timing is critical. Major renovations can take as long as new–builds and the market can do somersaults which may work against you. Many of my clients have fallen for this trap and it is always a hard and expensive job to dig them out if the mess they created.
You will of course be liable for tax as a trader but if get to keep around 80% it’s not too bad.
I am always amazed by the large number of investors who seek my and my teams advice, who have rented their houses and flats out for much less than market rents effectively subsidising their tenants. Conversely some amateur investors would rather leave their properties empty than rent them out at a small discount. It is obvious that 52 weeks rent at a few dollars a week less is better than a vacant property.
It is also a wonder to me when analysing clients investments how much rent is being lost through deferred maintenance making a rental harder to let.
One client in particular comes to mind, who refused to carry out the simplest upgrades because of the cost involved.
After showing him that $2000 spent on touch up paint, a could clean and carpet repairs would increase the rent by $50 per week putting him ahead long term after only 9 months.
The current buoyant market will likely continue but somewhat subdued by the threat of interest rate increases and political shenanigans. All the more reason for new investors to bargain hard and be prepared to walk away. For existing investors, having regular tune ups and close management is a must.
It is an interesting fact that in Australia, 85% of investors have their properties managed by professional managers while Kiwis are just the opposite, foolishly preferring to self manage amateur style– and losing money hand over fist as a result.
In my view their is a strong likelihood of rents rising rapidly over the next year or two. If costs increase, investors will look to their tenants to pay more and we will have the beginnings of the infamous wage – price spiral.
The chart below shows that rents are way below sensible returns so either we have a substantial rise in rents or an equally substantial fall in house prices:
Some Noises Off Stage
A commentary on residential property would not be complete without mentioning the latest ravings of a noisy outfit called “Demographia International who claim that our houses are “seriously unaffordable” and therefore grossly over priced. Tell that to the good people of Southland or Invercargill and see what sort of raspberry will get blown your way.
In my view this stuff is unadulterated rubbish put out by self serving wannabes.
If it were true we would have armies of people living under bridges or rioting in the streets and every builder and developer would be instantly out of work.
Instead we have a smoothly running market with thousands of houses being built, or bought and sold every year, coupled with plenty of reasonably priced rentals and only a handful of mortgagee sales from time to time.
My views are backed by other professionals as are the statistics:
The facts speak for themselves and show that Demographia methodology is either seriously flawed with its calculations or it has another agenda all together.
I suspect the latter.
As we know commercial property ( shops, offices, factories) run on quite different rules from residential.
A house is worth the same whether rented out or not.
The value is influenced mainly by position and condition.
Not so with commercial property.
The value of any commercial property is seriously effected one way or the other by:
- Rent received
- Length of lease
- Strength of tenant
- Terms of lease
- Condition of property
- Earthquake risk
- Number of tenants
And many more as well.
It is quite possible to have two identical commercial properties side by side with the same rental returns but to have a 100% difference in value simply because one has more advantages . Simply put, investors are prepared to pay very much more for the right combination.
Therefore with the right advice it is quite feasible to pay, for example, $500,000 for a commercial property, and with a stroke of the pen and some sensible negotiation double the value to $1Million without spending any more money- just some patience and good advice.
Nothing to do with inflation or luck.
All to do with doing your homework first and not guessing or hoping for the best.
As an example of this I had a client who owned a weary block of suburban shops which only stayed upright because it didn’t know which way to fall.
With my teams help the zoning was changed to a much denser zoned category which suddenly made the site much more valuable .
He subsequently sold it for 3 times more than what he paid for it and promptly retired from the proceeds.
Because interest rates have been low, the returns from good commercial property have been steadily dropping.
Properties, that a few years ago would be hard pressed to return a 10% yield now sell for sub 5% yields.
In other words investors are paying more and more for the same rental returns.
All the signs say this will be a good year for the economy and this in turn must flow into the property market.
The economy continues to be buoyant compared to other developed countries due to our increasing exports of food based products.
This in turn is encouraging immigration and a feeling of confidence amongst consumers which in turn improves the economy even further. The result is that the economy however becoming more and more Auckland centric as jobs increasingly move to Auckland which attracts more yet still.
All of this pushes the Auckland residential and commercial property markets along, with supply simply not keeping up with increasing demand. Hamilton is also benefiting from this situation as the real travelling time between the cities rapidly continues to shrink.
It appears certain that the main economic drivers being the Christchurch rebuild, net immigration, and continued positive economic growth in China, as China moves more towards a consumer based economy, plus rising confidence and more jobs; all these may play an even bigger role in our economy than ever before.
Now is not the time to be distracted by all huffing and puffing of the gloomsters and stirrers.
Now is the time to take advantage of the current climate.
Remember: It only takes one good deal to change your life for better for ever.