The Year in retrospect … and What is to come (Column)

Olly Newland’s column November 2012

As the end of the year draws near, now is a good time to review the past 10 to 11 months and look into the foreseeable future.
Let’s look at a number of influences and influencers on the property market in general. I’ll also look at the suggestions being made to ‘help’ first time home buyers into the market, as they get further and further left behind.

‘New Initiatives’

The Government is about tell us about some ‘new initiatives’ to help the housing market and, supposedly, to put some heat into the supply of property instead of just hand-wringing. Looking at what has been suggested, the effect will be minimal even of the intentions are well meant.

The Government is poised to announce changes to development laws that will make it easier and cheaper to build houses, stretch Auckland’s city boundaries, upgrade existing state houses and transfer state houses to non-government and local government providers.
It may also signal changes to income-related rents and state subsidies amid moves to ensure tenants’ needs match the size and type of house.

Link: Government grasps housing thistle (stuff.co.nz)

My view: Perhaps your grandchildren may get some benefit, but for those looking for affordable home today the cupboard remains bare.

Making more land available sounds good in principle, but land supply is only ONE part of the equation. There’s also the need to create the associated infrastructure (roading, power, sewerage, transport — even without considering the cost of that.

The cost of house construction materials is still one of the greatest problems. Despite massive imports from China of cheap fittings and appliances (some of appalling quality) the cost of building materials remains stubbornly too high. It seems odd that in a country where timber, aluminium and steel are produced in massive quantities, the end cost for us is way over what the same materials cost overseas.

The reasons are easy to explain: low turnover, lack of competition, a dearth of builders and the huge dampening effect of GST on all new materials and land. These all combine to stifle progress.

Making more land  available will do little until these other price factors are resolved.

Interest rates

The low interest rate environment continues, with the pundits pushing their predictions for interest rates rises further and further into the future. I take the opposite view. I believe that interest rates will remain at or near the current levels for many years to come, and may even fall further.

This is the new “normal” and is, in effect, a huge wage rise for the mortgage belt and working classes, let alone for investors and first home buyers.

Never in my lifetime have I seen interest rates so low as now, but I am reassured by the fact that the current rates are in line with the rest of the world. Unless massive inflation appears, there is no reason why rates should ever go up significantly.

A low interest rate environment means that people can afford their mortgages — and even borrow more — which, by the way, is why prices are steadily rising in many parts of the country, Auckland in particular.

Even if interest rates were raised by a quarter or half a point, what difference would that really make?

The side-effect of low interest rates is that savers are tempted to put their money into other avenues of investment, with  investment property being one of their options. In my view, the merry dance will continue. House prices are likely going to double again over the next few years. Of that I am certain.

Pieter Brueghel II “The Wedding Dance”

Look at it this way: All that is really happening is that as prices rise, people are merely swapping equities. The value of a house goes up making the owners feel richer, and they then buy another more expensive house using the “extra” wealth and thus the beat goes on. The only people affected are those NOT already on the property ladder — and they make up a small minority.

But from a political point of view first home buyers are hugely important. The left wing professional mourners love to weep copious tears about the homeless, as if it was a crisis of monumental proportions with insurmountable difficulties for first home buyers.

Don’t’ forget: that ‘struggle’  to get one’s first house has always been so. It was much worse when I was a first home buyer, (cue: violins) but these days generation Y’ers seem to want to start where their parents ended up.

A quick look at what is currently available on Trademe, shows approximately 15,000 houses, 1,800 town houses, 1,200 apartments and 1,800 home units all for sale — at under $300,000.
The trouble is, they are not all in central Auckland.

Maybe some of the first home buyers will have to learn cut their cloth a little.

Commercial Property

Commercial property does not make headlines much but it too is undergoing a revolution. The low interest rates have made the returns from commercial property that much more attractive. Where once upon a time a 10% return was commonplace, this has slipped to 6% or less depending on the quality of the location and the tenant.

Put another way, good commercial property has doubled in value, and hence we now have a plethora of commercial syndicates offering all types of commercial investment for the smaller investor seeking higher returns.

They come dressed up in various forms such as proportional ownership, units, shares etc. but the end result is always the same: Some syndicates are absolute dogs, enriching the managers rather than the investors. Buying a big dinosaur with a specialised single tenant in the back of some provincial town is not the best investment to get into, in my opinion.

The Financial Markets Authority has finally issued some new guidelines about syndicates and not a moment too soon.

link: FMA Guidelines (via Bob Dey Property report)

One elephant in the room for commercial investment comes from the pressure from the top echelons of insurance companies to grade every commercial property according to their vulnerability to earthquake.

From level one (virtually no risk)  to level two (slight risk) to level five (very high risk) — the grading is a nonsense.

Despite having sucked in huge premiums for decades, the insurance companies now want to recover their losses as rapidly as possible. You have to ask what’s happened to all the moneys they have collected over the years?

To strengthen a building can be prohibitively expensive and there is no guarantee that having done it, the building will be of any use. For example, the CTV building, the subject of the most lethal damage in the Christchurch quake, was relatively modern so what does that prove?

Furthermore, the cost of strengthening is a fiction and quite impossible to pay. In total it would run into many tens if not hundreds of billions of dollars. In many cases the cost could be on the tenant as many leases contain clauses that put the cost on the tenant if any upgrading of a building has to be undertaken.

“In the wake of the Canterbury earthquakes, lawyers, landlords and tenants are carefully examining lease clauses (possibly for the first time) to determine who is responsible for strengthening earthquake-prone buildings and to what extent. One such clause is the Improvements Rent clause, which potentially gives landlords the right to pass on earthquake strengthening costs to tenants.”

Link: Earthquake prone buildings: Brace yourselves (Minter Ellison)

For a once in a 10,000 year event,  a more pragmatic approach is needed e.g. strengthening to be carried out when major upgrades are undertaken and certainly with new building projects (as is the present case in any event).

Despite all this background noise, retail shops remain one of the more popular commercial investments, followed closely by small industrial units. Anything with multiple tenancies is of high demand because that arrangement helps spread some of the risk.

If rental housing is not to your taste think about commercial. It’s a whole new world and the difference between the two is like chalk and cheese.

The Emergence and re-emergence of Property Spruikers

The improving market has brought out the usual bunch of spruikers offering “instant wealth” through property. All of them offer a quick path to riches, initially at little or no cost to you – or so they say.
My friends, do not be fooled.
There is no such thing as a “free lunch”.

These spruikers are either going to sell you a property from which they will collect a hefty fee through an option or some kind of side deal arrangement.
Or they will charge you after you have been convinced that it was all free.

Get your investment advice from genuinely independent sources, where the fee is up-front and there are no hidden agendas or add-ons to come, and where your advisor has no part in the sales process, disclosed or undisclosed.

Public Works Act

The Christchurch disaster has brought the subject of compulsory acquisition and other powers to the fore.
The Christchurch Earthquake  Recovery Authority (CERA) has draconian powers similar to the Public Works Act and many people complain that they are not getting a fair go.
You can understand why sweeping powers are needed to deal with the Christchurch situation and there will always be an element of unfairness.

The threat of compulsory acquisition of private property in  Christchurch’s CBD is the  elephant in the room no-one is  talking about as the government  moves to develop a new blueprint  for the city’s reconstruction

link: Compulsory acquisition could reconfigure Christchurch CBD (stuff.co.nz)

But not just there. In Auckland the Public Works Act (PWA) is being used on a huge scale for different purposes. It is being used to compulsorily acquire land and buildings by Auckland Transport (aka Auckland City Council) to push through the Central Rail Link (CRL) connecting downtown Auckland with outer suburbs.

Nearly three hundred commercial and residential properties are affected and will be taken to create the rail link for  the betterment of the community. The trouble is that someone else’s betterment may be to your disadvantage — and then it’s a different story indeed.

The cost runs to billions.  Auckland Transport has already stated that the estimated cost to acquire the properties will be around $2.8 billion and they hope to recover that by selling the land back to the market after the work is done. (In your dreams maybe.)

Most people would see such a rail link as a good thing –- that is until you are the one affected by the stigma (yes – this is the very word being used by the people from Auckland Transport, according to my clients) when your home, commercial property or business has had the designation slapped on requiring it under the PWA.

From the propaganda available, one would suppose it’s all sweetness and light. There’s no problem. You just give up your legal rights to your private property, and all your years of scrimping and scraping and shepherding your investment through troubled time … and then quietly go away.

“We are aware that property owners adjacent to the CRL will want to know more about future construction impacts such as noise, vibration and access. We will explain these over the next few months and address them at a greater level of detail in future design and resource consent processes.” — David Warburton Chief Executive Auckland Transport

link: City rail link route identified (scoop.co.nz)  Also see PDF Auckland Transport ‘fact sheet’.

When you get to the fine detail it’s a lot different for the owners and businesses.

For instance

  1. Once the designation is on your property, it remains for up to 20 years. That means you cannot sell or redevelop your property into the market or to any outsiders for all that time because the only buyer allowed will be Auckland Transport.
  2. No allowance is made for any tax you may have to pay if you are obliged to sell. If you make a profit on the ‘negotiated’ price you may be reluctantly forced to settle upon, and if company or personal tax is payable then you have to bear the cost. There’s no compensation for that.
  3. If you own a business in a building, there will be no compensation if your business is destroyed or if the lease is cancelled by virtue of the fact the the building will be  demolished.
  4. Should you get a better offer during the 20 year wait you can’t accept it – you can only get what the Council and you “negotiate”. (How you can “negoitate” when the PWA can ultimately take the property by force is beyond me.)

In summary, the owners of homes and buildings along the proposed route will eventually wake up to the fact that their property is theirs in name only and they will be faced with the stigma of the designation and in virtual limbo for many years to come.

Think about it. Would YOU buy a property that was going to be taken compulsorily at some date in the future?  I doubt it.

I recall the same happening on the 1960s when the then Auckland City Council issued maps of Auckland showing where proposed motorways and road widenings were planned. As soon as the dotted lines appeared on the maps, wholesale destruction of value followed. Any property that had a dotted line was virtually sale-proof and remained that way for years and years.

There are many more disadvantages which I will outline in a later article but you have been warned.

Where Is Best To Invest?

Now that the doom merchants have all but disappeared (and the world has not come to an end), one of the most frequent questions my advisory clients ask is: Where should I be investing for income and security?

They realise that the market is improving and that many parts of the country are now enjoying a resurgence in demand and values.

The first matter that has to be explained is that the market is NOT a homogeneous lump moving in unison one direction or the other. No. The market consists of many parts all moving at different speeds. The trick is to pick the slice of the market that is about to move rather than climbing into one or another market at the last minute.  Even more important is not to be talked into buying cheap rubbish in depressed suburbs. There lies losses and heartache trying to deal with third-rate tenants in fourth-rate houses.

So what is ‘hot’ and what is not?

Houses:
If you can afford to buy into what I call the “Mum, Dad and three kids” market then that’s the best market of all. Good average family homes with a bit of land to kick a ball around will do just nicely.

Regular three (or more) bedroom homes, made of traditional materials in an average-to-good suburb is the most likely to hold its value — and indeed grow in value at an above average rate. That’a what you want. The price should be in the affordable range — up to $500,000 in Auckland, and the equivalent in other cities or towns.

If the property can be improved, then so much the better. Growth and income are bound to rise because of the shortage of just these types of property. Remember it’s the LAND that is the most valuable part.
Buy as much land under the house as possible and avoid tiny sections.

With any luck you may be able to subdivide as pressure grows to provide more infill homes. Buy land, lots of land, together with rentable solid houses and it will be hard to go wrong.

Shoe Box Apartments:
These have had a bad rap in recent years and have by and large hit rock bottom. For income as a factor of the price paid, these are hard to beat.

Apartments come in all qualities and shapes so buyers need to exercise great care in this market. Remember: apartments cannot be changed (other than internal redecoration and refurbishments). There is no land to speak of, and they rarely if ever suit the “Mum, Dad and three kids” scenario.

Having said that, it has to be agreed that despite being shoe box size, the better apartments are getting hard to find, the best land having been taken, and the cost of replacement sky high. (Luxury apartments are a separate topic altogether.)

For pure rental income, shoe box apartments would be one of the best investment options around — but serious capital gain may be somewhat far off.

Town houses and Units:
Much of what applies to houses as above also applies to these properties. Position and construction are vital as they too are often hard to extend. Town houses and units make up a great part of the market for first home buyers and retirees — so buy in confidence once you have done your due diligence.

Lifestyle & Beach Homes:
These are still suffering and are hard to make money out of unless the market regains its boom mentality again. Lifestyle and beach homes were the toys of the wealthy (or indebted) during good times. Now that times are not so good, these toys aren’t played with as much as before.
Some represent huge bargains if you like sniffing ozone or the smell of cow patties.

If you buy into these then don’t expect capital gain, or big rents in the short to medium term (Kim Dot Com may the exception if what he paid in rent is correct.)

Bare Sections:
If you can afford to buy big pieces of land in a well built-up area, then you may be sitting on a gold mine. But land that is out in the countryside, or by some swamp or silted-up river, is almost impossible to sell let alone get an income from it. Buy if you must, but at your own risk.

Shops, Offices  Industrial:
Keep in mind that, unlike residential, commercial is 90% about the lease and the tenant. Investors buy cash flow and the stronger and more reliable the better the value.
Checking the lease(s) and the strength of the tenant not to mention the location, is a major task not to be attempted by beginners.

The big advantage of commercial is that it is sometimes possible to virtually double the value of a property overnight (or, equally, halve the value through a blunder or by carelessness.)
Shops are the most popular because tenants are plentiful and most people ‘understand’ shops.
Offices, on the other hand, are more difficult because of home computers doing the work of clerks and secretaries.
Small and medium industrial properties are also very popular so long as the premises are not too specialised.

When considering any form of commercial investment always ask “What if?” … meaning, what if the tenant leaves? Can the premises be leased again quite easily? Or used for another purpose?

Commercial also has one disadvantage as compared to residential: it is a little harder to finance.
Most lenders will go to 65% of value (as compared to 90% for residential) which means a larger deposit is required to purchase.
This gap can be filled by second tier lenders but their interest rates can be horrendous.
In the good old days, finance companies were only too happy to lend on second (or even third or fourth) mortgage but since their demise, this avenue has been closed off, leaving only a few ‘lenders of last resort’ remaining.
As a result, partnerships have become quite popular for commercial  investment. If a deal is too large, it then leads to the creation of large syndicates as we discussed earlier.

The Rascal’s Guide to Real Estate

A new, updated and expanded edition of this best-selling property investing handbook

My latest book, The Rascal’s Guide to Real Estate is about to be released. It is a totally rewritten, expanded and up-to-date version of the 2002 edition of the same name.

It’s available here at www.EmpowerEducation.com.
The last 10 years have (literally) seen seismic shifts in the real estate market. So much has changed. With the boom and bust, the Global Financial Crisis, the collapse of finance companies, the convictions and jailing of a string of company directors, the loss of billions of dollars of people’s savings, the Christchurch earthquake … to name but a few.

But one thing never changes with human nature: greed, fear, ambition, the quest for power and the need to own land.

If you invest in property carefully, prudently, and with forethought — while keeping your hands clean at all times — you could do very well indeed.

Best wishes
Olly Newland
November 2012
www.ollynewland.co.nz
© 2012 Olly Newland. All rights reserved.

Posted in News & Articles | Tagged | 1 Reply

One thought on “The Year in retrospect … and What is to come (Column)

  1. Hi Olly, I appreciate your knowledgeable insights into the property market. You mention in this article that house prices will double over the next few years. Can I ask do you see this just in Auckland or the median New Zealand house price? By the way I am in Tauranga which has experienced good growth in the past but is currently affected by the PSA in the kiwi fruit industry which has impacted on the job market here.

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