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Slow and steady wins the race

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  • Slow and steady wins the race

    Slow and steady wins the race
    By GREG NINNESS - Sunday Star Times | Sunday, 03 February 2008

    Property investment has been one of the most popular forms of long-term saving in this country and it's easy to see why.

    Until very recently, house prices have been racing ahead, providing both owner-occupiers and investors with extremely good capital gains.

    Over the past five years, the national median dwelling selling price has increased by 80%, rising from $192,000 in December 2002 to $345,000 in December last year, according to the Real Estate Institute.

    However, this has also led to a widely held perception that residential property has performed better than most other types of property-based investment vehicles.

    Yet many of the same forces which have driven the housing market to ever greater highs over the past few years have also been hard at work in the commercial property sector. And this has flowed into the return generated by the managed funds and property companies which dominate that market.

    The accompanying table shows how well three of the biggest property players listed on the NZX have performed over the past five years: Kiwi Income Property Trust, Property for Industry and AMP NZ Office Trust.

    It compares their closing share or unit price on December 27, 2002, with their price on December 28, 2007, the difference being the capital gain over that period.

    Added to this is the value of the dividends investors would have received during that time, including the value of any tax imputation credits.

    Combining these provides the total gain figures, which range from 70% to 80% for the five years.

    That's pretty good, but to enable a comparison with other types of investment, such as finance company debentures, the gain figure must be adjusted to recognise the fact that the capital gain on the share or unit price would be tax-free for most people.

    The bottom line in the table makes that adjustment, to give the equivalent before tax returns over the five years, which range from 87% for Kiwi Income to 115% for Property for Industry.

    Those sorts of returns are equivalent to compound annual interest in the 13% to 16.5% range.

    Over the past five years popular finance company debentures have not offered interest rates anywhere near that.

    So even without factoring in the high risks associated with most finance companies, the listed vehicles have been a significantly better performer for those seeking an exposure to the property market.

    But how have they performed compared to direct investment in residential property?

    Anyone who bought a residential property at the median price of $192,000 in December 2002 would have done extremely well over the past five years.

    It is likely that the 80% increase in value to $345,000 over that time would be tax-free to most investors. That would be equivalent to a before-tax gain of about 130% on a taxable investment.

    To provide that type of return, a finance company would have to pay an interest rate of around 17%.

    On top of that, if the property had been bought for cash, the rent it generated would surely have covered expenses such as maintenance, insurance and rates, several times over, providing the investor with a handy regular income stream, as well as a capital gain.

    Of course most people do not pay cash for a property, they borrow the money from a bank and in recent times it has become the norm to borrow 90 to 100% of the purchase price.

    At current interest rates it would be very difficult to meet the repayments on such a large mortgage and other expenses, such as maintenance and rates, from the rental income a residential investment property is likely to produce. While housing prices have leapt ahead in the past few years, rents have not.

    According to REINZ figures, the median rent for a three-bedroom house in a popular investment area such as Avondale in Auckland, was $320 a week in December 2002. By December last year that had climbed to $365 a week, an increase of just 17% over five years.

    In the Auckland CBD the situation is even worse because the median rent for a one-bedroom unit had actually decreased from $315 a week in 2002 to $300 in 2007.

    The likely scenario is that investors with large mortgages will be topping up their rental income with cash from other sources, such as their savings or wages, to meet their outgoings.

    Even with an equivalent before-tax return of 130%, investment properties aren't doing that much better than the higher-yielding listed investments such as AMP NZ Office Trust and Property for Industry.

    And with housing prices starting to fall, capital gains will start to come under pressure.

    Although many residential property investors regard listed property vehicles as taking the slow road to wealth, they may yet prove to be the tortoise that overtakes the housing market's hare.

    "There's one way to find out if a man is honest-ask him. If he says 'yes,' you know he is a crook." Groucho Marx

  • #2
    Not a bad article but comments:

    1. It is good that they recognised that debentures from finance companies were probably a lot risker than their interest rates implied.
    2. I dont think they compared returns were there was a loan involved well enough. They state that people use 90-100% loans but forget to say then that this increases the return on investment significantly.
    3. It would be interesting to see year on year returns for the property funds. From memory, they went through a sharp spike in the last couple of years when tax changes made the property companies much more desirable.


    • #3
      90% bank loans for funding? Thats a lot of leverage.

      "Think about it"

      Look theres a white rabbit