One for the data geeks out there

[Paul34]

Hi Guys

I was looking at the latest property magazine with a focus on the growth in rents across different parts of New Zealand over five years. What I noticed, just with a cursory glance, is that rental increases are relatively consistent across the board over an extended period (excluding the likes of Queenstown). The smaller areas, appear to be playing catch up, with rents and house values, and anecdotally there have been some significant gains, from a small base, in recent years.

I have two questions that I wonder if anyone has the answer to:
1. Has anyone plotted an increase in landlord related expenses (rates, repairs, insurance) over a five year period?
2. How does this compare to rental inflation?

I'm interested in how an I only approach might work on a property that is brought initially on -ve cashflow. Would this ever catch up, or as I suspect, it is highly unlikely given the differing rates of inflation and deferred maintenance?

Interested in the thoughts from those wiser than I on this.

[Bob Kane]

I have two questions that I wonder if anyone has the answer to:
1. Has anyone plotted an increase in landlord related expenses (rates, repairs, insurance) over a five year period?

This increase is similar to inflation/CPI

2. How does this compare to rental inflation?

Rental inflation is higher than general inflation/CPI

You're welcome

[Keithw]

an excellent question Paul, not one i can directly answer but offer the following observations:
it will be very dependant on where and the type of property.
Figures are often quoted for "the Auckland market" but theres no such thing. Auckland has at least 4 major markets, and then theres markets within markets, Depending on where the property is, the type of property / apartment and the size of rooms (particularly apartments)
in the last 3 years i have seen insurance costs double, - as a proportion of the rent the insurance was somewhere around 6%, now its more like 10% - so thats 4% of the rent lost to insurance increase over those 3 years.
Rates have gone up by at least 30% (despite the councils touting 4-5 % per year) as a proportion of the rent the rates were about 6.5 %, now more like 10 % - thats another 3.5% of rent lost.
Tradies fees have skyrocketed, with minimum callout fees of over $200, against around $75. Bit hard to quantify the increase, but you might choose to use say 3 callout events per year with a typical maintenance allowance of $5k pa (others may come up with some better suggestions) so thats (3 x 125)/15000 - say 3% increase in base cost before any work has been performed, representing another 2.5 - 3% of rent lost to increases.

so thats a total of about 10% of the rent being lost to increases (not accounting for compounding)
and thats before any additional costs brought about by regulation change (change in smoke detectors. insulation, heating, P testing), admin costs, advertising fees, credit checking etc.
And for apartments, long term maintenance plan costs have seen many body corp fees (which also include insurance) double from around 7% of the rent to more like 14% of the rent for some of the apartments I have. Since that includes the insurance component, which comprises 4% (see above), that means an additional 3% due to LTMP and other body corp fee increases.
so 13% all up/

in the same 3 years rents for many apartments / units have typically seen increases of up to 10% per year if they were being relet but i would guess more like 5% per year for sitting tenants.(again not accounting for compounding effects)
So best case 30% increase, average case probably 15 - 20 % increase in rent.
Still ahead of the basic increases noted (insurance, rates, maintenance) but the gap is rapidly closing.

what will have a bigger influence on whether cash +ve or -ve will be interest rates. Rents have got a long way to increase before Auckland properties are +ve if you are using current values against current gross rent.
The same 3 years have seen at least 30% value increases (typically 10 - 15% pa) before any discounting for the current slowdown , but because that is on much larger numbers (4-500,000s against 20-30,000 in rent), the gross return is rapidly going backwards.
eg 4.9% to 3.8%
so if interest rates are over 4% you will be -ve on interest alone, before any other costs.

[Paul34]

Thanks Bob and Keith for the response.

The CPI would seemingly be a poor guide to the inflation that is experienced by resi investors (in line with KeithW's notes). That said I agree that the best we can hope for is an estimate. The idea of the proportion of rent is a good way to look at the problem.

Of interest in the explanation provided is the idea that the costs are going up 10% (i.e. compounding) but the rental figures presented in the magazine are a gross total. Thus, it would appear to me that once in -ve cashflow you are likely to always be in -ve cashflow.

The point about interest rates is equally interesting as a small change in these would have a much stronger impact across the board given that rental inflation appears harder to achieve.

I do find it quite interesting and wonder how many investors, who don't time the market and thus experience capital gain, make any money at all.

The other issue is the ratios of Interest payments to rent. While the rent is more substantial in the cities so is the mortgage. A 1% differential on say 200k is very different to 1% of 800k making the decision on where to invest equally challenging given what is noted.

[Perry]

wRents have got a long way to increase before Auckland properties are +ve if you are using current values against current gross rent.

How valid is that sort of comparison - really. It's just the smoke and mirrors of inflation, after all.

Would it not be more appropriate to use the investment cost as a base, rather than today's pie-in-the-sky value figures?

[Perry]

Lies, Damned Lies & Statistics.

2. How does this compare to rental inflation?

Rental inflation is higher than general inflation/CPI.

Bob is right, but the CPI is a crock.

The more realistic comparator would be the HPI.

That puts things in a more valid perspective and shows that rental inflation is well behind.

[Paul34]

Thanks Perry for the response

Excuse my ignorance but what do you define as Investment cost, this is not a term I have heard before? If it is as I presume, the cost of the investment, then this is where things may get interesting.

If I look at an approach such as Graeme Fowler's the most significant advantage I see is the ability to create positive cash flow that can sustain investment over the term with minimal deposit. This would seemingly be the real kicker. Even at 10% gross yield this is still not paying for itself given costs and then tax. To flip that switch requires money in. At this point, the ratio is irrelevant what counts is the actual amount necessary to turn the switch.

Naturally, as others have noted this is irrelevant if you have capital gain as the loss is offset. 10% growth on 1 million is handier than 10% of 200k. But in the absence of capital growth, the pendulum must swing back to the cheaper properties. Thoughts?

[Perry]

Excuse my ignorance but what do you define as Investment cost, this is not a term I have heard before? If it is as I presume, the cost of the investment, then this is where things may get interesting.

Yes. It is ROI.

Sure - the investment property may be worth $800k, but how much did the investor actually have to pay out to buy it? Let's say $200k

If one takes the rental income less expenses and uses that as a percentage return on $200k, the result will be one helluva lot different to the percentage return on $800k.

[Paul34]

I agree with this logic wholeheartedly and perhaps you have cut to the chase.

The ROI of the investment over the long versus short term would be interesting to see and is a hidden statistic in the current comparisons offered for the value of this investment class. Leverage is apparently the key advantage that it has.

With the new bright-line test, this will make everyone an investor in ways that I don't think are fully appreciated. Five years is a reasonable amount of time to feel the actual costs of holding property. So the ROI in the absence of capital gains will be nil aside from all but the most +ve geared property if there is no cash in.

This should require cash investments to be made to hit a maintainable level. I would like to see Graeme Fowler's view on this, but I would suggest that this figure is more like 15-17% (rent*52 weeks/purchase price) (if one is to account for tax).

The ROI then becomes the amount invested to achieve this. As I write, it becomes evident that this logic, the ROI, is in effect the only way to look at the investment, as are all investments.

Thanks, Perry. As simple as what you wrote is it has undoubtedly knocked my brain in the right direction.

[Perry]

No revelation from me: just repeating what I've learned from others.

[Anthonyacat]

Tax should be taken out of the equation as a 'cost' for purposes of breakeven. You only pay tax on your profits, so by definition if there is tax, you're making money overall. Tax will never turn a positive profit into a negative one.

[BlueSky]

Yes. It is ROI.

Sure - the investment property may be worth $800k, but how much did the investor actually have to pay out to buy it? Let's say $200k

If one takes the rental income less expenses and uses that as a percentage return on $200k, the result will be one helluva lot different to the percentage return on $800k.

Can be Skewed if borrowed with a 100% loan originally. Say 370K PP, gross yield then 6.5% . Property now worth $800K gross yield 4.0%

Without capital gain makes it a bad investment.

How do you work out ROI in this case ?

[Paul34]

Hi Anthonyacat

You wrote:

" Tax should be taken out of the equation as a 'cost' for purposes of breakeven. You only pay tax on your profits, so by definition, if there is tax, you're making money overall. Tax will never turn a positive profit into a negative one".

UsuallyIn most cases I agree with you, but with a leveraged investment where you are paying P this is not the case. As it is leveraged than the profit you make goes to pay P (Graeme's approach). This is taxable, and if the mortgage + tax payment is higher than the profit, this money must be found from an external source thus making the original system -ve. Only if the entire process is funded inside the original entity is it truly positive.

Obviously, if there is no mortgage than I agree.

This is not semantics. If people move to p/ I, they have to think of tax, and this needs to come from a secondary source.

I agree with the notion of P/I by the way but to sustain without a secondary source I wiould suggest that one would need a 15% gross yeild at minmum, which requires a cash depoist and a sensible buy. This is why the concept of ROI is the key metric.

[Bob Kane]

I do find it quite interesting and wonder how many investors, who don't time the market and thus experience capital gain, make any money at all.

???
Buy and hold.
Over 20 years the capital gain will be noticeable.
The rent increase over 20 years will be noticeable.

Or are you meaning flippers - short time owners? How do they make money? They struggle...

[Paul34]

Hi Bob

Thank you for taking that quote and replying which helps clarify my point. To reiterate, I said, "don't time the market and therefore don't make capital gains". The key, therefore, is not the ability to hold but the ability to be there when and if CG occurs.

The discussion indicates that rent inflation will, if lucky, merely match associated costs inflation, so the idea that rent inflation even factors into the equation seems negligible at best. On a -ve cash flow this is even more of an issue.

Therefore the key is the capital growth. If you buy at say the top of the market, you need to wait long periods for that growth (as is the case in many parts of NZ outside main cities or maybe what Auckland may experience). The success stories from the recent cycle through to the guys from the previous cycles seem to rely much on the fact that they timed an area that then boomed (thus allowing quick gains to be locked in) as much as buy and hold. I'm certainly not arguing that this was part of their strategy but the fact the CG happened soon after their purchase makes the account far more palatable.

The morale that we seem to be both pointing out is there is no way around it you need capital growth. Moreover, it needs to be of a certain size to be able to offset the loss through the period, which then becomes the ROI over time. While I agree this is obvious, working through the rent inflation has helped clarify the buy-hold strategy.

By way of example, the alternate investor story is the guy who buys at the top of the market holds forever, property grows a bit, and this covered his loss, and then he buys again at the top of the market etc. This person would be following the exact buy-hold strategy, but the only variable that changes is time, and it is timing that will ultimately account for his ROI.