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C & D

Residential Property Investment

21 Mar 2017

Residential property investment is not an area that we use in our client investment portfolios. We typically advise and manage client investments in an asset type diversified portfolio manner. However, all our clients do have residential property being their primary residence. Others also have holiday homes, and a few have residential investments. Within our investment portfolios, the property exposure is typically via Australasian listed property companies.

In New Zealand, there are no managed funds that invest into residential properties. Twenty odd years ago, one was started, and it was a total failure. It failed because it did not attract any funds flow, and because the management was totally inept. It also had a massive hurdle to overcome compared to individuals buying investment property. That was the taxation system.

Residential property has been a wonderful investment for many New Zealanders. Despite minor short-term slow-downs, it typically shows excellent long term capital gains provided it is in the right geographic region. However, as the Sage of Omaha, Warren Buffet has noted, past returns and future return are quite different things.

To understand where price rises come from, we need to break apart the roles of the key price drivers, such as growth in rents, from market factors such as how much the market is prepared to pay for a dollar of rent. What this approach says is that the price of a property is determined by net rents multiplied by the amount the market is prepared to pay for each dollar of rent. This is the Rent Multiple. It is also the inverse of the yield on a property.

Residential property is so expensive in places such as Auckland because people are looking for somewhere to live rather than pricing as an investment using conventional metrics such as net yield. Owners of residential property are largely owner occupiers, however there are also many private investors.

So how much do home buyers pay when house hunting? It is largely whatever they can afford. Buyer strategy is to work out how much they can borrow and then look for the least worse place they can buy for that amount of money. Yields or rent multiples don’t come into it as they just want to own to live in and in which to raise a family. The amount they spend is whatever the bank will lend them.

How much a bank will lend is based on their assessment on the ability of the borrower to pay interest. So, when interest rates fall, borrowers can borrow more and vice versa when interest rates rise. If there is a constant supply and demand, then prices should rise and fall accordingly over time.

There has been a lot of talk over recent years that it is investors and immigrants that are driving property prices. The borrowing rules have been changed by the Reserve Bank. Owner occupiers can borrow more on a property than an investor can (against solely the single property), so they now have a greater influence over pricing than investors. Investor returns are not primarily yield based. They are property value based and won’t be realised until sale time.

Disclaimer

Steven Barton (FSP 32663) and Susan Pascoe Barton (FSP 32382) are Certified Financial Planners and Authorised Financial Advisers.  Their initial disclosure statements are available free of charge by contacting them on (07) 3060080 or they can be downloaded from www.pascoebarton.co.nz. This column is general in nature and should not be regarded as personalised investment advice.