Caglan Bagci Lodestone
A friend of mine once bought Air NZ shares at $1 and saw the price fall to 15 cents within a few weeks. This kind of volatility is extremely unlikely for the property market. The main demand component for property is population. Statistics New Zealand expects New Zealand’s population to reach 5.05 million by 2051. These people will continue to need a place to live and will continue to earn and to spend. So ‘crash’ is probably not the best word to use when talking about the property market - but “correction” is so boring. However, there are indicators that property prices may be a little high and we may have a stagnant period ahead. The average house price is more than six times the average income, compared to three times in the 1980s. Also, property as an investment is not standing up quite so well compared to alternatives as it has in the past.
Understanding the risk/return tradeoff with property
There is no risk-free investment. Every investment outlay is made with the hope of a greater return at some point in the future and with the knowledge there may be a loss. Property investments carry a range of risks, some specific to the type – tenant default, vacancy, building costs, damage, planning changes, legal changes, etc - and some attributable to changes in the marketplace driven by changes in the economy, interest rates and inflation.
Take government stock as a benchmark. At the time of writing, a $10,000 investment in New Zealand Government stock maturing in 2009 will yield 5.78% gross. For an investor wanting too take on slightly more risk, $100,000 invested on call with UDC will yield 7% gross. For the extra time, effort, energy and risk associated with direct property investment, a significantly greater return should be sought. Recently, I have seen commercial property trade with yields as low as 3.5% and residential yields at 4%. The 100% financed, self-servicing investment property type is very hard to find. Remember to put a price on your time if you are determined to do so.
If you had the capital to buy a direct property investment without borrowing, the expectation of capital growth alone would be the only justification. Computer model for long enough, and you may be able to show some reasonable returns for property investments where a sufficient deposit allows a rental surplus to clear debt. Remember, however, that while leveraging will improve your profit model it will also increase risk.
As always, if the time horizon is long enough (10+ years), now is as good a time as any to make a direct property investment. But with short or medium-term expectations of the market, then I recommend you also model scenarios where prices are stagnant for a number of years or even fall.
The bottom line, however, is that we have excellent returns on low risk fixed interest investments in New Zealand.
Caglan Bagci is Principal of NZIJ Mortgages. This article has been reproduced with permission from the NZ Investment Journal.