Jarden Wealth Weekly: Is property really the crème de la crème investment for New Zealanders?
Kiwis are fascinated with property. Everyone has an opinion and summer BBQS inevitably include a discussion on the price direction and the sharing of intel from a local real estate agent.
Consequently, property investment is deeply ingrained in our culture. In fact, many consider their house an investment rather than a home. There are many reasons why property is viewed so favourably, including that property is tangible – you can drive by and see it, you can borrow against it, a large portion of the returns are tax free, and it can provide a relatively passive income stream.
But does property really produce the best returns?
It’s clear that property ownership has generated good long-term returns. The REINZ national median price went from $169,500 on 31 December 1999 to $760,000 on 31 January 2024 . This means a return of almost 350% over the 24-year period - an average annual return of 6.4%. Over the last decade the median price has increased 6.6% per annum. Investment properties also generate rent, but with the average gross rental yield 3.2% currently ( just 2.6% in Auckland), capital gains are the main source of returns, especially when you take into account the expenses of owning a property.
These returns sound impressive, and they are better than term deposits which have had an average one-year interest rate under 5% in eight of the last ten years . However, during the same period the US stock market, as measured by the S&P500, increased 10.5% a year, while the tech focused NASDAQ 100 has increased by 17.1% a year. Even the NZX50 has returned 9.3% a year, despite being one of the few global share markets not close to all-time highs at present. Note that these are index returns, which include dividends and exclude any management fees.
Does this tell the full story? There are a couple of other factors to take into consideration. Expenses such as council rates and insurance place a drag on investment property returns. That’s before you get to interest costs, and with the average one-year fixed mortgage rate currently above 7%, these alone may exceed the rental return on highly leveraged properties. On top of that, you have the expenses to maintain what is inherently a depreciating asset when you exclude the land.
Another factor that is often overlooked in house price movements is the extent to which improvements contribute to the increase in value. Over the long-term, people upgrade houses – they put in a new kitchen, renovate the bathrooms, landscape the gardens or add a pool. This investment significantly diminishes the overall net capital gains.
Is investing in property ‘safe as houses’?
One of the key advantages of investing in residential property has been the ability to borrow against it. Leverage amplifies returns. For example, if you purchase a house for $1m and borrow 80% you are investing $200,000 of capital. If the property goes up in value by 20%, you will double your investment. However, if the property reduces by 20%, which is close to what we have seen between the most recent peak in November 2021 and current, you would have eroded your entire investment, and the property will effectively be worth as much as the debt owing on it in simple terms.
Another risk with property is the lack of diversification. When combined with the family home, some investors are highly concentrated in one asset class, often with a single income stream (i.e. the tenant). This leaves them exposed to specific event risks, such as a natural disaster, or the macro-economic conditions impacting the New Zealand economy. As the old saying goes, don’t put all your eggs in one basket.
Another factor often overlooked with property investors is the lack of liquidity. Liquidity refers to the ability to turn an asset into cash. With shares, you can sell them and have the money in your account a couple of days later. With property, achieving a sale at your desired price can take some time (and cost) and is subject to timing, and supply and demand. Auckland listings are currently at an 11 year high, while the most recent auction clearance rates were just one-third.
What is an alternative option?
An alternative to investing in property is having a diversified investment portfolio across multiple asset classes, such as bonds and equities. Not only does this reduce risk and provide better liquidity, but historically the returns have also been attractive. In the last decade a balanced portfolio, holding 40% in income assets (cash and bonds) and 60% in growth assets, has returned 7.5% a year. For those with a greater risk tolerance, a growth portfolio (targeting 80% growth assets) has returned 8.9%. These are just index returns and past performance is not a reliable indicator of future returns.
What is actually the most valuable asset you have? Time. Managing and maintaining investment properties takes a lot of work. Many people love this and that is great. For others, the simplicity of term deposits or using an independent wealth adviser to manage a diversified multi-asset class investment portfolio tailored to their goals can provide them with more time, lower risk, the potential of improved returns and peace of mind.
Andrew Ford is a Wealth Management Adviser at Jarden in Auckland.