Blog: The Landlord says...

Sometimes sitting and waiting for an important appointment is one of the hardest things to do. It feels like that at the moment, as we are just under a fortnight out from what maybe one of the biggest forces to hit the property investment world – the May 20 Budget.

The government has made it clear changes are imminent, but what is in store still remains a mystery. In talking to property investors there is a view that the changes will not be as big, as first indicated. Maybe it will be changes to depreciation rules and a little bit more tinkering.

Then maybe investors are being lulled into some false sense of security, thinking this government isn’t bold enough to make mega-changes which would hurt a core constituency?

While the changes are unknown their pending announcement is being blamed for a subdued housing market.

This week Barfoot & Thompson put out its latest sales stats for the Auckland market. These showed that sale prices dropped by more than $3,000 last month.

Likewise, ASB put out its quarterly housing confidence report. This too showed things are pretty subdued at the moment. Indeed ASB is predicting that house prices could fall 3% to 4% this year due to a lack of buyer appetite.

I think that is a pretty brave call. Many of the factors which influence the market are reasonably neutral at the moment. Perhaps the biggest factor in real estate land is the “wide imbalance” between supply and demand.

I’m wondering if once the Budget comes around people will act quite quickly and try and sell properties (if the news is bad) or whether the opposite happens. That is if the changes are palatable, uncertainty is removed and buyers will act quickly.

Perhaps this situation would be helped by the prospect that interest rates will start increasing in June or July at the latest. Whatever, getting this appointment behind us is something all investors are looking forward to.

There is a view that property investing is easy and making money is a given. Well a story today shows how it can all go terribly wrong.

Last year we profiled in the NZ Property Investor Magazine a young man who was doing some amazing things. The guy, Laurence Pope (22), basically bought a street load of houses in the Waikato town of Paeroa as an investment.

He became pretty popular with the locals as he transformed what was referred to by some as a “ghetto” into a much smarter street.

Meanwhile other property investors where pretty impressed with his deeds.

However, things have gone wrong. His parents who acted as guarantors are reportedly in some difficulty and the bank probably hasn’t done too well either.

Bayleys have sold eight of the properties in mortgagee sales to other investors across the region.

The homes sold under the hammer for between $64,000 and $90,000, yet Pope had paid around $120,000 for each of the properties and improved many of them.

It’s sad to see someone who made a difference in a town like this fail, but it also shows some of the risks involved in residential property investing.

On the upside the sale also demonstrates what we talk about in the May issue of NZ Property Investor magazine – that is the return to positive cash flow investing.

The article has a comprehensive table showing readers areas throughout the country where you can find cash flow positive properties. Not surprisingly many of them are in the provincial regions.

According to Bayleys Pope’s Paeroa properties sold on rental yields of seven to 10%. These are well above comparable investments in the likes of Auckland, Wellington or Christchurch, and show that by looking outside the square, there are plenty of excellent investment opportunities available in the residential sector.

I wasn’t expecting an Auckland University think tank on retirement income was the sort of crowd who would drop a bombshell on the Tax Working Group, but that’s exactly what they did yesterday.

The Retirement Policy and Research Centre, headed by well-known superannuation commentator Michael Littlewood released a paper which questioned the accuracy of one of the TWG’s numbers on the property market. By questioning the group’s predictions on the size of the residential investment market it also casts significant doubt over the assumptions made about how much revenue the government can raise by putting new taxes on property investors.

To his credit Finance Minister Bill English was quick to comment on the research and even acknowledged it may mean changes to their thinking.

He says Treasury analysis was showing that changes to property tax would make a smaller contribution to government tax revenue than what was estimated by the TWG.

Pity his side kick Peter Dunne on the revenue side hasn’t listened. He made a speech today with the same old line that changes to the tax treatment of property were likely, to make the rules fairer and more equitable for all taxpayers.

Some of the questions one has to ask is what other fundamental errors did the TWG make? Also one wonders whether they were in fact just a ginger group set up to stir up a debate and prepare Kiwis for radical – and unpopular changes – as opposed to an objective working group.

I know last week’s Blog, where we talked about some numbers produced by the NZ Property Investors Federation. It calculated that if the government goes ahead with changes to depreciation rules for residential property investment then rents are likely to rise. Landlords, it estimates, would lose on average $1750 a year if they lost the tax deduction and this amounted to $34 a week, which would be passed on to tenants.

These calculations provoked a response that that this numbers from the federation where use political statements lacking analysis.

Judging by what we have seen from the Retirement Policy and Research Centre there are questions that need to be asked about the TWG and its plans.

The good news out of this is that maybe there is hope that the government will not be as harsh on the residential property sector as first indicated. We will know on May 20 – Budget Day.

It was pleasing to see the NZ Property Investors Federation come out and put the issue of rent rises on the agenda this week.

For those who missed it NZPIF vice president Andrew King calculates that if the government goes ahead with changes to depreciation rules for residential property investment then rents are likely to rise.

He says landlords would lose on average $1750 a year if they lost the tax deduction and this amounted to $34 a week, which would be passed on to tenants.

There is no doubt that any changes to investment rules will impact on the economics of property investment.

After all it is an economic equation which needs to balance up. There is little point in making an investment if the returns are not there. You need to remember that most investors are after cash flow and income; they are not speculators chasing quick capital gains.

Rents are one of the key inputs into this equation and another, from a cash flow perspective, are depreciation claims.

It seems absolutely logical that if you change the rules around depreciation it will have an impact on rents.

So Prime Minister John Key sounds like he has had some dud advice when he told TVNZ that the advice he has received is that proposed changes will have little impact on rents. (We’re looking to find this piece of advice at the moment).

Likewise arguments that tenants set rent is only part of the picture.

What hasn’t been touched on is that if other changes are made to penalise Kiwis who choose to prepare for their retirement by investing in property then there is absolutely no doubt rents will rise.

Next week is shaping up to be fairly a interesting one for the housing market and where it is headed.

It’s not quite the big bang – that’ll be May 20 when the government unveils its new taxes in the Budget.

Rather, next week we see the latest house sales data from QV and REINZ, plus we have the next Official Cash Rate announcement from the Reserve Bank.

Anecdotal evidence we are hearing is that the housing market has slowed considerable, especially amongst investors.

There have also been reports floating around that a good number of investors are saying enough is enough. Let’s sell before the government destroys the market effectively taking away property investors’ retirement savings.

However, others are sitting tight waiting to see what happens.

The OCR announcement is a critical event to watch. While we are not expecting the governor, Alan Bollard, to increase the cash rate (like his counterpart across the Tasman did this week), we will be watching for a strong steer on where rates are heading. Or more precisely, we know they are heading up, we want an idea of when and how steeply they will rise.

There will be a point where borrowers enjoying these wonderfully low floating home loan rates will have to make a big decision.  Stay floating or move to a fixed rate? If it is the latter, the question becomes what term?

At the moment it looks like the shorter duration loans – out to around two years – will be the ones to go for. Longer term loans look pretty expensive right now, even though we have seen some decreases in the past couple of weeks.

So next week will be one to watch. While the data and news isn’t likely to spark huge amounts of activity, it will be fundamental information needed to plan future moves in the property market.

Property investors have been inundated with reactionary views on what the government plans to do to them through the tax system.

Now a bit of time has passed since Prime Minister John Key outlined the government’s plans to Parliament it’s worth reflecting on what might happen.

The first point is don’t be lulled into a false sense of security. Key dismissed some of the most distasteful ideas such as “comprehensive” capital gains tax, a land tax and a risk free rate of return method of taxing property.

You could almost hear the sighs of relief from investors.

What hasn’t been said though is what the government will do.

It’s pretty clear residential property investment has been singled out as the great evil which needs to be dealt to.

Apparently we all rort the system, pay no tax and are generally bludgers. What bunkum.

My views on this have been spelt out many times – the underlying premise being investors are business owners providing a service. They should be treated just the same as any other business owner and be subject to the same tax rules.

What’s on the cards?

Changes to depreciation for one. Property investors can live with that. After all it’s really just a timing issue and brings forward some revenue for the Crown.

What I wonder is this: Why the government should make a whole set of new tax rules?

It seems to me that Inland Revenue has had quite some success with its so-called Property Compliance Programme. Under the PCP it has been chasing investors who clearly have been buying properties and flicking them on for a profit.

So far they the programme has raised more than $214 million.

This is just the low-hanging fruit. Surely one option is to clarify the rules here and continue to enforce them.

Clarifying and enforcing these rules is something investors could live with too.

If the speculators’ activities could be curbed that would undoubtedly take some of the pressure off house prices. Particularly for those in lower price brackets.

The talk about changes to the tax system has died down a little and now reality is starting to sink in.

Most commentary has been around the fact that the proposed changes are designed to whack residential property investors. The anti-property brigade has been in strong voice once again pushing the spurious line all property investors are fat cats rorting the system; thankfully investors have been putting up a pretty good defence.

While things are still murky around what the government will do and how far it is prepared to go to alienate a good chunk of its support base, there is acceptance change will happen.

As I have digested the changes and talked to other investors it has become clear this is big.

Indeed I would argue the changes are once-in-a-generation stuff. The rules around residential property investing will totally change. The business will be totally different and investors will have to change their approach.

I have heard that many investors have got the heebie geebies and are already looking to exit and have put properties on the market.

I’m not sure that is necessary. The changes don’t necessarily mean that investing in residential property will no longer be profitable. It means you will need to think about how you approach it.

One change I suggest will happen is that some of these companies who find properties for investors and sell them to them on the basis of depreciation gains and tax benefits will struggle to survive.

Also the changes are likely to drive up rents over the medium term. While that is a plus for investors, tenants won’t be happy with the government.

The March issue of NZ Property Investor will be giving you lots more information about what these changes mean and what you can do adjust.

I’d love to hear your thoughts on the changes and how you plan to adjust to them. You can comment below or send an email to thelandlord@landlords.co.nz

PS: I was in Auckland this week and attended one of Kieran Trass’s breakfast presentations. He has plenty of views on the changes and also some ideas on what to do. If you are in Auckland and want to attend one of these Wednesday sessions click here.

Residential property investors have been a political target for some time now and today’s report from the Tax Working Group (TWG) made it clear they, unfairly, remain in the sights.

The TWG has put the acid on the government throughout the report and raised ideas which will be clearly more than the government can stomach.

The question that I struggle with is how far would a National-led government be prepared to go and clobber the property investment sector?

There is little doubt in my mind that the vast majority of property investors would vote National or some other party on the right of the political spectrum. To penalise several hundred thousand of its core supporters is the equivalent of political suicide.

National has plenty of political capital to burn, but moves such as the TWG have proposed are like lighting a bonfire.

I suspect there is some “low-hanging” fruit the government can pick. For instance the land tax idea is something that wouldn’t be too hard to do, and could raise a reasonable sum of money.

I am told there used to be a land tax (apparently it was a pink form filled out each year which had to be filed by the end of May).

Likewise changes to depreciation are possible. There is an argument which suggests depreciation isn’t really justified when the asset is generally appreciating. There maybe some instances, such as leaky buildings, where there is a genuine reason for depreciation, and the rules could be made to accommodate this.

Also an increase in GST would mean that property investors paid more tax.

One thing which was good to see is that the TWG didn’t get stuck into the argument about loss attributing qualifying companies. Many commentators have described this as a rort that property investors shamelessly exploit.

I have always had trouble with these arguments. The view being that property investors are in business providing a service (accommodation) to customers. They should be allowed to operate under the same rules as any other business. LAQC’s are legitimate structures for them to use.

This was summed up by the Institute of Chartered Accountants tax director, Craig Macalister, at www.netprophet.co.nz when he queried whether the current “emotion” around property investment was getting out of hand.

“We need to be careful not to fall into the trap of selected taxes for different assets or investments for all the reasons why these were a failure in the past,” he said.

The Reserve Bank governor threw a cat amongst the market pigeons this morning, defying predictions about when rates will rise.

Economists and the market have all been predicting that the Reserve Bank will have to back off its earlier predictions about rate hikes. Some even argued increases to the OCR could occur early in the New Year, rather than late in 2010.

Today they were right about one thing: the OCR was left at its historical low of 2.50%. Where they were wrong was with Bollard’s position that he sees no need to start tightening monetary policy soon and the increases are still some time in the second half of next year.

He made his views very clear in this part of his statement: “In contrast to current market pricing, we see no urgency to begin withdrawing monetary policy stimulus, and we expect to keep the OCR at the current level until the second half of 2010.”

Just for the record, current market pricing was saying there were expectations for a 100% chance of a 25 basis point hike in January and 200 points of hikes priced in over the next 12 months.

The central bank’s comments today will do nothing to stop the on-going increases to medium and long-term fixed rate home loans. The pricing of these mortgages comes off the back of what is happening overseas. Bollard and the Reserve Bank have no control over them.

However, today’s announcement will mean that variable rates stay low and, arguably, there could be some more downward pressure on them.

There is already a big variation in rate cards. In the competitive floating rate market the range is from BNZ’s 5.59% for its Total Money product, through to ANZ’s 6.45%. Added to this you need to look at revolving credit rates too as some lenders are using this product as its leading variable rate offer. Here the range is from Westpac’s 5.69% to 6.85% at HSBC.

Adding to the complexity of this market there are a number of lenders with more than one offering. ANZ has in the past month introduced what it calls its “Simple Variable” floating rate which has a few conditions attached, but is competitively priced at 5.69%.

The latest round of house price data clearly shows the market has a strong heart.

Overall prices are up, proving, as I long expected, that the bearish pundits were wrong. They said house prices would fall 30%. While I’m happy to see house prices and activity pick up again there are still plenty of obstacles facing the market.

The obvious one is tax changes – but I promised myself we would not talk tax this week – far too dirty. Instead, the biggest obstacle facing the market may be interest rates.

As our table shows, home loan rates have been rising strongly. Up until recently most of the changes were at the long end of the yield curve, now they are creeping right down to six-month fixed rates.

The only area immune from increase, it seems, are the floating rates. These and many revolving credit rates have been falling to quite low levels. It is clearly the part of the market with strong competition.

The range is from BNZ’s 5.59% for its Total Money product, through to ANZ’s 6.45%.

With revolving credit rates the range is from Westpac’s 5.69% to 6.85% at HSBC.

Adding to the complexity of this market there are a number of lenders with more than one offering. In the past month ANZ has introduced what it calls its “Simple Variable” floating rate which has a few conditions attached, but is competitively priced at 5.69%.

The concern for the property market and house prices is that expectations are building that the Reserve Bank will increase its official cash rate sooner than it has forecast.

There are also growing signs that when the increases come, they will be stronger and higher than many expect.

If this happens it will be like pouring cold water onto a property market that is starting to warm up. We will watch next week’s official cash rate announcement carefully.