Long term property investing reduces volatility

The headline may be a case of deliberately stating the obvious, after all, economists will always tell you that investments of any shape or form; whether shares or property perform well in the long term, their advice is be patient, stick with it.

No; my interest was not in a catchy headline. I wanted to examine the data behind the claim that longer term investing in property from a rental business perspective is less volatile, especially when compared to shorter term investing. To be clear I judge short term to be 3 to 5 years with long term being 10 years. 

The ability to undertake a detailed analysis of the investment returns of rental property has been greatly assisted by the Ministry of Business, Innovation and Employment who have released online the full data set of rents by Territorial Local Authority (TLA) by month going back to 1993. The data set identifies the mean rents and the lower quartile rents.

I have used this data set and mashed it together with the REINZ median house price data going back to 1992 and the Reserve Bank of New Zealand data on mortgage interest rates for the same period. This collection of data has allowed me to build a model that shows the real rate of return based on the median house purchased and rented with a notional 100% mortgage paying the monthly variable rate of interest on the mortgage. The rate of return is based on the selling price at the end of an investment period being the median price at that month, plus the monthly rental income, less the mortgage payments, less the original purchase price at the start of the investment period based on the median price at that month. Note that mortgage payments are only the interest component.

Before detailing the presentation of this data I thought a couple of preliminary charts might be of interest. The first is the indexed growth of property prices and rents over the period since 1993. 

Not surprising here. Property prices have soared ahead of rents. Given the often quoted economists view that property prices need to reflect fundamentals of the comparable cost of renting, the message clearly have not got through. The massive divergence of the indicies from 2003 onwards is so clearly seen in the chart. There was some adjustment as property prices eased back in 2008 but the recent resurgent property market now sees property prices at an index of 350% of where they were in 1993 with rents at 232%.

Looking at the financial performance of rental investment, a simple judgement of the investment is to see how much of the monthly mortgage repayments is covered by monthly rents. The chart below details this as a trend line by month from 1993 to date.  

As can be seen the fact is that at only two occasions over the past 20 years has the the mean rent actually come close to covered the monthly mortgage. Towards the end of the 90's when property prices stagnated and interest rates fell as a function of the Asian Crisis and then again in 2002 jus before the massive surge in property prices again at a time of low interest rates. However in today's world when interest rates have never been lower for longer the rental income barely covers 80% of the mortgage repayments as property prices continue to grow. 

So having provided some contextual data for the mean rents, property prices and mortgage rates here are the charts which show the actual financial return in dollar terms for rental property invested over a 3 year / 5 year / 10 year period for each month right up to June 2013.

Over the 3 year horizon the significant returns achieved by buying in the early 2000's are not even close to being achieved again at this time and clearly the worst outcome would have come from the net losses attained in the period of 2009 to 2011.

The 5 year horizon resembles very much the 3 year investing picture, with slightly higher returns for those exiting in the perfect position of the peak of the market in 2007 - again recent returns based on a 5 year investment come nowhere close to those levels.

The 10 year investment horizon demonstrates the value of long term investment which is always around $70,000 for the 10 year period. What is interesting is despite the recent low interest rates and rising prices the recent level of return is declining and is likely to continue to show lower returns on a 10 year horizon as the purchase period slips into that period that saw the greatest rise in property prices. So the guidance would be - hang on in their for the long term.

The short term investment of 3 or 5 years can achieve excellent returns but as ever you have to time the market perfectly and this is only ever really seen in hindsight. The current return on all 3 periods shows a level lower than the peak and the average. 

Leasehold property makes for an interesting option

The article in this week’s NZ Herald titled ‘Buyers wary of house bargain’ got me thinking of the subject of leasehold property.

Leasehold residential property is certainly a rarer commodity than in other countries; I always marveled at the concept of a 99 year lease for London property when living there, imagining the world in 2087!

We do have a few such properties in NZ but I think we have even less understanding of the concept of leasehold and recent stories has probably only added to a sense of apprehension in them and a sense of “steer a wide berth” and stick to freehold properties.

The property in question in the article which is for sale in Greenlane, Auckland is a substantial 4 bedroom home on a large quarter acre section of 1,093 m2 on the edge of Cornwall Park. The property has a ground rent fixed until 20127 at $30,000 a year. It is being sold with an asking price of $475,000.

The Auckland Council in their rating assessment value the land at  $830,000; with the improvements (being the building itself valued at $460,000). This is one case where the Current Capital Value actually bears relevance to the value of the land and property. The land rent of $30,000 a year represents a 3.6% yield on the value of the land at $830,000. The selling price of the improvement at $475,000 is in line with the assessment of $460,000.

So why is the property, as the article says, attracting so little interest in what is a very hot and active property market in Auckland; a market where as we constantly hear demand is very strong and supply very weak?

Simply people in my view, cannot rationalize the inconsistency of a property of this size being sold for less than half a million dollars when other similar properties in the same area attract prices well in excess of a million dollars. It has all the hallmarks of “too good to be true”! Equally I believe they perceive that the ground rent will suddenly and unexpectedly double overnight without any notice and lastly I think they believe that in 5 or 10 years the property will be worth nothing at all and they will have lost $475,000.

Lets look at the reality of the situation and in doing so expose what might actually turn out to be a great financial decision for a prospective future owner.

I have not examined the actual lease document for the property but the listing advert states that the ground rent is fixed at $30,000 a year until 2027, 14 years from now. Real estate agents have a legal responsibility to provide such information with full accountability so I would believe that as an owner you will be liable to pay $30,000 in 2014, 2015 and so on through to 2025, 2026 and 20027. No adjustment, no inflation just $30,000 a year.

As to the residual value of the property – well the value of the physical property, described, as the improvements in the assessment are valued at $460,000 now. The owner of the land who is providing the lease for the property has no right or ownership in the property. It is very likely that in 2027 the owner of the land will have little or no interest in the land aside from continuing to lease it. I do not know, but would doubt that the owner of the land has any prior right to occupy the land (they would certainly have no right to occupy the property as it is not theirs). So the property will always have a residual value in 2027 or anytime between then and now.

So armed with these facts lets look at this property not so much as a property to buy at $475,000 with a annual leasehold cost of the land of $30,000, but rather as a rental property that costs $577 per week to rent.

This level of rent is considerably cheaper than the market rent in the area which for this type and size of house is more comparable to this house for rent in the same area at $800 per week. However to be able to rent this 4 bedroom house at $577 a week you have to pay a bond, a pretty significant bond of $475,000. That bond has benefits:

1. You have complete right of tenure – for the next 14 years
   
   
2. You have a fixed rent per week that will not rise by any form of inflation for 14 years – you will pay $577 a week in 2027
   
   
3. You can do what ever you like to the property in the form of improvement without any recourse to the landlord
   
   
4. You can at any stage decide to move house – cancel the lease and recover some or maybe the entire bond

Seen from this perspective the leasehold property takes on a somewhat different perspective. In terms of financials it could be a smart decision as the following scenario shows. I have assumed that a prospective buyer has $475,000 in cash. As i see it there are 3 options to live in this area in a 4 bedroom house:

1. Buy a property with the $475,000 as a deposit and finance the balance of the $1.2m purchase price with a 20 yr mortgage – assume rate of 6.6%
   
   
2. Rent a property at $800 a week with a rent inflation of 4% per annum with the $475,000 being invested at 5.1% on term deposit
   
   
3. Buy the leasehold property with the $475,000 and pay the annual fixed lease of $30,000

In terms of monthly costs the leasehold property costs significantly less than buying an equivalent freehold property: $2,825 as compared to $5,773; however if the option 2 was taken and a rent of $800 a week was paid and the $475,000 invested the net cost would be the lowest of the 3 options at $2,054 per month.

However what is more useful to examine would the comparable situation set over a 7 year period, that being an average occupancy period for a property.

As the details show below the cost of the outright purchase of a property is the most expense option at $488,449 over 7 years with the rental costing a net cost of $212,935 after recovery of interest; whilst the leasehold net cost is $240,817.

Now of course this assessment would not be complete without looking at the true impact of the investment of the original $475,000. As the spreadsheet shows with a property price appreciation of 4% per annum the outright purchase option shows an increase in asset value of $388,270 on top of the original $475,000 this being the increase in value of the property plus the repayment component of the 20 year mortgage after 7 years. Taking this into consideration the outright purchase over 7 years costs just $100,179.

The option 2 of renting and investing the sum of $475,000 sees a compound asset appreciation of $115,634 which means the net cost is $212,935 over 7 years.

The third option of the leasehold property has a gain in asset value of $35,943. This has been assessed as being the apportionment of the 4% of the property appreciation per year applied to the improvements; the land equally will increase by 4%. Allowing for this asset gain the net cost over 7 years of the leasehold property is $204,874, less than for renting but twice the cost as for outright purchase.

Out if interest I did an extreme scenario to see what would happen if say rents rose at 6% a year as opposed to 4% and at the same time property appreciation only rose at an equivalent of 2% per annum. Based on this situation the differential becomes much closer with a 20% variance between all 3 scenarios.

What I think this shows is that the cost of property ownership / occupancy can in theory be pretty similar based on the options of rent, buy or lease if property appreciation in the long term is on average low – if that takes off to anything well over inflation the leverage factor of borrowing certainly benefits purchasing a home. For leasehold property – this analysis shows that certainly it could be considered as an option, especially if you do not have the income to support this scale of mortgage.

Potential impact of policies to address the 'hot' property market

Real estate agents might be urging the government to "be careful what you wish for" in regard to any government or fiscal intervention  in the NZ property market -  especially if they have read about their colleagues in Hong Kong!

With further evidence that the NZ property market is building up a significant pressure bubble – the ever-present question is whether that bubble will see the pressure released slowly or just simply burst with negative repercussions. 

Measured on a 5 year basis the REINZ Stratified house price index shows a 17% increase, with over half of that gain in the past 12 months! This has prompted extensive calls for some form of non-monetarist intervention via the Reserve Bank to focus on LVR and also calls for controls on overseas buyers.

With this as a backdrop it is worthwhile to compare and contrast the NZ market with the Hong Kong market given its topicality. Accepting the Hong Kong market is a very different market; the choice is a result of the fact that the local government has recently introduced far-reaching controls to bring some reigning in of a super hot market that has seen property prices rise 120% since 2008.

These new measures coupled with the tightened of existing policies is an attempt to make property, especially apartments more affordable – now where have we heard that cry before?

However to begin with there is an important perspective that needs to be seen when comparing the Hong Kong market with the NZ market. We are so often told that NZ and again particularly Auckland has some of the most unaffordable property in the world when comparing house prices to salary. The NZ ratio has house prices close to 5 time the average salary – that pails into insignificance as Hong Kong sits at a whopping 12.6 times average income!

The measures brought in include a doubling of stamp duty to 8.5% for property over HK$2 million (NZ$330,000) . I was interested to read in the South China Morning Post article of what I would consider as the most appropriate measure, being the requirement for banks to assess the ability of borrowers to manage a three percentage point increase in mortgage rates, up from the prior test at two percentage points. Additionally a stamp duty has been introduced to curb speculation payable by sellers if properties are sold within 3 years – the duty is now between 10% and 20% of the selling price. Lastly the measures also include (which will be of interest to NZ) a 15% levy on non-local property buyers!

All in all some very stringent measures, which from the data published in the article shows the policies appear to be making an impact as property sales collapse.

 Estate agents march in protest at moves to control sky high Hong Kong property prices

This collapse is having its effect on the industry of over 40,000 real estate agents in Hong Kong  which interestingly equate to 1 agent per 175 of population, compare that to NZ with 1 agent per 440 of population. These agents are up in arms as the slowing sales cuts their income – so much so that these agents association are marching on Government headquarters to have these policies reversed – could this end up being the case in NZ if proposed government and Reserve Bank measures cool the NZ market ending it backwards and jeapodising the income of 10,000 agents? – it will be interesting to see!

Realestate.co.nz iPhone update - the return of Google Maps

It was just over a year ago that Apple took a bold step that ultimately lead to massive backlash, as it deleted Google Maps as the default mapping platform for iOS devices (iPhones and iPads) and replaced it with Apple maps. Now in many countries the change was not so bad, but in NZ the change was dramatic especially when viewed by satellite image.

Apple had not even come close to providing the resolution quality of Google Maps - so for Apple iPhone and iPad users they had to accept that situation or download another app such as MapQuest, at least until December last year, when a native Google Maps app appeared in the apps store.

However for applications such as the Trade Me and Realestate.co.nz apps which rely so heavily on the default mapping platform, there was at the time no alternative and as such the user experience fell seriously backwards in June last year with a very poor low resolution experience for satellite view of property on the app.

Now I am delighted to see that Realestate.co.nz has released a new version of the app (Version 1.5) which uses Google maps again as the underlying platform layer for satellite and street maps. 

It's funny but it is not until something is taken away do you realise how much you missed it! 

This return to the Google maps layer for the Realestate.co.nz suddenly in my mind catapults the app far ahead of Trade Me Property app, a far cry from the rating I gave it just 4 months ago - especially as both now have synced integration of saved properties between web and mobile. 

Just look at the side by side comparison between the apps for the same property on the market. The image on the left for the current version of the Trade Me Property app in satellite view mode is the highest zoom before you loose image - the Realestate.conz app on the right uses the same zoom - staggering difference!!

Then the Realestate.co.nz app satellite view gets even better given the quality of the underlying image resolution allowing the tighter zoom-in as shown from the screen shot on the right. 

In my view this now places the Realestate.co.nz app as the must-have for mobile property searching. 

The NZ Property Cycle - 4 years to June 2013

The Properazzi Property Dashboard portrays the barometer of the regional property market which is very firmly in favour of sellers

Property markets move in cycles. The current market is firmly established as a sellers market. This current state is widening, in the sense that the total market when seen by region is gradually migrating in the direction of more and  more favouring sellers. 

In order to present this analysis of the market I have created a series of 4 charts which show the picture of the NZ property market by region for each of the past 4 years 2010 - 2013. I have used the measure of inventory as presented by the NZ Property Report from Realestate.co.nz which each month assesses the market in each region measuring the available inventory of property on the market and dividing it by the average weekly sales for the past 3 months using the REINZ sales figures. This computation generates an inventory; not as an absolute number, but as an equivalent stock in number of weeks based on the current rate-of-sale.  

I very much favour this approach as it reflect the key driver of the property market which is supply matched to demand. As sales increase and inventory is slow to respond, as has been the case for the past two years the inventory measured in the number of weeks of equivalent sales falls sharply.

These monthly statistics of available inventory drive the Property Dashboard which is presented by Properazzi each month in the form of a barometer of the market visually showing the degree to which each region of the country is experiencing a buyers or sellers market. 

The four charts presented below present the inventory at June 2010 / June 2011 / June 2012 and June 2013 and clearly show the trend. The trend which over the 4 years has seen a situation where in 2010  4 years ago, all but 4 of the 19 regions were in a balanced or buyers market to where today in 2013 only four regions are in a balanced market with none favouring buyers and the majority in a moderate or extreme sellers market.