Isbister Partners New Zealand

Is Property the Darling Investment it once was?

Is Property the Darling Investment it once was?

There is a long held notion that if you leverage property (borrow other people’s money) it’s a winning investment.  How does leverage work? Here’s a simple example:

Purchase price of property $500,000

You borrow $400,000 at current rates of approx. 7%

Your deposit $100,000

Growth over 1 year of 8.6% (long term average return on property since 1971 according to Booster, it pretty much doubles every 10 years, see graph below.)

Property Value after a year, $543,000

Return on your initial $100,000 investment is $43,000. If we take interest for the year of $28,000 (7%), your net return is $15,000 or 15%.  You can see why property has been so attractive. Key to this equation working is that capital appreciation (8.6%) exceeded the cost of debt (7%) – More on these assumptions to follow….

I recently attended a property master class, run by a trained Financial Mathematician (simply put an Investment Specialist).  They took us through some interesting assumptions and calculations.  I’ll try and discuss them simply here.

Here are the long term returns of different assets dating back to 1971 as presented by Booster.  The green bars at the bottom represent inflation.  As you can see inflation ran hot through the 70s and 80s and then settled down once inflationary controls were put in place in 1989 through the Reserve Bank Act. 

Once inflation was brought under control all assets have delivered lower returns.  See graph below:

The above graph represents returns from 31/12/1990 to 31/12/23.  Inflation has averaged 2.3% since 1990.

All asset classes are impacted by lower inflation.  However, property was more heavily impacted by inflation controls than other assets.  A 2.5% difference in annualised returns.  You can also see that there is a correlation between interest rates, availability of credit (how loose credit policies are) and property prices.  Just look at property price growth before the global financial crisis and during the COVID crisis.

When interest rates dropped to record lows during COVID people were able to borrow about 8 times their income.  That’s because their monthly surpluses were still good with low interest rates.  As rates rose, those surpluses have shrunk.  Now we see the introduction of Debt to Income Ratios (DTIs).  This is where people are not able to borrow more than up to 6 times their income.  This will prevent huge loans being approved in the future if interest rates are required to be extremely low again.

What does this mean for Property Investors?  With a laser like focus on inflation and DTI’s in place, property prices are going to be somewhat restrained for the next 5-10 years until incomes allow borrowers greater lending capacity.  The qualified opinion from Booster’s research team is a long term sustainable growth rate for residential property sits in the range of 4%-5% per annum nominal growth, which means 2%- 3-% real growth above inflation (1-3% RBNZ target range). This 2-3% rate above inflation is also consistent with historical property growth rates over 8% when inflation was over 5%.

Below is an actual example of how this plays out when you apply it to a property.  The figures below were applied to a property I found on trade me for sale in Khandallah.

You can see the purchase price used was $745,000, with an expected rent of $635 per week.  The buyer came in with a 35% deposit and is paying 7% on their mortgage.  Rent is expected to grow by 2% (inflation) and the property is expected to grow by 4.5% (assuming mid-point between the 4-5%) per annum.

Expenses include property management at 8%, insurance at 0.2%, maintenance at 0.5% and rates at 0.6%.

In this situation your net rental yield is -0.4% and your annualised return over the 30 years is 1.71%

The questions you need to ask are:

Do you agree with a 4.5% growth rate for property?  Would my capital (money) be better off invested elsewhere?

It may be that property investment is only attractive if you can add value by developing the property beyond its current state. Moreover, professional property investors with scale, can access cheaper building resources, giving them a significantly lower entry price compared to the average Kiwi Mum and Dad Investor.

It’s not all bad news for property… Just because property appears to be a poor investment, the reality is that we all need shelter. When faced with the option to buy or rent, the numbers still work for people who want to live in their own home. Especially, those that have 20% deposit or less.  Furthermore, owning your own home comes with many more benefits that cannot be financially engineered!

Disclaimer:  This newsletter is meant to be informative and engaging, hopefully not a cure for insomnia.  Please don’t take this as personalised financial advice.  Discuss your situation with an Advisor.  This is where I need to say past returns are no guarantee of future returns. 

Share:

More Posts

Retirement Blog

Into Retirement and Beyond!

Into Retirement and Beyond! When Buzz Light Year shouted “Into Infinity and Beyond” we often think about how KiwiSaver is becoming much more than an

Secrets of a happy retirement

Some people who imagined they’d leave all their worries behind once they quit working are finding retirement isn’t quite as blissful as they dreamed it

Losing the home

If you asked most people what they would do to keep their home if they lost their job, they would tell you anything. They would

Join 1000+ Kiwis who've trusted our expertise

Our team is working New Zealand wide
Contact Us
We love hearing from you, let us know what's on your mind