It's still worthwhile investing in residential rental properties, although if interest rates rise further the shine could come off them, according to Westpac's chief economist Dominick Stephens.
In his latest Home Truths newsletter, Stephens said that once maintenance costs and management fees were taken into account, the net yield on a rental unit was generally less than the interest rate on the mortgage that financed its purchase.
Investors were only willing to accept such low yields because they anticipated making capital gains, Stephens said.
In the early 2000s, interest rates were low and so were house prices relative to rents, so a long term capital gain of 3% was sufficient to allow the investment to break even.
"No wonder there was such a craze for property investment at the time," he said.
Then as house prices and interest rates rose during the 2000s, so did the amount of capital gain required to make the investment worthwhile.
Westpac estimated that at one point a long term gain of 5.7% would have been necessary to justify investing in an average house.
That had since dropped back to around 4.4%, which was under Westpac's forecast of 5% house price inflation this year.
However the calculation was based on a mortgage interest rate of 6.3%.
"Should interest rates rise in the future, as we suspect they will, the required capital gain may once again rise into unrealistic territory," Stephens said.
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But there is a point at which houses cease to become unaffordable, even to cashed-up new migrants. Look at really long run house price series, e.g. the Herengracht Canal, house prices move up and down with the economy but don't appreciate much in real terms in the long-run.
Assume his 'break even' numbers are for NZ over all?
In auckland, taking one example, net rent after fees = 400, price = 550k, rates insurance = 3k:
Assume own a house outright and have used equity to borrow 100% of purchase price (to avoid difficult considerations of opportunity cost of using deposit to earn $ elsewhere).
$34650 interest exp + 3k = $37650 + 2k maintence = $39650 expenses.
rent income = $20,800.
Net operating loss = $18,850 Gauranteed loss p.a. = $13,195 loss after tax refund.
Equivalent to 2.4% of purchase price of house.
So long as prices continue to increase by at least 2.4% then they will be breaking even/ make money.
Would have been 3.4% if tax refund was unavailable (eg set up in trust).
So my figures make it look a bit better than Dom's above... Some working of his numbers would be good to look at.
Outside of Auckland example:
Purchase price: 200k. Net Rent 300. Rates insurance 2700. Maintenence 3k
int exp = $12,600
total exp = $18,300
Total income = $15,600
Net loss: $2700, after tax refund = $1890, or 0.9% of purchase price of house.
So the capital gain needs to be at least 0.9% p.a to break even (barely have to keep up with inflation);
For properties that have not seen any price increases during the same time auck/chch has moved into 'very stretched' territory, I know where I'd feel safer placing my $$.
So your buying up large on stewart island also?
It's all relative.
Historically, Auckland house prices may have been 2x a provincial towns prices.
Now they are 3-4x.
Have the geographical restrictions suddenly occured over the past 3-4 years to cause this disconnect? Or has sentiment/emotion fueled irrational buying thats pushed auckland prices above a level where fundamentals support them?
Yes and all those factors are well and truely priced into the current auckland housing market (and then some due to media hype), so all this future growth has been pulled forward and sqeezed into a few years leaving the next 5+ years of flat lining and yearly losses as rent fail to keep up with mortgage payments.
From my Auckland example, an investor can easily still make money if they want to gamble on price rises of atleast 2.5%.
What it also highlights is the fact they get close to $7k of tax payers money every year to make up for there constant loss. (Likely a lot more once 'paper expenses' are added, eg chattle depreciation, travel expenses for inspections).
Then to rub salt into the wound, they then benefit from tax free capital gains.
Sorry but as a PI myself, I see this as wrong. Either they plan to make a profit from renting, and hence pay a yearly tax (not get a yearly refund), or they make a loss (get a refund) and in so doing admit they are buying for captial appreciation and hence pay a capital gains tax (assessed after say 5 years of ownership after looking at tax returns and GV's of the property).
Fairs fair, and you shouldn't be able to have it both ways. I dont buy in auckland as I cant logically justify lossing 18k a year on the hope that already stetched house prices get even more stretched.
How to implement:
Change the IR3 ( I think it is..) form to include a tick box where before any tax refund is given, the investor must admit that the decision to purchase the property was at least partially based on the prospect of captial appreciation, and in so doing they are now liable under current law to pay a captial gains tax on this property.
It would be easier Simon to just ring fence investment property losses all together.
Simple.
Easy.
No extra box to tick.
Then, in the end, the only refunds that would get 'claimed' are when and as the property actually makes a taxable profit, which should have been the investors intention. You dont need to rely on an investor to declare their intention at all.
Just enforce income taxation on any property you have claimed interest deductions on, even if you have scammed your family home into it some how. The whole "I didn’t meet to make a capital gain" path to avoiding paying any tax must be close to the biggest farce in NZ.
Why not look at the other side of the coin Averageman......how about allowing all house owners the ability to deduct interest, rates, insurances and R & M from their earnings!!
Everyone in the market is then treated equally......of course all accommodation supplements, WFF etc would have to be dumped as well.
Governments need to be encouraged to cease this endless wasteful spending so in treating everyone the same Governments are actually incentivised to keep their costs lean and mean at all times.......
By the way it is not an income taxation issue....PI have to pay income tax,
Fully I agree I'd be all for that.......Yes I know why real estate is is a preference.....and I'm certainly not blaming people who invest there...people have a responsibility to look after themselves and their money.......for some reason a certain percentage of people just don't get the system......and hence fall through the cracks which ends up costing us all........ hence let everyone claim the interest, rates and insurances.......instead of Governments creating inflation and taxes us all the time....you'd create a system where the Government spending would be restricted as people would have the capabilities of looking after themselves and not so much interferring in the market and that is a good thing.
Lets not invent more tax models - just use the existing ones. Most profit making investments attract tax on the profit/income differental. Why is rental housing different. Buy for Y, Sell for X (assumes a profit), difference is Z . Apply your tax rate. Simple.
Rentals that operate on a realistic yield model - no problem. Ones that operate on a twisted leveraging model that is hanging out for its tax free gain for doing sod all...needs change.
Interesting that it was a non event in election run up. Perhaps it was swamped in the noise of affordable housing debate.
Its Balony, not all investors buy property to experience capital gains. Some investors actually feel comfortable paying into an investment thats operating at a loss knowing they will have multiple streams of income in retirement.
Perhaps Westpacs experience is that are providing loans to over-leveraged speculators?
Sorry, but no investor pays into an investment making a loss unless they expect to make a gain down track. Otherwise what you are saying is that you are a charity giving your cash away.
The reality of Auckland house prices is that absent capital gains, you are better off putting your cash in a risk free bank account as even the post tax interest rate is higher than the rental yield you can get from property.
Tis is the key indicator that the IRD should use to determine whether to tax gains, whether the market income yield on a house is higher or lower than the fixed interest rate for savings at the time of purchase. Data is readily available. And very transparent.
No one said anything about not making a gain, only about earnings/income/profit.
Every quality investor has core investments and higher risk investments. When their activities are analysed it becomes clear to why this strategy is essential.
The most common successful strategy is the "big paycheck job" . Sadly many people get the big paycheck career and consume their "children". Another major downside is clearly not everyone at the company is going to be CEO or getting CEO pay packets.
Another strategy, which is harder, is the Warren Buffet startup. He started trading very young and had significant advantage against his competitiors which he learnt to capitalise on. Youth, contacts, lower than legal wages, free supplies and transport. Should he be charged back taxes on the gains his youth gave him?
Likewise with the stored equity. One can put cash in a bank (and get almost inflation rate interest). Or a managed fund, tied up forever, significant fees, and zero control over your investment, and only when the people who own your money say you can have some back do you get to use it. Or you can do a similar step and put it into an asset. Could be metals or stones. Could be a career or marriage. Could be paying chunks of compulsory savings via a mortgage into a property - the sooner that core equity starts building, the sooner there is a workable ante. And every dollar paid off principle saves you Interest% in gain. So perhaps you want to start taxing that gain that people make of saving interest?? As long as the overall cost doesn't outstrip your investment then the equity will accumulate.
It is the same pattern I use with my FX. I never expect to see my original 5k back in position trading. It sits there and I hedge against it. thins go the wrong way, I save a little more into the fund. Dollar reverses eventually my 5k brings home some friends and they all go back out to work as soon as the market slows. It reverses again, my hedge pays out instead. 5k in and there's 38k bouncing up and down 9months later. And every now and then I'll tap off a little to pay for something extra. In electronics it's known as a tuned circuit, it doesn't provide the end result it is merely means to enable other things to function.
Would this discussion be any different if the Goverment published the Total amount of
(a) Tax foregone on negatively geared rental properties nationwide
(b) Total rent assistance paid to all private landlords
(c) Total Rent assistance paid to domestic landlords
(d) Total Rent assistance paid to foreign owners of private domestic rentals
(e) Rent assistance paid out on negatively geared rental properties
And exactly why all the knobs have to be turned to make this leech like investor behaviour a thing of the past. I was pretty furious when I read the article, ropable when I read your comment. New Zealand is turning into a totally dumbed down renting and consumer society and we won't even be able to grow our own fruit and veg shortly.
It's the way debate is conducted.
There are 4 broad groups of participants involved
(a) Government
(b) Media
(c) Professional Bodies
(d) Hoi Poloi
An issue arises.
If important, the Govt either issues a silken motherhood statement designed to ease the fears of the hoi-poloi, or dismisses it as irrelevant. Never provides essential information that the Hoi-Poloi needs to make informed decisions.
The Professionals remain silent
The news media gets its teeth around any sensational aspect, like a dog with a bone or ignores it, they rarely go and consult the professional experts, obtain professional opinions, concentrating only on the sensational instead
The Professionals remain silent
The Hoi-Poloi react to that which is published or broadcast
The Professionals remain silent
Meanwhile Govt plays Pied Piper of Hamlyn, while pouring $ billions into the pot
So Mr Ninness and Mr Stephens - help us out here
Actually my strategy IS to pay into properties without realising Capital Gains. At 26 years old and owning 4 rental properties without children/dependents my only goal is to have 6 properties paid off giving me income when I hit 65. Having to pay Property managers/insurance/rates etc for the first few years out of my pocket due to being negatively geared is more valuable than "putting money in a bank account". Lets be honest how many Gen Ys have the ability to save that religeously and over that period of time. My strategy works for me, but at the same time more "astute" investors will be looking at different ways to make a buck.
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