By Matthew Gilligan*
Tyson is a property investor, looking at investing in the Auckland market.
He has been told by his parents that he should ‘buy the worst house in the best area, and only invest where he would be comfortable with having his tenants over to dinner’.
(Some people call Tyson’s parents awful snobs, and they might have a point.)
Alternatively, some of his friends are saying he should look in areas with cheaper homes, lower income tenants, and seek cash flow. Personal bias aside, do the socio-economics of an area dictate potential returns (one way or the other), in the Auckland market?
Tyson decided to test his parent’s theory and look at the maths of the 10-year return on two specific suburbs, and make his investing decisions based on numbers, not old sayings and emotion.
Otara vs Remuera
Tyson picked Otara (cash flow) versus Remuera (capital growth) as comparison suburbs.
He picked four-bedroom houses in Otara with permitted sleepouts, which rent at $550 per week, but he used $525 to be conservative. He picked four-bedroom houses in Remuera which seem to fetch $1020 per week for a house of circa $1.3m.
He started looking at capital growth rates and observed that houses in Otara had a median price of $64,500 in 1992, and as at December 2014 the median was $372,000. This revealed a long-term annual straight line growth rate of 22% over that 22 year period.
Remuera went from $271,000 to circa $1.3 million over the same timeframe, revealing a 17% straight line growth rate.
In more recent times the 12-year growth rates were Otara 13% versus Remuera 11.6%.
The nine-year growth rate from 2005 to 2014 reveals a more even position of Otara at 9.4% versus Remuera at 9.3% – almost the same.
Of course cash flow also needs to be taken into account when making investment decisions, and areas like Otara tend to produce better cash flow, whereas areas like Remuera often require cash to be injected into the investment over time. So Tyson expanded to a total return analysis as follows:
- Looking at a portfolio of four houses at Otara’s December 2014 median house price (but targeting houses with permitted sleepouts) versus one house in Remuera at its December 2014 median.
- Using Otara growth at a more conservative 8% and Remuera scaled back to 7.5%, being numbers Tyson is comfortable with as he believes growth rates will decline over time.
Tyson was interested that Otara, with its higher cash flow but similar capital growth, won the contest on total return. He wanted further convincing so looked at the five-year and two-year comparative growth rates to see if the shorter term trends were changing. This revealed as follows:
- 22 Year: Otara was doing 22% vs Remuera 17%
- 9 Year: Otara was doing 9.4% vs Remuera 9.3%
- 5 Year: Otara was doing 12.2% vs Remuera 10.5%
- 2 Year: Otara was doing 22.3% vs Remuera 12.5%
(Source Property Ventures Real Estate / REINZ Median House Price Data)
Otara is still standing up.
From an internal rate of return (IRR) perspective, selling at year 10, this is how it stacks up:
Comprehensively then, looking at the total return and IRR, Otara keeps up with Remuera’s capital growth, but thrashes it when cash yield is added into the analysis.
Author notes & morals of the story
1. Contrary to intuition, Otara is in fact higher growth than Remuera.
2. Buy the ‘worst house in the best area’ is an old, outdated saying that is a very narrow view, when it comes to investment property. ‘Do I want the tenant to come to dinner?’ is also (at best) a very uninformed property buying strategy.
3. In this made-up case study, Otara is meant to represent many of Auckland’s cash flow suburbs. Remuera represents stereotyped capital growth suburbs. My point is, the growth differential between ‘quality growth suburbs’ and ‘cash flow suburbs’ in Auckland is a bit if a myth. In my experience, the so-called ‘low growth, high cash flow suburbs’ are in fact high growth, high cash flow suburbs, and outperform the prime capital growth suburbs on total return and IRR for simple residential investing.
4. Some investors will be able to find cash flow in the prime capital growth areas – I accept that and I do it myself on occasion. But it is much harder to do than in the so-called ‘cash flow suburbs’, where cash flow is everywhere and you still get high growth. My Otara projection is arguably low – I routinely beat this in South Auckland as far as cash flow goes.
5. You could argue that picking Otara houses with sleepouts introduces selection bias in the projection, because the rents are slightly higher than the norm for Otara, where median rent for a four-bedroom property (without a sleepout) is closer to $450. However, informed investors targeting cash flow are entitled to pick the better cash flow houses in the cash flow areas, as part of their investment assumptions. If you are a cash flow investor, you buy the cash flow asset, not the median/average return. I hope that makes sense.
6. No doubt readers will be concerned about vacancy and potential repairs and maintenance from rougher tenants in the cash flow suburbs. In fact some people I talk to get hysterical at the thought of the tenants in lower socio economic areas, and what they might or might not do. In reply:
a. Personal Experience: I own 10+ residential properties in South Auckland. I’m not having significant problems with them.
b. Renovations: In my experience, if you adapt the standards of the renovation to the suburb, you can keep your costs down, i.e. don’t put Remuera tradespeople and fit-outs into South Auckland, and control your costs.
c. Vacancy: It is very easy to get a tenant anywhere in Auckland, and has been for at least the last decade.
The argument against cash flow suburbs (concern over potential vacancy rates eroding returns) may be valid out of Auckland, in areas that do not have a deficit housing supply. In Auckland I have never had a problem getting a tenant in cash flow suburbs like Otara, Manurewa and the like. The deficit housing supply makes obtaining a tenant very quick.
Summary
I am not saying, ‘Here is a silver bullet, go buy in South Auckland for cash flow and high growth and this should be your only property strategy’.
Far from it, and I spread my investing dollar around too.
I’m simply pointing out to those that ‘want to be able to have their tenants to dinner’, that there are other places you can invest in Auckland, and do very well, possibly even better than in the perceived prime residential suburbs.
Coupled with South Auckland’s high capital growth, I routinely obtain net yields (rent less operating expenses / cost) at close to 7%, in this market.
Not a bad day at the office when you get total returns at close to 15%, if long term capital growth trends of the region prevail.
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Matthew Gilligan is a chartered accountant, and has been practicing since 1992. He is the managing director of Gilligan Rowe and Associates where he works assisting the firm’s clients in taxation and property related matters. You can contact him here. The author notes past performance is not a guarantee of future performance. This article is a generic discussion only, and should not be construed as financial advice.
111 Comments
Deep breath!
Crikey! Where do I start?
Firstly. What exactly is straight line growth?? Did you not notice that the straight line returns diminished over shorter time periods?? For those of you with an understanding of numbers you will feel my horror...
$64.5k to $372k in 22 years is 8.3%pa ... Not 22% per what? ... In fact at the same rate of return over 10 years would give a "straight line return" of 12.2% based on the calculations used in this "analysis"!!
So apart from decidedly dodgy mathematics, the argument to buy in Otara over Remuera is flawed on so many levels.
1. Buy in areas where people want to leave, not areas they live because that is all they can afford.
2. Buy in areas likely to improve that are relatively undervalued for some foreseeably fixable reason.
3. Buy the house with the best prospects for being a nice home, that is something in one of the best streets, with parking, with sun, with land etc etc
4. Buy properties in an affordable rental price range and keep the houses tidy but affordable.
5. Keep clear of impoverished locations. If you want higher rental returns, over the long term prime locations in other centres will beat grotty locations in outer fringe Auckland.
Anyone who chose to invest in Otara 22 years ago versus, Grey Lynn, Sandringham or Onehunga where rental returns were available at similar yields, would have been seriously disappointed.
Thanks Chris_J, you beat me to it :)
I don't think the point of this article is to invest in the worst suburbs you can find, but rather to open your eyes to the possibility that these less desireable areas out perform the areas where people want to live. Good cashflow and and good capital growth are not mutually exclusive. Both can be achieved but it tends to be in less desireable areas where the rent is high relative to the purchase price for obvious reasons.
Also I have no issue with the straight line method. That's what the property industry works on. I understand the difference between compounding and straight line but it makes sense to use the industry standard.
Unless the growth rate is very small, Gilligan's method is both meaningless and erroneous.
I would like to know who in the property industry uses this method? Perhaps failed finance company directors??
good call.
For long term you have to stick to the fundamentals.
Doing it on the numbers makes an assumption that the factors aren't going to vary, wihch the longer period, eg 22yrs, makes that unreasonable - if you've got a crystal ball that good, sell you're services as a consultant you'll do much better and much less risk.
Chris - love to see your next worth if you analysis investments like this.
As I would see it there are potential large (masssive) short and long term gains in Otara. Well done Gilligan for pointing this out. The AUP provides for lots of rezoned areas as the NIMBY owner occupiers in A suburbs restrict rezoning - did you listern to the Reserve Bank's comments on this? Also have you been to a GRA workshop and heard what they preach - I did on Monday and this was exactly what Mr Gilligan was saying.
He said we needed to be careful to buy in in the best parts or agreed you will get bad tennants. Also there are good and bad property managers and only buy stuff that will be rezoned. Isn't this exactly right?
You people seem focused on a maths debate and seem to forget how the average person has got ahead in NZ. What Gilligan has said works - go listen and see for yourself.
Seems to me he's just making a point you can get returns outside of prime areas and no all of us can afford remuera or Grey Lynn.....
Schlong, so are you saying this guy is running classes on buying property while not knowing how to analyse returns?? This is troubling stuff...
If you were inquiring about my net worth, it is substantial.
Being troubled by the fact this guy might be running seminars, I did a little digging.
Interesting that Gilligan doesn't own any properties in his own name (according to CoreLogic).
Not surprising that he is a director of some companies then, especially being an accountant, as he likely has the business in a company, maybe he has his properties in a company or two, and obviously he may be trustee for his clients.
But being a director of 220 companies?? 132 current companies ... This is not an insult but that is Hubbard scale.
Next: one of those companies was Richmastery.
David Chaston, that should have been disclosed given the history that that business had. I am very disappointed as a reader you withheld that kind of information about a columnist.
An after thought is that perhaps GRA were involved only on a professional basis with Richmastery Limited, however I then looked at GRA's website and it has the same "feel" as Richmastery.
Could we please have an explanation and disclosure.
I am also struggling to believe that we have a law in NZ that excludes property promoters from being financial advisors. Surely if you are promoting an asset class, the use of credible financial analysis is part and parcel of that.
This is shocking stuff.
David Chaston an explanation is required...
Subsequently I have researched the companies register further:
Richmastery Limited from 14/3/2005 to 20/5/2009 was struck off on 4/10/2010 and liquidated. Director Phillip Ronald Jones was bankrupted on 24/1/2013 according to insolvency.govt.nz
A new company also called Richmastery Limited (note exactly the same spelling and name) was registered on 3/2/2014. Gilligan was director until 10/3/2014.
Given the history of the Richmastery seminars the choice of name for a new company is unusual and together with the fact GRA is now holding its own seminars, an explanation and disclosure of what relationship if any there is is really required please.
You are on the right track Chris_J
Under ASIC regulatons, property spruikers are tightly controlled, being required to register with ASIC and obtain a Financial Services Licence. Apparently not so with the FMA. Different administration it seems.
As a giver-of-advice, registered with ASIC, subject to their rules, a long-time NZICA practitioner, I have been troubled (disturbed) by this article. As pointed out by Chris_J and Two Otherguys, it is flawed thus misleading. It is the first time I have come across a professional firm of chartered accountants promoting property seminars
A professional approach is to conclude the article with a disclosure that the author does not own any property in Otara or Remuera, and a disclaimer that the article is not intended as personal financial advice and any reader intending to act on it should seek independent financial advice
Interesting that Gilligan doesn't own any properties in his own name (according to CoreLogic).
Stop the press, an accountant not having any properties in his own name, OMG. What has the world come to. Seriouisly if your accountant has property in their own name you need to sack them right now and get a real accountant.
Chris you are really revealing you own lack of understanding of property investment and indeed business in general. Even a graduate accountant would tell you that owning a business, any business, in your own name is a bad idea. One of the fundamental functions that accountants should be performing in addition to standard compliance is providing you advice on asset protection. The fact that you think it’s odd that the writer doesn’t own properties in his own name shows that your accountant hasn’t given you this advice so I suggest you find a better one.
As for the number of companies he has, this only suggest to me that he is actively involved in businesses. I wouldn’t want someone to be giving me advice if they didn’t have first-hand experience at running business themselves.
I know for a fact that Matthew sued Phil Jones (previous owner of Richmastery). Matthew was successful in his application and they settled out of court. I recently asked Matthew about Richmastery and he told me that he heard Phil Jones was back in town and looking at restarting Richmastery. Matthew didn’t want him to do that, so he registered the company to get the brand off him (this was late last year). Matthew has nothing to do with Richmastery except that shelf company to stop Phil Jones from re-registering Richmastery.
You also say Matthew is a director of 220 companies as if this is an evil thing. Maybe there is actually more to Matthew Gilligan than you give him credit for, Chris.
I know for a fact that Matthew sued Phil Jones (previous owner of Richmastery). Matthew was successful in his application and they settled out of court. I recently asked Matthew about Richmastery and he told me that he heard Phil Jones was back in town and looking at restarting Richmastery. Matthew didn’t want him to do that, so he registered the company to get the brand off him (this was late last year). Matthew has nothing to do with Richmastery except that shelf company to stop Phil Jones from re-registering Richmastery.
You also say Matthew is a director of 220 companies as if this is an evil thing. Maybe there is actually more to Matthew Gilligan than you give him credit for, Chris.
And Matthew does personal diligence on all of those 220 companies?? I don't think so.
I was reluctant to post on this comment thread, because many of the comments seem to be personal attacks on Matthew Gilligan and I find it a somewhat toxic environment. But then it bothered me so much that people are clearly missing the point that I have relented. Londoninvestor very succinctly sums up my opinion. (I have copied his comment below). From what I understand, straight line growth is commonly used. Matthew’s maths seems fine to me - when I did the calculation over the timeframe he took, I got 22% straight line as well (372,000 / 64,500 – 1 = 4.77. Divide that by 22 years = 0.22 or 22%).
But that is beside the point – Matthew Gilligan’s article is about the fact that Otara beats Remuera on capital growth and total return. I thought this was very interesting, useful, and perhaps surprising information, and that it would benefit people to be aware of it.
Londoninvestor said:
Sadly, I note, in some commentators above, a complete missing of the point (made by the author, as per the title he gave his article):
"a case study comparing investment returns in ...Otara and Remuera. "
Isn't it obvious that the author has made a very strong and well substantiated point and analysis that the total returns( yield plus capital growth )from Otara ( as a metaphor for South Auckland) has beaten the total returns from Remuera in each of four time periods from short through to long.?
Whether you calculate returns in each suburb by Straight Line Growth (as used by REINZ, or Core-Logic, the standard-bearers in the property industry of the statistics ) or whether by Compound Annual Growth Rate, the stated point of the article cannot be challenged mathematically - Otara's "total return" exceeds Remuera's for each and every time period. What is relevant in that analysis is that the same method of calculating return is used for all the comparisons, which the author clearly does.
The fact that the standard bearers in the industry choose Straight Line Growth means that, as professional investors, rather than novices, we should be familiar with its meaning, as with other methods of calculating growth, like CAGR. Indeed, showing depth of understanding, and a symapathy for alternate forms of growth calculation, the author offers Internal Rate of Return as well to make the same point for each time period regarding "the less desiarble to live suburbs"
One commentator, Chris, above says, " What exactly is straight line growth??
Clearly this commentator admits to having no idea, and yet is prepared to castigate the author. One wonders if he does not have an agenda, other than professional commentary that is contributory to the debate.
The main point of Investing is Return on Capital Employed.
Return on Capital Employed in Otara versus Return on Capital Employed in Remuera for each of the four time periods was greater.
This point is well analysed and clearly substantiated in the article.
When comparing investments, especially long term investments, the annual compounding effect must be taken in consideration.
So "straight line" will give you a 22%, the last year won't be 22% increase on the previous years equity value. nor with the second to last give a 22% incease on the year before that.
With the compounding effect, IIRC it works out about 8%.
So the value of the property goes up 8% in the first year - when compared with a Term Deposit or Opportunity cost.
In the second year it goes up 8% of it's current value (1+ 8%)*(1+8%)*original_value
Third year (1+8%)*(1+8%)*(1+8%)*original value.
Total gain by year three is 25.97%, if using straight line 25.97% / 3 = 8.66% but we know we've only be getting 8% each year because that's the number we used, and compounding it because we can't withdraw it on long term assets. It's that we can't withdraw pieces is the major reason the compounding formula has to be used, and it reflects the devaluation of currency/inflation, rather than a re-investment choice, as opposed to rolling over a Term Deposit (where the extra part which would be compounding is often paid into a separate bank account, even if the principal is re-invested.) A similar caution exists for share holdings when comparing yields between companies that pay out dividends and companies that prefer to compound the distributable earnings within the business.
Notice how we'd already gained an inaccuracy of 0.66% by end of year 3? with the compounding effect that just gets more significant as the number of periods increases.
The "how it affects me" is that in a "straight line" of 22% you might think that sounds pretty damn good, put me down for a year. or three years.
But a year would only get you 8%.
And three years a total of 25.97% all up (rather than 3 lots of 22% pa = 66% total return!!)
Exactly right cowboy!
It is misleading and confusing to describe the return as 22% over the 22 year period.
22%pa over 22 years would have increased a $64.5k house to $5.1m!
Crappy house = crappy tenant
It's an investment. You put controls in place to minimise risks e.g. from a crappy tennant. The numbers still stack up. Anyone with a nice investment property in a nice area will tell you that they are not free from R&M and the "nice" tennants have higher expectations about what state the house is in. In my experience even the damage caused by the occasional bad tennant is cheaper than having to keep a nice house at that quality standard.
Going back a few years, I did someone a favour of looking after their rental in Panmure while they were overseas. We couldn't get anyone with stable income or anyone with a clean credit history. In that short while we had mis-payments, complains of big noisy parties and several old cars on properties when they left.
Total opposite story when I rented my own home in central Auckland during our first few years in Australia
No offence but that sounds to me like poor property management. You can't get away with leaving these properties to run themselves. Unless you really know what you are doing you really should get an expert property manager to take care of this. They have the systems and channels to ensure an acceptable quality of tennant and they know exactly how to handle tennants who don't play ball. This is the same with nice houses. You are obviously far less likely to get someone leaving old cars on the property but in my experience it's much easier for nice properties to sustain expensive damages because you can't get away with cheap fixes like you can with cheaper houses.
I have a property in an undesierable south auckland suburb which has had the same tenant in it since 2012. Never have any problems with the tennant.
My last "professional property manager" put in someone - I got a call 6 months later from a neighbour about a broken window. Couldn't get hold of tenant to arrange repairer, so manager went to property. It only had one couch inside. Person was on government benefit..yet could afford to pay rent for a house they weren't living in.....
getting good tenant is luck of draw.
Previous property manager in different area, they been told not to let the place while I was doing some repair work. Put tenant with dogs, in no pets property. couldn't get them out , they then stuffed up the 90 days notice by putting wrong date on the notice... then 60days later when tenant refused to move the property management company twinked out the date and re-wrote new date (notice to leave is legal document, altering it qualifies as fraud). etc
getting good property managers is also luck of the draw (although apparently they can't be found in the bottom of a wine bottle.....)
did learn something nasty though : as land owner I had no rights. The tenant had contract with Property Management Company - I got stuck with all the legal problems and rulings, but I wasn't allowed to represent myself or my interests because I wasn't part of their contract. My only recourse was to sue the Property Management company in District Court (where they got to use the cheaper Tenancy Tribunal)
I am sorry for what happened to you but again this sounds like a story about bad property management. I don't think anyone would deny there are bad property managers out there just like there are bad fund managers out there. In the same way that you would/should due your due diligence before investing with a fund manager, you must do the same before trusting a property manager with your investment.
Sounds like you're coming from a theoretical or student level understanding of the process.
As the property owner (residential) you don't get to choose your property manager. It's a service you contract from a company that sells the service.
The one with the dogs, was a massive step up for the previous company, who put in a tenant that was partner to a Sole Parent Benefit family that lived next door...and who was the cousin of the previous tenant that we had evicted for smashing half the windows and not paying the rent. That tenant was removed when they were prosecuted for frauding WINZ.
But that wasn't as bad as when their vetted tenant sold off all the old roses in the garden AND all the internal doors of the house, they were also the one that didn't pay rent for 3 months, and when we finally got them evicted by the police they left us a bedroom filled with all the rubbish they had generated during their stay (9 months, with theoretically 3 month property checks.) The REALLY annoying part is -that- company's administrative staff returned 100% of the bond as due course "because they finished renting"
These are all licensed and trained people. Employed by their company to do these tasks as professionals, and in well regarded companies.
You know we're not talking about the another (subletted) tenant who was on ACC, and didn't bother getting out of bed to urinate, so kept soft drink bottles of it in his room under the bed and would sleep in his clothes, and shower only once a week. Fortunately he was only doing this for a month before I told the contracted tenant to get rid of him (they were afraid of reprisials).
So not not really "bad property management". There just are people like that and agitating them won't help. So they had some parties and annoyed everyone - not uncommon. Getting them out/calmed without major vandalism or police intervention is _good_ property management. Remember it takes 90 days to get them evicted, and only then can you can police (and risk reprisals) - and while "immediate danger/damage" might work seldom will the Courts risk infringing the tenants rights for a few thousands dollars worth of damage.
The claim about Otara that the "long-term annual straight line growth rate of 22% over that 22 year period" is bogus. A 22 year period is long enough for compound interest to have a significant effect, and it should be taken into accout in any calculation.
If during the 22 year period, the average price increased from 64,500 to 372,000, then the new average price is 5.767 times the old average price (nearly six times).
The annual percentage increase can be calculated using
(1 + r/100)^22 = 5.767
which gives r=8.3. This represents an annual percentage increase of 8.3%, which is still impressive, but nothing like the 22% that Matthew claims.
Surely, anyone who has studied compound interest at high school would know this.
I think you are missing the point here (or maybe I am). The point this article makes is that les attractive suburbs like Otara blitz the more desireable suburbs from an investment point of view. So if you apply your logic to the Remuera figures, Otara still comes out on top. What am I missing?
Pythagoras, Of course I concur. This was sixth form mathematics and for a chartered accountant and "property expert" not to understand the error, or pick up the error himself when considering the different time periods is a little disturbing...
[ deleted ... Ed ]
Property can be an extraordinarily good investment, but [ ... unnecessary insult deleted. Contrary opinion is fine but drive-by smears aren't. Don't do it. Ed.]
It's great that you guys are part of a mutual appreciation society but I think you are continuing to miss the point here. Straight-line return is how property stats are measured but who cares about that as 22% is not the centre of the argument. He is not trying to tell people to invest in Otara to obtain 22% returns. He is simply comparing the performance of two suburbs using industry standard methods and statistics. If you use an index/compound rates then you still come to the some conclusion which is that the suburbs that nobody wants to live in out-perform the suburbs that everyone wants to live in.
Sgtsosidge, who uses a straight line method???
No one does, except for very small time periods where a quick approximation is needed.
What is sometimes referred to as a straight line method is actually just the average annualised return not the method used above.
straight-line returns is certainly NOT how property stats are measured.
not here, not at university coursed, not in financial orlegal advisement, not in accounting end of year documents !
Re do the maths with the overheads taken in to account.
Then do another comparison including a fact for real risk of damage and maintenance issues.
Yes a low priced bond or property WILL indeed return a higher yield. However, often this is because it is more risky, and thus if repeated (or consulted) has a high chance of poor performance over a statistically large period.
Also if one does trade, then there's a high chance that resale of the property will occur, which means taking into (1) tax on the sale even if it is above the purchase price as it was a known source of possible revenue, and (2) the size of the payment.
Also figure in a leverage factor.
A property worth 200k, might get you 20% growth and 200pw rent = 40k
A property worth 800k, might only score 15% growth and 900pw rent = 120k
But if you're going in at 1% positive cash return (after expenses) you might find that the 800k gets you a LOT more profit than the same money put into cheaper houses, as the bank will lend more on nicer properties.
Dear Editor (David?)
A general reference to others who in the past who have used dodgy mathematics to promote property investment to unsuspecting customers was not intended as an insult.
However I do have to take exception to the above article which uses blatantly incorrect calculation methods to provide returns. It is a point of debate whether an article such as the above touches on being financial advice, whether or not it is financial advice, correct financial analysis methods should be used. Suggesting a 22% return was achieved over 22 years is nonsensical and erroneous.
Spot the people who invested in Remuera :p
Translation: "I've bought too many dodgy south auckland rentals and a few are turning out to be real headaches... the auckland market is seriously irrational with prices way out of wack.. its definately time to off load a few of these hard work properties, lets pump up the market with some over the top made up numbers (so I can brag to my wife that im the real wolf of wallstreet) to get me some buyers.."
Anyone who invests in property on strictly mathmatiical grounds should get out of the business.
Residential property is 90 percent emotion and trying to fit formulae over the top is a guarantee of failure.
No two properties are the same so results will vary widely.
If your accountant uses this type of hocus pocus get another accountant.
Who is suggesting to invest purely on mathematical grounds. Nobody on this forum that I can see. But it would be ignorant to think they don't play a significant role even if it is simply to draw comparisons between two options as is done here.
(Comment deleted, I've nothing to add, sorry.)
Agreed. But mathematics (and spelling!) are still important to understand what you are doing. Unfortunately the above analysis uses mathematics without the user understanding exactly what mathematics needed to be done...
speling is overrated
Only if you're dixlexic... Only if you're dyslectic... dyxlectic...
Only if you can't spell!!
;-)
LOL maths is now "hocus pocus" and a gurantee of failure, we should invest with our 'emotions', and fire an accountant that thinks about maths.
Any sufficiently avanced troll is indistinguishable from a kook
But isn't it also important to confirm decisions not solely on gut feel but also on eduction, reserch and confirmation of numbers. If you don't listern to a good accountant you might get equity (fluke it) growth but die on cashflow and then you couldn't pay your bills. Not a good idea...
It’s kind of annoying that he doesn’t even acknowledge his absurdly optimistic assumption about capital gains. The gross yield in Remuera is 4% on his numbers. If rent goes up at 3% a year for 10 years (optimistic), but he gets his 7.5% price appreciation, the gross yield will fall to 2.7%.
At that point, the investor he sells to with his assumptions will be paying $128 608 in interest only, each year, and receiving $71 292 in rent. So... they’ll be having to somehow fund a >$60k yearly cost (add rates, insurance, repairs etc.) out of other income. Why would they buy at that price? And what if interest rates are 8%?
not to mention that if he's hoping to get capital gains, he's just announced that he's got intention to sell = tax that 2.7%
Cannot wait for the day that a government has the guts to alter tax laws etc to be absolutely in the favour of owner occupiers rather than leech class
It will come, we'll see no option but to tax anything left standing I think.
Actually got some really bad news for you.
You see the comments about the cars dashboards being own by GooApp ?
Or notice how there is a solid political push to get "productive" corporations into owning and running wage slaves on factory farms instead of family farms?
The tax laws etc will never again be favouring the "owner occupiers" - doesn't that LVR and other actions against FHBs, and CGT on the horizon (since property companies tend to turnover houses they end up being taxed where currently owner occupiers don't, possible comprehension tax theft levied against home owners... so that will be a cost burden to owner occupiers but just a rental expense to corporate entities.
Tax laws etc will keep being pushed towards corporation and loss of ownership.
You will rent, people will work and be taxed to look after your domocile, you will be a ward of the state. That is the NWO, you were sleeping when the bus took that off ramp, and unlikely anyone will be able to get enough power to do otherwise, and a steady influx of self-interest immigrants will keep things that way
And you have no idea what I am, other than to say, that I am not of the rentier class and very proud to be able to say that.
It is going to be interesting looking back at these comments in say 5 years time, yes indeed.
OK read the article.
(1) The area of auckland is clearly high demand for any kind of housing - especially now goernment made it illegal for people to put families in their garages...... hardly a level market.
(2) The Remura house would involve significant negative gearing. This is buying beyond their means. The old adage of "Buy the most house you can" also runs out
(3) minimum gross rent should be 0.1% of market value, per week.
the Remura house clearly does not get that 1296k vs 1020 - short 21%
where the Otara house is 372k v 525 - better than target by 41%
Since you've got a high demand market that gross yield is pretty solid.
There are more New Zealanders who can afford to pay 525 and annual increases than can afford 1020 per week and annual increases.
"The worst house in best street" Great if you're a property person, lousy if you're an investor.
"The closer to the street you spend money, the more of what you'll spend you'll get back". That worst house is probably worse for a reason and will cost a medium size fortune to bring it up to scratch - your target market would be either , pretentious hopeful renters out for the best schools, or other mugs looking for the worst house....
Buying in poor neighbourhoods however is very risky. But demand is high, pass on the insurance cost, and wait to clean up.
However if you're buying in poorer areas, you certainly don't want the worst house, unless you also want the worst tenants !
You want that "house you'd have people over in" because your target market is tidy people looking for a cheap place to live and raise family/save money. If they were dirt cheap and had other issues, they want the el cheapo house and don't care about how nasty it gets. But an ok house in poor area, gets you the better tenants in that area. Nicest house will just get you vandalism and break-ins.
Your bank finance should not be negative geared, so will be work out to be leveraged off what the net yield can service. that 20% below GrossProfit vs 40% above GrossProfit, that says everything. Of course gross capital growth will look better when there's a 60% spread on your purchasing power !
What really distorts the figures is the local demand for rentals.
Normally you'd have to calculate in downtime. Remura is one property, probably stable people, but high price tag. Otara, 4 times the chance of downtime, and increased exposure to significant negative events (vandalism, thefts, bad tenant issues). Otara has much high tenant turnover (4houses, possible "by the room subletting ) so much higher chance of bad tenant (ie outside auckland).
"There are more New Zealanders who can afford to pay 525 and annual increases than can afford 1020 per week and annual increases."
Indeed and if those who pay $1020 cant then they move to th $800s and the $800s move to the $525s, whose landlord now charges $550.
There gets to be some of that drift but there is generally other reasons why someone would pay $1020 that doesn't relate to price sensitivity. (like all the wealthy people who say how much you get paid isn't a factor because money isn't important)
Otherweise the $1020 crowd would just buy up the $550 range and build to their desire.
Otherweise the $1020 crowd would just buy up the $550 range and build to their desire.
In correct, wealthy people/ high income earners buy or rent in top suburbs because they don’t want to be seen in a less favourable suburbs or have to worry about crime or can go out for coffee in their fancy cars. Its an ego thing.
I would have preferred to see a comparison between the digs in Remmers with an equivalent portfolio in Whangarei where the quality of the homes would likely to be of better quality, but the estimated capital growth would likely be lower and the rents probably similar or slightly lower.
Whangarei would give you an IRR of about 15% without any capital gains, so you could own one without topping up the mortgage or going interest only. 2% capital gains give you an IRR of 25%. 2% is inflation so nothing to get excited about, but sustainable.
Calculating in capital gains can be troublesome. First up it documents and budgets on the expectation of profitable future sale which means you're liable for tax on that sale. Second, if the property IS doing well, why are you selling a good performing asset...which is connected to Thirdly why would you buy an intentionally badly performing one.
Better to calculate to buy and hold and use a re-draw facility to release the equity. That also means long term development is strategically viable, where calculating loss of the asset for captial gain revenue means that improvements are not feasible.
The only time to double down (by selling a good asset and rebuying with leverage) is when you're offered more than it's potential worth. Which either means you've found a bigger fool, or you're not recognising your assets value fully (which makes you the fool ;) )
The re-draw isn't as significant cashflow advantage as the sell up, so the leverage is less for future earnings, however that's where looking at the steady IRR vs rebuy costs come in and the rebuy will mean extra tax due to the asset trading.
eg I bought 1 x 2bd+study house, for 105k cash. intention to rent at 200pw. Do some renovation work to make it 3bd, no study. Neighbouring house of same design listed at market for 185k, fully tidied. I'm offered 170k (after agent fees) halfway through renovations (with kitchen still to do).
Since the neighbour hasnt sold at 185k, that's my peak market point. Kitchen would cost 10k. Therefore property is near top of it's potential market value. Buyer approached me, and I was documented to prove that I intended to hold property. At 200pw, how long would it take to make that 60k cash (interest return at 3%).
That's the time to double down. Even if I released equity through a loan the property would not pass that current value for a long time, so it had entirely maxed it's value.
so I took my 170k, bought a nice 2bd with little work to do, for 180k (but potential 210k). then redraw on that one to get myself a new leveraged "do up". Considering the market in the area was up, it was a challenging finding properties under their peak value.
Good piece, doing the Math often blows away the cobwebs of emotion and mis-understanding.
Is a house in Otara with a sleepout going to cost the median house price? Would it not be more expensive?
It's the same on the monopoly board, which is about 100 years old, the best ROI is from the cheap streets. You can't buy too many negatively geared properties before you some a cashflow wall. Yet 5 properties with an IRR of 20% will buy you a new house every year, forever.
Houses were cheap back then, partly because government was motivated in the past to provide cheap houses, now the government is sitting on its hands, and has left it to the invisible hand, people are really struggling. I can't imagine how soul destroying it must be to pay $550pw for for a house in the worst part of town. That is really sad.
I don't want to say too much and create massive demand at the bottom end of the market
(which using free market laws, would cause an upwards correcetion in the bottom end of the market, where people looking for homes are trying to create a life and future for themselves.)
"Yet 5 properties with an IRR of 20% will buy you a new house every year, forever."
And would disempower banks, remove significant risk, cause a pause in rent prices, empower the public, and create piece of mind.
Although you tend to need 7 properties to pull it off (diminishing return).
The $550pw is really a mind game, as theoretically wage inflation should track at the same rate as domocile demand. Sadly because a large portion of the labourers value now disappears into complaince and overheads, and doesn't get to the labourer it means that the labourer only receive a small portion of their generated market value ... and since they're also being squeezed from the other end with compliance and compulsory add-ons to the house cost the cost of production & margin are also out of line with value of domocile demand (which SHOULD equate "all up", to around 25% of income maximum.
Which is why "ransoming" that 25% your wage from the "landlord kidnapper" should be straight forward in a properly balanced economy. Which can only be achieved by viable alternatives provided at that 25% level for the wage earner in that wealth level. (c.f. a car for a wealth level should cost one year gross income)
I made a bit of a mistake there, the IRR is not cashflow, the cashflow from the article is still terrible, even in Otara. You have to be interest only mortgage, you'll have to sell down some if you plan on retiring. Which is the only time you find out what your capital gains actually are.
I think some of the comments to begin with are missing the point of the article. If you are not a savvy property investor or never have been a property investor the old saying was to buy a really nice expensive house have it negatively geared and reap the rewards in years to come. Well that’s fine to create a balanced portfolio with cash flow and capital growth properties but for most first time property investors dumping a large deposit and continue to pay out every month because of negative equity is not the best investment option.
Whether you fiddle with the stats right or left up or down the article is saying, aye you don't have to buy in high class areas to make money from property, invest in other areas like Otara where properties are cheaper you will get cash flow (or slightly negatively geared that you can afford and still buy the bread and milk) and actually over time you will get good capital growth as well.
As for the tenant situation, isn’t that what investing is all about risk and reward, sometimes you get a great tenant and sometimes you don’t. Same with shares sometimes you make money sometimes you don’t. There are P-labs in affluent suburbs as well, but I guess the BMW's outside don’t look as suspicious if there were BMW's outside an Otara property.
It's like saying there's money in being a slum lord.
No personal attack on Matthew here but what gets me is that people like Matthew do not need to be authorised (AFA) to give investment advice with the FMA.
May be a CA sure, and have some numbers and formulas around investing in property but there are also some wild assumptions and projections based on historical returns here.
I guess he is just taking advantage of the system and Kiwi's love with property but when the house of cards falls over will he be here to take the critisism or hiding overseas?
I'd like to ask Matthew if he has kids and how he feels about his kids ability to afford a house in NZ in 20 years time?
Doing a 6 week course and calling yourself an AFA or choosing any Accountant who has been in the property industry for 15 +years, mmm I know which one I would want to talk to.
Interesting you talk about 20 years’ time, my golf buddies were discussing the other day how they use to pay 22-28% interest rates on homes back in the day. Now its 5%. Can you imagine paying 28% on a $400,000 mortgage.
When interest rates were 28% inflation was running at 20% ish. Five years of 20% inflation would cut the real value of a $400k mortgage to $160k in real terms, so it wasn't all bad...
no quite Chris_J
Since September 2002, the inflation target has been to keep inflation within a range of 1-3 per cent on average over the medium-term. Since 1990 CPI inflation has averaged around 2.5%. This compares with averages of around 12% in the 1970s and 11% in the 1980s.
Remember the mid to late 80s??
High interest rates coincided with high inflation. In fact real interest rates remain reasonably consistent despite the turmoil.
The author is not giving personal investment advice, and it is superficial to suggest he is. This piece is general in nature using a case study format. Readers can make their own mind up. No one is saying 'this is what you should do', least of all Matthew Gilligan. He is setting out one comparison, a very useful addition to the debate. By revealing the details about how he reaches his assessments be is being much more transparent than those who just push their 'judgment'.
David, technically this may not be financial advice, but this article is a good example of why people making such statements need to have some accountability. So perhaps it is a reason why the rules around financial advisors need to broadened to encompass publishing articles on property investment matters (and also to encompass those offering property seminars, events etc)??
Clearly the article contends that prices increased by 22% a year over 22 years in Otara. Clearly this is false and no reputable financial analyst would determine that from the figures used.
The correct return is 8.3%pa, which is a world away from 22%.
What are the options?
The author is a Chartered Accountant, so perhaps a complaint to his institute is appropriate??
That probably wastes everyone's time.
The obvious thing to do is to refer back to the author to correct his errors.
if the author believe's he is correct, I will put the question of whether "straight line" methods are appropriate this way:
Imagine over 50 years an asset increases 101 fold. That is an annualised 9.7%pa increase. It is also a 10,000% increase over 50 years, or according to the author's method a 200% increase a year!!!
QED.
As I commented earlier, I believe straight line growth is commonly used. But whichever way you do your maths, Otara still beats Remuera. That is the point. Matthew is not telling you to invest in Otara or anywhere else; he is basically saying check your facts and do the numbers – you may be surprised at the results. He is not giving advice. I would like to point out that Matthew Gilligan is very knowledgeable and experienced in tax, structures and property. I have been a very satisfied client of Gilligan Rowe for over 10 years and I know that Matthew Gilligan has over 3,000 family groups under his watch – you don’t get that without knowing what you are doing.
Grey Lynn Girl, firstly I do not know Gilligan's and knew nothing of him until reading the articles he has posted on interest.co.nz over the past few months. What concerns me is that there are several problems with Gilligan's conduct in writing these articles.
1. He does not disclose that he is offering property seminars and property coaching services. My initial impression was that he was offering independent financial analysis, whereas in reality he is going to have a vested interest in promoting property - it is much like listening to a real estate agent for advice on buying property - taking an agent's advice must be done in the knowledge the agent has a vested interest in closing a deal.
2. A number of posters have made comments that the straight line method is what the real estate industry use. REINZ clearly use compound average growth rate in their statistics for multi year analysis. Anyone with any financial analysis qualifications knows that the straight line method is invalid for the type of calculation Gilligan does. As pointed out above on a 50 year time period such a calculation looks absurd. The reality is that over a 22 year period with an annualised growth rate of 8% plus, it also looks absurd, hence the controversial "22%" return. This roles into point 3...
3. The statement that the capital growth rate was 22% over 22 years is entirely misleading. Why? Because someone not trained in financial analysis reading the article and relying on those figures would draw the conclusion that the capital growth was significantly higher than the say 8% pa average interest rate you would have to pay on a mortgage over the same period. In fact the mortgage and the capital growth rate over the period were roughly similar. A lay person reading the article could be led to believe the growth rate was triple the mortgage rate over the period, which is so far from reality, that it is possible the presentation of "facts" in this way would cause the reader to make financial decisions which they would not have made had they known the true facts.
Now, in regards Richmastery, thank you for your comments. Your suggestions sound perplexing and it would have been nice for Matthew Gilligan to address this concern and the others raised as he did respond directly on his first post.
As I understand it, having a company name registered would not prohibit someone else from registering a virtually identical company name eg "Such and Such Ltd" and "Such and Such 2015 Ltd".
In regards the number of companies registered in Gilligan's name. I believe the number of current (non struck off) companies about half that. But that still is a companies office annual return filed every second business day. Add to that a lot of GST returns, end of year returns, minute books etc etc if they don't have exemptions.
My point is, which has been a point raised when other well known persons were revealed as having significant numbers of company structures - is the complexity really necessary?
The only reason I searched Gilligan's name is that a number of people who claim to have huge property experience often do or did not. The examples have to be some of the operators of now defunct and well known schemes.
Gilligan's records were too complex for me to ascertain his property experience with any ease. He clearly is a director of companies that act for a very substantial number of his clients and their property ownership vehicles as one would expect from a professional firm such as his.
I have no issue with Gilligan's business or him as a person, but given real estate agents have a code of conduct, financial advisors have a code of conduct, Chartered Accounts have a code of conduct, yet there seems a massive loop hole that property promoters are largely left unchecked. This is an issue for our politicians and regulators.
The financial calulations performed in this article are misleading as previously outlined. I believe the publisher of the article and the author both need to address that issue.
You make it sound as though Matthew is trying to sell properties to people. He isn't. He educates people about property as a form of investment (and how to assess what makes a good property investment, based on his extensive experience), but he doesn't 'promote' specific properties as you seem to be suggesting. He certainly doesn't try to coerce people into anything. Perhaps you have misunderstood what his seminars are about?
Matthews message of milking a one teat cow in Remuera vs a 4 teat cow in Otara is a great comparison and a good risk management strategy!!
Thanks for your insightful article. It really highlights why the housing system in New Zealand is COMPLETELY BROKEN.
In what way is it broken. It seems to fit the market conditions rather well.
Better than Housing NZ renting out million dollar properties for peanuts.
The article is predicated on Capital Gains
The article fails to mention anything about the tax liability on the profit
The Remuera scenario pre-supposes the investor has enough income and pays enough tax to cover the negative gearing to obtain the tax benefits
Gilligan Rowe and Associates are waving a red rag at the IRD and saying here we are come and look at all our clients
i agree
Nonsense. You don't know anything about tax. And the article is simply talking about south Auckland vs traditional capital growth suburbs, making an interesting point. Keep the comments on track, it's a hypothetical case study to compare returns and it is a very interesting comparison. Also people in here seem to think it's a sales pitch for property investment. It's a simple comparison making a point, you can get equivalent capital returns to A Suburbs, but better cashflow. Very good point thank you Matthew
tax comes into play if they're doing capital gain calculations, and so must be included in the result.
If you're planning to profit (and that's what those calculations are, profit calculations) then it is "intention for future sale", which means any capital gain is taxable under NZ law.
This is because you can't realise capital gain without a sale. :. using capital gain in your calculation demonstrates that sale is a real intention. Otherwise the comparison needs to be done without including capital gains (and would probably need trust costs added, as a vehicle to go beyond one Trustees lifetime ...ie something which indicates the intention is to hold indefinately)
Herald this afternoon "Landlords a danger to the financial system". A bit on the late side, but at least someone somewhere is beginning to take notice - even Bill English.
'It's superficial to think he the author is giving financial advice' Give me a break. Every other financial adviser is having to jump through all sorts of hoops but property invesment advisers/real estate agents/Accountants/Lawyers/Journalists can do and say what they like and not's advice?
Which property did he tell you to buy?
Which investment vehicle has he recommended to you?
explicitly, remember. Not what inferrals are you extrapolating from what he said.
If I say "I make good money in FX" - that isn't advice or instruction. If I say I make more on the Short of NZD than the Long of GBP, then that is simply a statement about me, not advice.
You'll get yourself in big trouble in you're going to keep taking what others say as advice from them.
Splendid article by Mr Gilligan. It points out features I have noticed about my "less desirable" properties.
I own houses in various areas of New Zealand. My experience over more than 25 years is that the houses in the so-called "less desirable" areas of Auckland provide lots of benefits that help improve my property returns.
Sure, sometimes market conditions are poor in those areas, but the positives of owning houses in such places have more than outweighed the negative.
I would never think of selling them. As each year passes those houses put more and more money in my pocket, both by capital growth and rental growth.
As I'm sure scarfie agrees, I have 'earned' my money well by owning them.
Sadly, I note, in some commentators above, a complete missing of the point (made by the author, as per the title he gave his article):
"a case study comparing investment returns in ...Otara and Remuera. "
Isn't it obvious that the author has made a very strong and well substantiated point and analysis that the total returns( yield plus capital growth )from Otara ( as a metaphor for South Auckland) has beaten the total returns from Remuera in each of four time periods from short through to long.?
Whether you calculate returns in each suburb by Straight Line Growth (as used by REINZ, or Core-Logic, the standard-bearers in the property industry of the statistics ) or whether by Compound Annual Growth Rate, the stated point of the article cannot be challenged mathematically - Otara's "total return" exceeds Remuera's for each and every time period. What is relevant in that analysis is that the same method of calculating return is used for all the comparisons, which the author clearly does.
The fact that the standard bearers in the industry choose Straight Line Growth means that, as professional investors, rather than novices, we should be familiar with its meaning, as with other methods of calculating growth, like CAGR. Indeed, showing depth of understanding, and a symapathy for alternate forms of growth calculation, the author offers Internal Rate of Return as well to make the same point for each time period regarding "the less desiarble to live suburbs"
One commentator, Chris, above says, " What exactly is straight line growth??
Clearly this commentator admits to having no idea, and yet is prepared to castigate the author. One wonders if he does not have an agenda, other than professional commentary that is contributory to the debate.
The main point of Investing is Return on Capital Employed.
Return on Capital Employed in Otara versus Return on Capital Employed in Remuera for each of the four time periods was greater.
This point is well analysed and clearly substantiated in the article.
LondonInvestor, I do not know the author, my only agenda is to make sure people make honest statements.
I have invested in property for 20 years (since a teenager) and have always been willing to share advice and knowledge with others (even if they are sometimes interested in the same properties!)
To make an informed decision you need facts. Straight line growth does not give you comparable facts. (Refer to my other comments which reiterate this point ad infinitum).
The whole idea of 'growth areas' is a myth. Over the years Ive crunched the % returns on 'growth areas' vs. cheaper areas, and there has never been much difference, and as seen in Matthews example, the cheaper areas, benefiting from a lower starting base, often out perfrom growth suburbs. The problem is people are bad at maths and only look at absolute gains in value, so see a pt. chev property go up 200k and think this is where the growths at, even though it only represents a 20% increase, equivalent to 40k on a 200k apartment for e.g.
The major thing that causes property to increase in value is the land component. And a lot of it is due to money losing purchasing power (at rates much greater than disclosed in inflation figures using some b.s 'basket of goods' method), as more is supplied to market, while land available reduces. Not just land in auckland, land everywhere with a positive population growth rate.
Since we are all happy with using straight line:
A p.n property of mine:
1981: sale price 22,500.
2014: sale price: 240,000.
Straight line growth p.a = ((240,000-22,500)/(22,500))/33*100 = 29.3% p.n straight line growth per year for last 33 years, and most likely returning more cash flow than both central and south auckland along the way.
Simon, your example is 7.4%pa, that compares to the 8.3%pa over 22 years in Otara.
I am not arguing with your point, but reiterating my point that correct financial analysis must be used to make comparisons. Your 29% return is actually lower than the 22% return!!
Hence my whole argument about a misleading article which misrepresents facts.
Chris J.
The projected growth rate used is 7.5% and 8 %. But to show Otara beats Remuera consistently, the article looks at 2,5 10 and 22 yr SL growth, looking backwards purely as comparatives, to say Otara wins, no matter the time series. At least 5 people above have pointed this out, the idea of the comparison is to show Otara winning.
Not to suggest the higher rates might prevail moving forwards. The forward rates were set against the 10 year rates, but are purposefully conservative. No one appears misled, why are you going on? How could they be if they read the article and see I use 7-8%?
Why not focus on the point of the article, rather than hypothesis that I intend to mislead people with the 22% and 17% rate, because I am some sort of evil property promotor?
The point I make with the comparison is, no matter what the forward rate used, Otara needs to be higher based on analysis of all time series. That's all the comparason says, and added to this is good cashflow, revealing a better total return.
Any doubt about what the rate expectation (in the made up example) is, and confusion stemming from the 22 year statsitic (which is only intended to be a gross comparable), is releaved by the forward rates used. This is very clear - I'm ising 7-8%.
Any suggestion I'm consciously or unconsciously being misleading, is a mischief.
Further despite you and a couple of others saying SL is not the industry norm, IT IS an industry norm for capital growth analysis for property to be SL. But in saying that I agree SL is not ideal for longer term Stats, if you are trying to determine what forward growth rates might be. You are 100% right there. But in context I was using the SL basis as a comparison, as discussed, so this argument is not an argument in context.
In relation to SL I have a contract economist on retainer at GRA producing data for me, and property data suppliers confirming SL is an industry norm. I just finished a book on property investment in NZ, hence my need for data people. But of course, SL is not the only analysis, obviously there are indexes and inflation adjusted numbers commonly employed, including for longer term data series compound rates. But SL is mainstream. If you are saying otherwise, you are simply wrong. I just read an article yesterday from Barfoots quoting 10 year SL growth rates and if you google NZ capital growth, you will see others using SL routinely.
But I do accept your point regarding compound growth rates, and agree with you. In summary and as several have said above, the historical 22% SL growth stat works as a raw comparative to say Otara did better. The suitability of this stat as a methodology over the longer term is not misleading in relation to the point of the article and the way I used the stat, as a pure comparative, as London Investor pointed out. Indeed any ambiguity self corrects from the conservative forward rates used.
I therefore find your response disproportionate to the issue and your attempt to disect my personal finances and business life, inappropriate.
I write these articles for constructive debate, in this case cashflow vs capital growth and the surprising result that South Auckland growth stands up against a prime suburb. It's intended to be contentious and debated.
Thanks though for the constructive emails and posts from contributors, who embrace the point of the article. If any one was confused by the way I have presented the comparatives, I do apologise. I hope it makes better sense with this explanation.
Thanks Mr Gilligan for your professional email, you could have gone off the rails on this against Chris_J, obviously shows you are the better man. I found the personal comments that were made by Chris_J against you insulting and discussing for a great website like interest.co.nz. Especially the way Chris_J has tried to dig up dirt. Seriously he needs to take a look at himself or herself (I don't know). Chris_J give some postive critisim if you don't like an article rather than sitting behind your computer and blabering on to try and insult someone.
Well said Tony76!
Stick to the topic, and debate this issues it raises. Trolling the writer in an attempt to discredit him is not constructive or necessary.
I note interest.co.nz encourage robust debate. If posters or authors write controversial articles, or use incorrect analysis or draw conclusions which do not appear valid they are routinely lambasted.
My comments above are not unreasonable is this context.
Also trying to establish the authors credibility in terms of actual ownership of property is not unreasonable given his claims and the fact he was attempting to show that a particular area was a better investment, which begs the question of what interests he has in the area, given that no disclosure of what percentage of his property portfolio was located in Otara or similar areas. If he owns 100 properties and 10 were in Otara, we could take it as being balanced. If he owns 12 properties and 10 are in Otara, it would be a different story.
Remember Bernard Hickey was severely criticised for his 30% fall predictions on this website, as have been many politicians for their articles or policy statements, Gareth Morgan and many others also have been scorned for their opinions and articles by commentators on this website.
Matthew should really consider what disclosures he should make if he is going to routinely publish articles which seem to promote a certain sector of the property market. Also any returns published should be to financial industry standards.
Given that this is a controversial area of "advice" and that property spruiking has a very poor reputation, then it behoves anyone offering such property advice to do their utmost to be accurate and fairly represent the facts, ideally in a journalistic rather than evangelical or one sided way.
Tony76, all my points are positive criticism.
Someone can not give financial advice based on misleading information.
I previously worked as an analyst (trained as a mathematician) and as a part of that role constructed databases and indices. If I had presented any return as a "straight line" return, I would have been fired!
Any jovial comparisons, are not inappropriate given the type of forum that this is and the fact that the author has the right of reply.
Many commenters on this site in previous articles make very negative comments referring to other commenters in derogatory ways. I have not done that. Yet you (Tony) make more than one very negative comment about me in this reply above.
There is a difference between blabbering on and raising and reiterating valid points.
For those who don't understand how to calculate an annualised return: you simply take the nth root of (present value/past value) where n is the number of years (of course subtract 1 and multiply by 100 to turn into a percentage). It is as straight forward as the straight line method where one would take the (present value/past value) subtract 1 multiply by 100 and divide the result by n.
There is no valid reason for using an SL method except that it can be done in your head for back of the envelope numbers over short time periods.
Matthew, while I appreciate your reply, I would like to reiterate a few points.
Firstly, the tenor of my comments were never intended as insults, but do convey my shock at how some of your figures were portrayed.
Checking to see that you actually owned properties might sound unnecessary but several of the property promoters of a decade ago barely owned any investment properties yet were telling people to buy dozens. All such information is publicly available.
My main gripe is that you don't seem to be concerned that your article clearly gives 22 year straight line returns which are not an appropriate financial measure.
All of the historical databases use either an index or price series (including REINZ). Returns are calculated by the user from these. No financial analyst would use any method other than annualised returns to calculate multi year returns. I note that on all of the published information from REINZ that I have seen (for multi year returns), the returns are annualised. I have never seen straight line returns quoted in the way you have used them before. Please post the link to the Barfoots article you mention.
You repeatedly state that straight line returns are the industry norm, when clearly they are not, as for even a 5 year period they are meaningless.
Failure to recognise the error and failure to admit that it is misleading to produce such figures shows a lack of understanding of what the issue is. It is a bit like a finance company or bank advertising an 11.6% (SL) return on a 10 year investment, when in reality it is a 8%pa return.
Whether Otara or Remuera proved a better investment over the past two decades is another debate, but certainly any long term investor would identify the benefits of buying quality, desirable real estate out ways the disadvantages of dealing with tenants who struggle to meet their weekly commitments.
Real estate investment is far more than just numbers. I might be happy with getting 8% gross rental return in a good area, but in a bad area I might need a 20% gross rental return to get me interested.
Whilst I am "blabbering on" as some may say, let me go back to the main point of the article: the purported 17% in Remmers versus 22% in Otara which is actually 7.4%pa versus 8.3%pa.
The question is, does the better quality of homes in Remuera with potentially fewer repairs (if it's not plasterclad), lower vacancy, and easier management make up a 0.9% differential??
I'd say yes.
But then there is another angle. Houses in Remuera have been actively subdivided over the 22 year period. Although there are larger mansions also being built, in general the housing stock is on smaller and therefore relatively lower valued land parcels than 22 years ago. If you purchased a freestanding house on a standard land parcel 22 years ago, you would probably find it had moved up to a different position in the market (ie increased by more than average). This would not have happened in Otara to any extent.
Also Remuera is blighted with leaky homes and suspect leaky homes which lowers the average house price. If you had not purchased such a property you probably would have also done better than the market.
Also as most properties in Otara are of a similar standard (wild generalisation but you should now what I mean, they all tend to be fairly standard modest 3beds with basic features) and the average priced property is probably a standard rental property, whereas in Remuera the average property is a very high standard property, probably well above the standard it needs to be to achieve the average rent for Remuera (most being owner occupied of course). Hence using average prices is not necessary a fair comparison.
Perhaps comparing potential student flat type properties with 4 beds plus in good central suburbs is a better comparison with 4 beds in Otara.
On that basis, 5 to 6% is probably achievable in the central suburbs (if you look hard), which compares to perhaps 7 to 8% in Otara, but then when considering vacancy, maintenance, types of tenants and the fact that the capital gain is in reality about the same, the argument for one over the other is neither here nor there and will depend on the specific property and the management skills of the owner.
BTW as given in an example posted by me in the comments on Gilligan's earlier article, a standard Grey Lynn villa grew in value 8.9%pa over a similar period, outstripping both Otara and Remuera in terms of returns.
At risk of being tiresome on this issue, I make one further point.
Clearly straight line returns are not what financial markets use to report investment returns! But perhaps Matthew is referring to a different industry in his comments of it being the "industry norm".
I have not come across it but maybe it is not uncommon in the sales and marketing industry?
For example: the following statement is clearly true and maybe could occur in a sale pitch:
"an investment in property x grew from $100,000 to $1m in 20 years, that is average growth of $45,000 per year for each year the investment was held, on average returning 45% of the original investment per year"
But would it be to true to be saying:
"property x experienced an average 45% growth rate over 20 years"?
The truth is property x grew in value at an average 26% pa.
Of those statements which could be included in a company prospectus or other financial document?
Why then does a financial analysis published in the media not need to meet similar standard?
Chris_J said:
“For those who don't understand how to calculate an annualized return: you simply take the nth root of (present value/past value) where n is the number of years (of course subtract 1 and multiply by 100 to turn into a percentage). It is as straight forward as the straight line method where one would take the (present value/past value) subtract 1 multiply by 100 and divide the result by n”.
In reply
- I am using an annualized return on a straight line basis. My numbers are annualized returns, straight line. I am using this formula you posted above in my numbers.
- It appears that you have spent this entire thread trolling me for not using annualized returns, because I used the word Straight Line ( by which I mean Annualized Return - Straight Line).
Discussion
- An annualized return means taking a return that is for longer or shorter than a year – it could be three months, it could be ten years – and finding the annual equivalent. That annualized rate could be expressed either on a compounding basis (which the finance industry almost always uses) or a straight line one (often used in property or in everyday conversation since the maths is easier – Chris_J may think compounding is simple but try working it out without a calculator). For example if a property has an annualised return SL of 10% over 10 years, most people can work out a $1m property will be $2m in 10 years time. But not many people can see that if you say teh annualised return is 7.% compounding, you need a calculator or a spreadsheet. Hence the proeprty industry likes to use SL annualised returns.
- Remember, the long rate (22 years) was used ONLY for past time series comparison. Moreover there is not inference in the article that says the future rates would be 22%. I used 7.5% and 8% SL, which is abbrieviated Annualized Return - SL.
Summary
The maths that you have put up above, is the maths that I have used.
I can't believe the number of posts you have made, and the level of hostility you have displayed Chris J, and it turns out you just didn't understand (or bother to check) my maths. My maths formula, is your maths formula.
Disappointing to say the least, but I guess one positive out of this is you agree with my methodology, because the formula you post is the formula I use.
Matthew, I am bewildered that you can not see the difference between an annualised return and what you calculate.
I fear that I am in some kind of twilight zone where financial definitions are all irrelevant!
To confirm what an annualised return is please refer to investopedia (used because it is easy to post links to, not because this is where I would recommend finding financial info!) :
http://www.investopedia.com/terms/a/annualized-total-return.as
Annualised has a specific meaning.
If the value of the asset remained constant, for example an investment where there was no change in capital value and investment income was not reinvested, then the straight line method would be appropriate. But in any case where the capital value of the asset changes, a straight line method would (in the case of positive growth in the capital value) always overestimate the rate of return. The longer the time period, the greater the overestimate. (As your example proves).
I have explained this ad infinitum. Are you not concerned that 17% versus 22% sounds quite different to 7.4%pa versus 8.3%pa?
My comments were intended to be constructive, to assist you in not being perceived as being misleading.
"Chris_J may think compounding is simple but try working it out without a calculator)"
If you don't have a calculator and need one for this kind of % and $ go get one. they're like $20.
And I have it on reasonable good authority you have access to a computer Matthew. You can use that, or download any number of online calculator or spreadsheet programs or apps. Many of which even just run in a browser window on a mobile device.
Remember if wass a customer I would be asking why the properties return dropped from 22% (historical AR-SL) to 7.5 - 8 % (future AR-SL). If you said it was that the previous 22 was from the length of time or number of years, I would go find someone competent.
Good advice cowboy.
Chris_J - Matthew has made an interesting point using consistent methodology in both scenarios. You have made dozons of posts some of which are personal attacks in an attempt to prove something that is actually pointless. Further Matthew's approach as may have said is correct and the industry standard. Why don't you give us your actual name so we can judge you with the same transparency the author provides?
Anyway a simple suggestion ... put the same effort you've put into bitching like a 13 year old girl into your marriage / relationship or burping the worm as we would all be grateful to see the back of you.
The point is not at all pointless.
These posts take little time and the last posts are in general replies to comments directed at me.
If I decide to author an article to be published I will give you my name.
If Matthew wants to discuss this in person I would be happy to call him.
To Chris_J, it defies belief that you continue to waste your time flogging a dead horse on this topic. Yes a calculator would make short work of these calculations like you say but it seems the only people this would help is you. The rest of the industry frequently uses straight-line because it’s so bloody simple. We can calculate it in our heads or on a bit of paper when we are out looking around without too much stress.
I believe I am pretty neutral on these articles i.e. I read them and take them for what they are. But it seems clear that you have been “trolling” the author as mentioned by someone else. I don’t know if it was intended as a personal attack or if you just get a kick out of doing this on all articles you read but you have clearly devoted a lot of time to this and for what? You haven’t added any value to the topic at all. You severely criticised the methodology and diluted the point he was making in the article.
I now see that the author has pointed out the truth i.e. the maths was correct and in fact the same maths you recommend. Your “expertise” in mathematics quite possibly armed you to sit in a back room doing complex equations but it seems it hasn’t equipped you for relating it to everyday situations or presenting it to everyday people.
I agree with your point that public forums welcome criticism but only if they are relevant, accurate and constructive. This is not parliament and most of us don’t have time to filter out the wasted comments you have made. I suggest you holster your pop gun and go back to trolling celebrities.
Interesting that the people who complain I have insulted the author for highlighting errors in the article, are the first to make insults.
I didn't even get to the point that the IRR calculation is also erroneous for other reasons. One of which Matthew should have picked up on from my post on his first interest.co.nz article.
I am clearly raising points of concern about the overall quality of such an article. This is irrespective of the author.
The "industry" (in NZ) might use inappropriate and improper techniques for calculating things, that wouldn't surprise me in the slightest. .... I'm hardly the only "cowboy" out there...
If you attend a Fundament for Finance university course, how and were to use these calculation make up half the syllabus as it is seen as vitally important - especially in cases where Annualised returns between differing vehicles and timeperiods occur. It's bad enough in residential property, almost criminal in commercial and industral, and simply insane for sharemarkets. However you do confirm my suspicions about the NZ "industry"
Chris J, since it appears you use the same maths as Matthew, I think you owe him an apology. Your obsessive focus and numerous posts on whether or not the straight line method is the right one to use has diluted the point of the whole article and seems more like a witch hunt than constructive comment.
And no matter how you look at it, Otara still beats Remuera, end of story.
Matthew's maths are not the same.
If you want to buy in Otara, please do so.
Put your money where your mouth is... then get back to us.
I'm bamboozled by this discussion
Straight Line methodology is used in accounting terms to amortise the cost of an asset over a period of time at a fixed rate on the assumption that the depreciation or the consumption or wastage of the value of the asset doesn't change from one year to the next ragardless of it's usage
However, this is the first time I have seen it used to describe the annual appreciation of an asset
This seems to be a debate about linear versus exponential rates of growth
Most people, on being told an asset is appreciating at 22% pa would automatically assume exponential
Very, very, few would understand, let alone accept a straight-line methodology
Exponential Growth Occurs when a quantity grows by the same relative amount - that is, by the same percentage - in each unit of time.
Linear growth means the rate of change is the same in each period
In Matthews example, using a linear growth of 22% of the starting cost of $64,500 is an annual growth of $14,190 for each of the 22 years
Year 1 +$14190
Year 2 +$14190
Year n ....... +$14190
Year 22 +$14190
Iconoclast, the only time I studied accounting formally was fourth form (I did maths, stats, physics, and engineering all to 300, 400 or post grad level at uni). Working as an analyst I never came across this type of calculation.
Tell me, would an accounting professor find this calculation acceptable, because I am concerned that there is some alternate universe where this calculation is acceptable??
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