Andrew Gawith: Banks trump housing as an investment

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Housing in Auckland remains an attractive investment but elsewhere the returns are not so certain. Photo / Paul Estcourt
Housing in Auckland remains an attractive investment but elsewhere the returns are not so certain. Photo / Paul Estcourt

Like most other investments over the past five years, property has been a bit of a dog.

House prices are in most cases still below where they were in 2007 and that's before taking into account the ravages of inflation, not to mention the ongoing costs of owning property.

But even over the past dozen years New Zealanders' favourite investment - residential property - has struggled to beat bank term deposits.

As with many other assets there are always exceptions within the broader market.

Apple shares have risen spectacularly over the past five years even as the US stock market has stagnated.

In the case of the New Zealand property market, Auckland is bucking the trend with house prices now firmly on the rise, and this trend is likely to continue given the obvious shortage of housing in the city.

New Zealand house prices on average rose by 120 per cent between 2000 and 2007, giving home owners a huge boost to their paper wealth, especially those that were heavily mortgaged (leveraged).

This boost to wealth, though, was largely a transfer between property- owning New Zealanders and younger New Zealanders, along with foreign buyers entering the market for the first time.

Let's not kid ourselves, this is a simulated rather than a real lift in national wealth.

The sag in house prices since 2007 was driven by a distinct loss of confidence in debt.

Banks pulled the plug on highly leveraged property developers, sending many finance companies to the wall.

Banks also tightened their lending criteria for property purchases, puncturing house sales.

Prices fell, according to Quotable Value NZ (QVNZ), by nearly 10 per cent between December 2007 and March 2009 and for many regions remain well below their 2007 peak.

People see property as an attractive investment for a number of reasons.

Its price is relatively stable compared to shares, it provides most people with a place to live, that is, it provides a service, capital gains are largely untaxed, and it is an easy asset to leverage - banks fall over themselves to help. But few people take into account all the costs of property ownership when calculating the returns from this important investment, nor the risks of realising those returns - the ability to sell when you need to.

Property ownership is by no means a costless investment.

Rates are an inescapable cost and one that has increased at more than twice the rate of inflation over the past dozen years.

Insurance is another cost that most prudent home owners would pay each year, and then there's the dreaded question of maintenance.

Unless owners spend a bit of time and money maintaining their house it is likely to decline in value at between 1.5 per cent and 3 per centa year.

These costs need to be subtracted from the apparent returns from property as measured by the change in property prices.

So if we look at the past dozen years, house prices have risen by around 6.5 per cent a year - this covers a period of very strong price growth from 2000 to 2007 followed by a soft five years.

If we take off, say, 2 per cent a year to cover the costs of home ownership (rates, insurance, maintenance, but not mortgage interest payments) we end up with a gain of 4.5 per cent a year.

Now, for those people with a mortgage, the gains on their equity will be bigger (they are leveraged in a rising market), but note that around half of all owner-occupied houses are owned debt-free.

Over the past 12 years the major trading banks have offered an average return of 5.7 per cent a year on six-month term deposits - on the face of it, a better bet than investing in a house.

The problem is, however, the government taxes the return from your bank deposit, but not the return you make on your house.

But even after taking tax into account, property hasn't returned much more than a bank deposit over the past dozen years of data.

Importantly, the risk and liquidity associated with a bank deposit are negligible compared to owning a house.

So, on a risk-adjusted basis bank deposits have trounced housing as an investment since 2000, suggesting our enthusiasm for investing in housing is misplaced.

The decline in home ownership may be a perfectly rational response to financial market signals.

Over the past five years there's certainly been no rational rush to get into the property market.

Bank deposit rates have averaged 5.3 per cent so a deposit of, say, $50,000 would have grown to $60,300 (taking into account tax at 28 per cent on the bank deposit rate).

But the average house price over that time, according to QVNZ data, has at best flat-lined, which means that budding home owners now have a bigger deposit relative to the average house than they did five years ago.

Also, incomes have risen relative to house prices since 2007 - housing has become more affordable.

However, as noted earlier, Auckland is different from the New Zealand average and definitely from a lot of the regions.

Strong population growth in Auckland combined with a low rate of new house construction is putting enormous pressure on the existing housing stock, so it is hardly surprising that house prices in the Super City are now rising at a rate of nearly 11 per cent a year.

Housing in our biggest city remains an attractive investment. The same cannot be said for many other parts of the country.

Andrew Gawith is a director at Gareth Morgan Investments. Any opinions expressed in this column are Andrew's personal views and are not made on behalf of Gareth Morgan Investments. These opinions are general in nature and should not be construed, or relied on, as a recommendation to invest in a particular financial product or class of financial product. Readers should seek independent financial advice specific to their personal financial situation before making an investment decision.

- NZ Herald

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