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My wife and I are in our 50s, and own three commercial buildings in provincial New Zealand (so very limited capital gain), and a business for which we have employed a manager. Put simply, our strategy is to "farm for cash yield". We are debt averse.
All up we have
around $3.5 million of assets, with debt under $0.5 million. Our rental income from the properties is $275,000 a year and our passive income from our business is around $100,000 a year. So a sound cash flow, and our current debt reduction is about $150,000 a year. At this rate we will be debt-free before we turn 60. We do not own our own home.
With interest rates low - and looking to remain low - we are wondering whether we should buy a house by borrowing money from a bank, or sell one of the properties to buy a house, or keep renting till we are 65 and try to save an additional $100,000 a year and buy a house for cash then. What would you suggest?
A: We could do an analysis of the options, but they'd probably come out about equal - depending on assumptions made. My advice: do whatever you most want to do.
Reading through your letter for the first time, I was astonished to get to, "We do not own our own home". I can only assume you haven't wanted to.
Another possible explanation - that you are so debt averse you didn't want to borrow to buy a property that doesn't bring in rental income - seems too far-fetched. After all, with your own home you don't have to pay rent. And avoiding paying something is as good as receiving income. A couple as financially savvy as you seem to be must have worked that out.
Anyway, if you would now like the security and pride that come from home ownership, why not go ahead and do it? And if you dislike debt, sell a property to fund the purchase. You'll still have plenty of income, especially when you take into account no longer having to pay for accommodation.
And hey, why not get a really nice place? Perhaps sell two properties to fund it.
You'll still be sitting pretty. If your income drops more than you would like, you can always then sell the third property and/or your business, and live off the proceeds.
It's time to start enjoying your wealth.
Q: Learnt something new (the hard way) recently about personal insurance (life, income protection, etc).
We were dissatisfied with our insurance adviser, so contacted someone else. They gave us a quote recommending we move insurers, change policy cover and would save money. So we did. Soon after we found out, from talking to a different adviser, we could have changed the policy cover with the old insurer, would have saved even more money and had a lot less hassle (medical tests, etc).
So why didn't the first adviser recommend this? We were told this is how the insurance industry works. There is no financial benefit (ie. commission) for an adviser to save you money with your existing insurer. The only way they can get commission is by recommending you move insurers. The adviser probably never even looked at costing the new cover with the existing insurer.
Also advisers, once they have sold you insurance, will not recommend you ever drop your cover, even if you are over-insured, as lowering your premium will lower their ongoing commission.
Therefore I don't know how you can change your insurer adviser or cover without changing insurance companies, as no adviser will want to work with you. This must result in a lot of needless churn between insurers, with no benefit for the consumer and insurer, but only the adviser.
I wish I had known this at the time, although none of it comes as a surprise once you know the adviser gets a commission for selling new policies.
A: A report published this past week confirms much of what you say.
We should note upfront that the report, written by consulting actuaries Melville Jessup Weaver and commissioned by the Financial Services Council (FSC), has been controversial. Says an MJW press release, "The report's findings and recommendations are MJW's alone and are not necessarily the views of either the FSC or its members. This should be made clear in any reference to the report."
Some in the insurance industry say it's unfair, as Tamsyn Parker has reported in the Herald. But the report rings true to me, in light of what I've read and heard over recent years.
The authors, David Chamberlain and Mark Weaver, say you're right, there is no financial benefit for an adviser to save you money with your existing insurer. In fact, an adviser will get less commission if you decrease your insurance. So they have a disincentive to point out that you are over-insured.
"Conversely they can get another initial commission (large financial benefit) if they move you to a new insurer after two years." Among other problems, this puts customers "at risk of having their claims declined in future for non-disclosure of medical conditions."
Chamberlain and Weaver say it's "impossible to accurately quantify" needless churn between insurers. But they give the following evidence that it's happening:
• "There are numerous anecdotal stories in the industry of this occurring (sometimes on a large scale)."
• "Forty to fifty per cent of business sold by advisers is moving the customer from one insurer to another." This is "greatly in excess of the level in the Bancassurance or direct to customer sales channels" - the other ways of buying this type of insurance. "While some replacement policy activity is good for the customer and should be encouraged, it is believed a fair proportion of the replacement policy activity is driven by the financial incentive to the adviser."
• "The pattern of policy lapses shows a distinct rise in the third year, coinciding with the end of the period when initial commission can be reclaimed from an adviser when a policy lapses."
What can be done about this?
Chamberlain and Weaver have made several recommendations, which are "designed to move advisers from viewing their relationship with their clients as a transactional relationship (a transaction that can be repeated over and over for a new initial commission) to a servicing relationship, whereby they earn value from the relationship over time.
"The principal remuneration recommendation is to change the shape of commission from front end loaded (200 per cent up front and 10 per cent ongoing) to a servicing commission that rewards a longer term relationship (70 per cent up front and 20 per cent ongoing)."
Note that currently advisers get twice your annual premium in the first year. Wow!
"Importantly the 20 per cent ongoing commission can be directed by the customer to the adviser of their choice, and the 50 per cent extra in year one is not payable again for seven years."
This would give an adviser an incentive to treat customers well, and not to switch to a new insurer within seven years. But, I asked the authors, why would insurance companies agree to that?
"The companies could never agree because they compete so vigorously for the attentions of the advisers. They have to. They have competed themselves into a stalemate.
"In the report we say 'the insurers are beholden to the advisers as a whole, and the interests of consumers are subjugated to the interests of the advisers.', on page 6. That is the position, and the current vitriol against the report only supports our view on this."
The only solution, say the authors, is regulation. Enter the Financial Markets Authority, which will have read the report with interest. It has been looking into much the same problems.
"The FMA highlighted these issues in the release of our Strategic Risk Outlook last year and our sales and advice report last week," says a spokesman. "The FMA is focused on conflicted conduct and in particular the risks associated with certain remuneration structures and the inherent conflicts of interest that sales commissions can create."
Maybe we'll yet get a system that rewards advisers who put customers' needs first.
Q: I'm an avid reader of your column, and often want to write in with comments, but I'm usually too busy. But I just felt I had to respond to your answer regarding selling your home before buying another one. And - and this is almost a first - I'm afraid I totally disagree with you. In fact, I think it is calamitous.
I suggest that the reason the son and daughter-in-law want to buy before they sell is not that "they do not want the hassle and expense of renting while they wait to buy again." It is more likely that they cannot afford to be out of the market.
If they sell and it takes several months to find a new house, they could be permanently priced out of home ownership. And the larger their mortgage the more the risk of house prices running away on them, because while house price growth is obviously on the entire price, they will only be earning interest on their equity amount.
Back in 2000, I was looking at buying my first house in Auckland. But I would have had to borrow $20,000 more than I wanted to at that stage. So, foolishly, I waited. It took eight years before I could afford to buy a similar house in the same area.
House prices won't go up like they are now forever of course. But while no-one can predict how far they might increase, they can fall only so far.
Hope you don't mind me emailing this contrary opinion.
A: Of course not. This column thrives on contrary opinions.
If ever there was a sign that the Auckland house market is in a bubble, this is it! In normal times, nobody would think to worry about house price rises over a few weeks or months.
And the couple might be right to worry about this - although there seem to be signs the price rise is at least slowing. Who knows? Maybe they could soon benefit from a price fall if they sell before buying.
It's interesting to look at why you got a second chance to buy your first home. New Zealand house prices fell in 2008-09 - as well as in the early 1990s and the late 1990s. As you say, it does happen.
And I wouldn't take too much comfort from "they can fall only so far". From 1991 to 2012 prices halved in Japan.
Can't happen here? Note the words of Matthew Goodson of Salt Funds Management in a July Herald article:
"There are many arguments and stories justifying the Auckland housing bubble. Immigration is perhaps the most frequently cited. Try telling somebody in Florida, Nevada, Spain or Ireland that this factor will prevent a subsequent bust.
"Likewise construction costs. Likewise restrictive planning rules ... the list goes on.
"Every bubble in history has had its reasons." But still, it burst.
'Challenging market conditions': revenue up but devaluations, other items hit bottom line.