Diana Clement: Safe as houses still rings true

There's nothing new about investing in property. Photo / Herald on Sunday

The Chicken Littles are out in force - the Budget changes affecting tax on property investments have convinced some the sky is falling.

In the immediate aftermath of the Budget there were predictions that investment properties would be sold as a result of the tax changes, which included the removal of depreciation on buildings, and changes to the way properties in loss attributing qualifying companies (LAQCs) were taxed.

It's unlikely we'll see fire sales en-masse. The investors that will be "forced out", if any, most likely weren't running a profitable business anyway.

As one investor on investment forum Propertytalk.com put it: "If a simple Government Budget (which changes from year to year) truly affects your bottom line then you were a gambler and not an investor to begin with, and should expect the worst."

There has been less said since the Budget about the news that the Government will close off Working for Families tax credits for many property investors. Under the current system good earners are able to write off property investment tax losses to manipulate the income on their day jobs, pushing them into a lower tax bracket and qualifying as a result for government handouts.

Finance Minister Bill English says the government is working on "urgent reform" of rules relating to income for the purposes of Working for Families, which will affect people with family trusts as well as LAQCs. This could cost some property investors several thousand a year.

LAQCs which investors often use to own their properties were also affected by the Budget. The change in the Budget was that profits are now taxed at your marginal tax rate, not the company tax rate. This move, although significant, is unlikely to force many investors to sell up, because it only affects those who are making a profit rather than financially stretched ones.

With interest rates tipped to rise later in the year, investors now struggling may be best to sell up, says Mortgage Broker Kris Pedersen of Property Financial Solutions.

They'll have time because the depreciation changes in the Budget don't take effect until April next year and property prices are unlikely to crash in the meantime.

Keeping the tax changes in perspective, Kiwi property investors have it easy compared to their cousins in many other countries. Australians pay stamp duty on purchases and capital gains tax on sales of properties, yet there are plenty of successful investors in those countries. There have been property investors since biblical times and before.

The property investment industry endured and would survive here even if there was a capital gains tax.

What matters really to property investment as a business isn't $15 a week in lost depreciation claims thanks to the Budget. It's property yields (what a landlord can expect to receive in rent, expressed as a percentage of the purchase price of the property).

The median gross yield across the country, according to Quotable Value, is 4.5 per cent, which doesn't even cover a mortgage, let alone other outgoings. In reality the majority of investors buying now are doing it for capital gain, not the yield.

Only eight of 298 areas listed in QV's figures have gross rental yields of more than 7 per cent, which says it all. It's nigh impossible today to buy a cash-flow positive property.

Another measure which is completely out of kilter is affordability, measured by the median house price divided by the median annual household income. Traditionally the internationally recognised standard of acceptable affordability is that house prices should not exceed three times annual household incomes. Yet in the latest Demographia International Housing Affordability Survey, median house prices in New Zealand were 5.7 times median household income.

It's not that we're living in a new investment paradigm where only capital gains matter. Financial markets all self-correct eventually. Sooner or later property investment will become profitable again.

Once the fundamentals right themselves investors will bounce back - especially as we're so much better educated about property investment now than we were a generation or two back when there weren't screeds of books to read or property investor associations to join.

When you start to look at the fundamentals of property investment then some sort of correction seems inevitable. "New Zealand is either bucking the trend or is not healthy or normal. The problem with the global economic picture is that nobody bucks the trend," noted the investor quoted above.

For there to be a return to more historic norms, house prices must correct or rents rise.

It's highly unlikely that investors will see tax or regulatory changes that will make their businesses more economically viable. Nor can costs such as mortgage rates, council rates and maintenance fall by much if anything at all.

For a house price "correction" to happen a drop in prices isn't necessary. A sideways movement in prices over time has the same effect.

The other measure that can move is rents. Research by the New Zealand Business Council for Sustainable Development (BCSD) following the Budget found that 48 per cent of landlords say they are going to put their rents up.

That doesn't mean that they'll get it. Rents rely on the forces of supply and demand and investors haven't been hugely successful in increasing their rents in the past three or four years during which yields have been out of kilter.

People may get used to price increases in general thanks to GST rising to 15 per cent later this year on goods and services (but not rents).

Economist Gareth Kiernan sees the possibility for softening of house prices combined with increasing rents over the next couple of years, which will help improve yields. The trouble is that there is very little residential building happening at the moment, which will begin to impact on supply in the next few years, which could put pressure back on house prices again.

The BCSD survey also found that 29 per cent of investors said they are less likely to invest in residential property following the Budget. That's not surprising. Markets have their ebbs and flows and when they're not as profitable, fewer investors buy.

When asked to predict a wholesale return to profitability for investors, which he doesn't deny will happen, Kiernan quotes economist John Maynard Keynes, who said: "Markets can remain irrational longer than you can remain solvent."

In New Zealand property and equity investors are mostly two separate beasts - and seldom the twain shall meet. A sensible investor buys more than one asset class, favouring one over the other when market conditions are right.

Kiernan points out, however, that rental yields benchmarked against the real government bond rate don't look too bad - although he wouldn't expect the bond rates to remain so low in the future.

There are plenty of people who make money off the back of property sales who will say that now is always the best time to invest. They can include real estate agents, mortgage brokers, seminar purveyors and even media, which benefits from the advertising that rolls off the back of a booming property market. Worst of all are the companies that peddle negatively geared properties. They still argue the tax breaks of investing as the reason to buy property.

The cycle could be long this time, says Kiernan. So there may be no rush. Cashflow-positive or even neutral properties are as rare as hen's teeth today, although there are more than a few in central Auckland's apartmentville. Investors also look for properties with a twist, such as where extra bedrooms can be made or a garage converted to living space.

Whatever the crystal ball throws up in the next few years, property investment will always be with us and successful investors with their heads screwed on will do well, tax breaks or no tax breaks. Some will even be finding profitable property in the current market. Such properties can be found if you look hard.