Top interest, no risk, sounds a mite dodgy

By MARY HOLM

Q. Re your first question in last week's column: " ... we have invested the $650,000 net proceeds of the sale [of our house] in three-month term investments netting 10 per cent after tax, and have rented a house of similar value for $27,000 a year.

"Ironically, our investments are short-term first mortgages in the property market."

Where do I go or who do I approach to organise the same?

A. I don't know. And even if I did, I wouldn't tell you.

Didn't you read my comments about the investment - that the people borrowing the mortgages must be paying extraordinarily high interest, probably around 18 per cent?

Presumably, they're unable to get cheaper money elsewhere. They must be pretty risky characters, which in turn makes the investment pretty risky.

But perhaps you - like too many other investors in too many different situations - are dazzled by the returns offered and don't want to know about the possibility that those returns won't actually happen.

If you won't listen to me, in my best schoolmarm mode, perhaps you will listen to another reader.

As he puts it: "Your correspondent last week should take his money to the casino. At least the risks he is taking will then be obvious."

Yours wasn't the only response to that Q&A. Others took different tacks.

But first, the story so far. Last week's reader was wondering whether he, his wife and three children should continue with the mortgage investment, or buy another house.

In my response I said that if the family keep renting and house prices rise more than expected, they could end up worse off.

Weighing up that and other risks, I concluded that they should probably buy a new house. Here's what some other readers thought about that:

Q. You gave the right advice to the ones who sold their house for $650,000 and thought they were on the pig's back.

One has only got to look at history and find that some people did that back in 1972. By 1975 they lived to regret it.

An ordinary home was worth about $10,000 in 1972, and by 1975 it was worth $30,000. And of course rents trebled.

Thousands of people who sold their farms and businesses, left the cash on interest and went for a trip came back to find they were completely dispossessed and could not buy a home or anything of value with the residue of their cash.

We were in Europe at this time living in a campervan for a year. We found on returning to New Zealand that a property we had sold for $10,000 had changed hands many times, and the last time for $30,000.

So I say to the people you were writing about to get back into a house of their own as quickly as they can.

You may want to study those particular years, as they blamed it all on the oil crisis. Rings a bell, don't you think?

A. A bell may be ringing. But I don't think for one moment that we're headed for a repeat of the house inflation of the early 1970s.

In one year in that period, house prices rose more than 40 per cent. Extraordinary.

Still, you're quite right that house prices could rise more than expected. And if they go up a lot, rents will too. The two don't move in unison, but market forces won't let them get far out of whack.

Given that the family have to be housed, either in their own home or a rented one, it's much less risky for them to own. Then they're in the housing market, wherever it may go.

While you think house prices might soar, the next reader has the opposite view.

Q. Is it correct, as you said, that if your correspondent buys a house, "the worst that can happen is that house values might not rise much?"

It could be worse, perhaps much worse, if house prices fell. And that has happened in many countries when a big slowdown hits after a strong rise.

Sure, it has not generally happened in New Zealand in living memory, but perhaps we've been lucky. Ask the British.

As you've said, whether the house turns out better than the 10 per cent after-tax mortgages (shudder) depends on what happens to house prices.

From where we are now, I'd guess that down is at least as likely as up. So putting it into a house has its own risks.

But with three kids, I'd agree with you. Owning a house is not just an investment decision. Family security matters more in the end.

A. I think New Zealanders are readier to accept the idea of a house price slump now than they were a few years back.

But you're too gloomy. For one thing, we haven't had the strong rise that, as you say, tends to precede a big price drop.

BNZ chief economist Tony Alexander expects house prices to continue to decline for the next 6 to 12 months, but then rise, at perhaps around 3 to 4 per cent a year.

I would be amazed if, five years from now, houses are worth less than today.

Now for another prophet of doom, who raises some other points.

Q. House prices may indeed start going up at any time. They may also drop further, in sympathy with the dollar.

How much of an asset is a $650,000 home (that you live in yourself) as that is happening?

Even if the home is realising 10 per cent a year capital gain, what kind of return is that compared with either the present investment vehicle they're using, or any other readily available unit trust or managed fund, most of which are returning that or more?

How much did this person spend on mortgage interest to freehold their property in the first place? What does owning your own home look like then as an "investment?" Would you consider that to be a risk factor?

I would have recommended - if buying was a viable option, rather than merely an emotional decision - they buy a cheaper house. There are plenty of those available, thanks to the Kiwi obsession with property investment.

Then they should split the remainder into at least two or three other investment vehicles. That way they won't end up asset rich and cash poor, like so many others.

A. The idea of the family buying a cheaper home crossed my mind, too. And for many people it's a good idea.

But this family are used to $650,000 worth of accommodation, whether they rent or buy, and there doesn't seem to be any compelling reason for them to lower their standard of living.

Given that the family have three children at home, I'm assuming the parents still have enough working years ahead that they'll probably end up both asset rich and cash rich.

Beyond that, I think you - along with the couple in question - have got too caught up in treating the family home as an investment.

Comparisons with returns on mortgage investments, unit trusts and so on make all the sense in the world if you're considering buying a property to rent out.

But a home is, first and foremost, a shelter, and a base from which the whole family operate.

You write of buying a home as being "merely an emotional decision." But there's nothing "mere" about letting your emotions affect such a decision. Security and family stability are, in part, emotional issues.

A couple more points. It's possible that house prices could be pulled down a bit if the dollar keeps falling.

"People would have to spend more on imports," says Tony Alexander. "That could reduce their spending on houses."

But who says our dollar will keep falling? Probably just as many people are predicting a rise.

Also, many unit trusts and other managed funds are returning less than 10 per cent a year.

*Got a question about money? Send it to Money Matters, Business Herald, PO Box 32, Auckland; or e-mail: maryh@journalist.com. Please note: Letters should not exceed 200 words. We won't publish your name, but please provide it and a (preferably daytime) phone number in case we need more information. Mary cannot answer all questions, correspond directly, or give financial advice outside the column.