Sunday, February 18, 2018

New Zealand's Property Market – dysfunctional by design

The affordability of housing in New Zealand or lack thereof has been the subject of endless commentary and it is undeniable that, relative to income levels, housing in parts of New Zealand, specifically Auckland, is very expensive both to buy and to rent. Demands that the government do something to make housing more affordable for buyers and renters alike have been continuous for probably the best part of a decade now. In spite of which, house prices have continued to march upwards as have rents to a much lesser degree.

Both the centre-left National government which held office until the 2017 election and the far-left Labour led coalition which subsequently took power took a number of steps with the announced intention of making housing more affordable and raising the quality of rental accommodation. These are laudable objectives. Unfortunately, the actions taken or announced by both parties have had, and were always going to have, precisely the opposite effect. Put simply, the laws of supply and demand have, time and again, proven to be more powerful than government decree.

Taxes make housing more expensive

It remains a rather inconvenient fact that capital gains taxes act as a deterrent to selling. People don't line up to pay taxes that they can legitimately avoid by not selling. New Zealand experienced this with the 1972 Labour Government's disastrous "property speculation" tax which did more to push property prices higher than the OPEC led double digit inflation of the time. Far from punishing speculators, it made them rich at the expense of people trying to get a foothold on the property ladder. The causative link between capital gains taxes and higher property prices has been a near-universal experience. Australia in the 1990s and Hong Kong over the last decade serve as other examples. There's an academic study by the Swiss National Bank which essential explains that people respond to incentives. So it should come as no surprise that when the National government introduced a two year bright line test, property prices continued higher. Labour is extending the bright line test to five years because, in the words of Revenue Minister Stuart Nash   "This proposal will ensure residential property speculators pay income tax on their gains and makes property speculation less attractive." Nash is also promising a "comprehensive" capital gains tax regime. Leaving aside the fact that Nash is in ignorance of existing tax laws which make activities carried on for the purpose of making a gain taxable so that any one who carries on business as a property speculator should already paying tax, history and Economics 101 will tell us that, absent other factors, these taxes will have the opposite effect on housing prices.

The only example I can think of where capital gains taxes co-incided with lowering of property prices is Singapore. However, Singapore also introduced draconian transaction taxes on foreign buyers and domestic investors as well as ensuring a significant increase in the supply of new housing. The former would have reduced demand and the latter made more stock available to the smaller pool of potential buyers – so no surprise that prices fell.

The rental market is also subject to the law of supply and demand

New Zealand also suffers from a shortage of good quality rental accommodation at affordable rental levels. Or so politicians, the media and other groups keep telling us. And yes, there is some really awful rental stock out there. With the announced intention of either removing "unfair" tax advantages held by property investors or making sure that rental properties are warm and safe for tenants, a succession of legislative changes were made including the abolition of depreciation allowances (even though depreciation is a very real expense) and mandatory requirements for the installation of smoke detectors and insulation.  We now have proposals to increase the required notice period to evict a tenant and to have an annual "warrant of fitness" requirement for rental accommodation. All of these are a significant cost which is supposedly going to be cheerfully borne by the wealthy landlords along with rates demands which seem to increase by more than the rate of inflation every year. Unfortunately, as any economics student will be able to explain in jargon-free English, increased costs lead to reduced supply. Given that some of the expenses are flat fee items rather than percentage items, the impact will be felt most acutely at the lower end of the market (i.e. where more rental accommodation is most needed). Expect to see more articles about New Zealand's Rental Crisis and the Reduction in Rental Stock as this plays out and the incentives to invest in residential real estate are inverted into disincentives.

As a real example, after paying rates, agency fees, repairs, taxes etc only 37% of the gross rent received on my single Auckland rental property ended up in my pocket. Based on the latest rates valuation, that's a yield of less than 0.6% (six tenths of one percent). And that's in a good year with 52 weeks' occupancy and no major repair bills. Even if I doubled the rent, it's still a lousy investment.

And government policy is to make the situation worse

The shiny new government's announced initiatives include scrapping a number of plans to expand existing roads or build new ones as well as building new low-cost housing areas on the far fringes of Auckland. It's not hard to predict the outcome: the already desperately congested roads will become even more congested with a combination of population growth and people having to commute longer distances to work adding to the number of cars on the roads. The uncosted light railway to Auckland Airport will be an ultra-expensive irrelevance to almost all commuters.

And the proposed prohibition on foreign investment in New Zealand residential property, the one thing the Labour government promised which would have had some impact on the demand for property is, I am told, being reconsidered.

Short version

Investing in rental property in New Zealand is discouraged as a matter of government policy and government practice. Expect to see rental accommodation continue to become more expensive and harder to find as rational investors invest elsewhere.

As an investor myself, I have abandoned plans to invest further in New Zealand residential property but will keep my existing property as a store of wealth and a portfolio diversifier in spite of the almost non-existent yield.

Thursday, February 01, 2018

Financial Review - January, 2017

January saw 2018 off to a good start with gains in Hong Kong and emerging markets, combining with positive cash flows from investments, appreciation in commodities and favourable FX movements more than offsetting small declines in my Australian and New Zealand equities and bonds to produce a 4.41 percent increase in net assets.

For the year, the portfolio is up 4.41 percent. The adjusted change from when I retired in September 2013 is a 32.52 percent increase. Hong Kong liquidity stands at 26.67 months of estimated outgoings, almost unchanged from the start of the year's 26.68 months.

Here are the details:

1. my Hong Kong equities appreciated. I sold my shares in Dynamic Japan (HK6889) at a 19% loss. The shares were purchased in the expectation that Japan would introduce casinos and the the company would be a front runner for one of the first batch of casinos to be built. The Japanese government has effectively stalled the necessary regulatory reform and there is no timetable for when it will resume (if at all). The company is well run but its existing businesses are in a declining industry denominated in a weak currency so I see no reason to keep holding. Most of the sale proceeds were reinvested in Hua Xian REIT (HK:87001). At the end of the month I sold a small number of shares in CNOOC (HK:883);

2. my AU/NZ equities were were marginally down. There were no trades this month. I currently have too high a proportion of my New Zealand assets in cash; equity ETFs were up (India, Hong Kong and China) in line with the local markets;

4. my position in silver rose slightly;

5. all tenants are paying on time and all properties are let. I had several maintenance bills this month and will have to fork out for the pointless window inspection next month (delayed by an uncooperative tenant);

6. the AUD and NZD were were up against the USD/HKD;

7. my position in bonds remains modest. Recent interest rate increases have pushed the holding values of some of my bonds to below par - since I intend holding to maturity (other than a solitary perpetual) this is not a problem. I unsuccessfully bid on two short term bond offerings and lost out on pricing showing that the demand for reasonably credit risk at the short end of the duration curve is very strong. I have a margin facility in place and my carry trade is doing its thing and generating a small amount of additional income. However, the spread between the interest earned and the interest paid has narrowed to about 2.2% and will likely narrow again on the next roll over date in February, 2018;

8. expenses were low.

My HK cash position fell slightly during the month. I currently hold 26.67 months of expenses in HKD cash or equivalents (down from 26.68 months on 1 January). This will increase once the CNOOC sale proceeds are received.

Total household gearing ((debt+accruals)/assets) is 8.73% of total assets. Property prices are as at 1 January, 2018 and will not be marked-to-market until year end. With a mark-to-market of equities, bonds and FX this number will fluctuate even if the amount of debt is being slowly amortised.