DIY Residential Investment Property investors beware

There are a number of reasons property is a less attractive option for investors looking to build wealth and a passive income through a ‘do it yourself’ approach with residential property investment . Historically a buy and hold approach has enabled value accretion through tax free capital gain,  whilst using leverage and revaluation to purchase again and again (Whether new builds or existing stock).  Bank lending criteria and historically low interest rates has allowed borrowers the confidence to purchase and maintain a positive cash flow.  Rental income exceeding the costs of borrowing and maintaining, if not totally, then certainly when expenses allowable as deductions, minimised personal income.

But times they are a changing.  Politicians, central bankers, economists, journalists - it seems they all have an opinion.  From down right damning of residential property investors to the rationalisation of supply and demand - the central plank of capitalism.  Power is addictive.  When the pressure of public opinion is maintained through circumstance and ideological debate, eventually the dam must burst.  If not at this election then certainly at the next. A New Zealand system of housing supply and development will be gone. It just will not be economic for Mum and Dad investors to risk without the benefits of deductible expenses and the added cost of a capital gains tax. The spectre of social housing and central bank interest rate and lending criteria is overwhelming.

The flow on effect will reduce the availability of housing stock. That demand will be fulfilled by either

1.  a socialist government building housing estates; or
2.  a nationalist government incentivising developers to build apartment blocks, flats and street developments.

Both (a) and (b) will be very price focused. Unfortunately we understand the inevitable social cost of (a) and the inevitable economic cost of (b).

Supply and demand, when left to the market, provides a self governing incentive and deterrent. When either (supply or demand) becomes disaffected by local politicians, central politicians or wealthy industrialists the balance of price, quality and service or availability of choice is usually seriously compromised. The global financial crisis is a prime example and as it happens, driven by the same central debate we have in NZ at the moment. Lack of housing and the escalating costs of houses – or housing affordability.

In the US the Democrats (the socialists) demanded that banks lend to the poor to allow them to buy a home – with no deposit. The new residents never paid the mortgage so the banks sold the mortgages to Wall St who bundled them into ‘saleable’ collateralised debt obligations (given AAA ratings by the ratings agencies) and investment organisations bought and sold them – worldwide. (The residents of the ‘new’ homes simply walked away from the property and left the debt with the banks. But the debts were sold off to various countries under the guise of AAA rated Bonds (including NZ) and the world owned properties all over US with no one in them). The rest is history. The greatest threat to the world’s monetary system since the depression of the 1930’s.

We do not have a housing problem in Wellington or most of the rest of NZ. We have a lack of housing in Auckland and Christchurch. Both are understandable. Christchurch the most obvious. When demand exceeds supply (Auckland) prices must escalate. They have, but the problem is one of supply not demand. The current government is working frantically with Auckland local councils to free up land for development, but years of bungling bureaucratic politicking at a local level is now taking its toll with development shortages. And so prices escalate because demand exceeds supply and when prices escalate to such an extent as they are in Auckland it influences the Reserve Bank mandate for containing inflation. Through control of the Official Cash Rate (the OCR) the Reserve Bank manages bank lending, however increasing interest rates also influences the exchange rate – upwards. This affects exports negatively and imports positively. And thus we have a scenario open for opportunistic central politicians with their own agendas and their own particular ideologies.

The key policies and the parties which support them are:

1. Ring fencing of rental losses. This  proposal would remove the ability of investors to write off their trading losses against other income, thus reducing their tax bills. Labour supports this policy and a
2. 15% Capital Gains tax on investment property to give what it calls greater fairness to the tax system and to respond to ‘housing speculation’. The Green Party is also in favour of a Capital gains Tax.
3. Currently National is trialling Warrant of Fitness on Housing NZ properties. They were a plank of the Maori Party policy but National hasn’t yet said whether WOF’s will be rolled out to private rentals. The

Greens want WOF’s as mandatory for all rentals. Labour believes tenants whose homes are not healthy should be able to take their landlords to the tenancy tribunal

4. Social Housing. Labour, Greens, NZ First and United Future will be encouraging various methods of social housing in competition to landlords. Even National says it will extend income-related rents to community housing
5. Resource Management Act – RMA. National says its reform programme has been about simplifying the RMA process and increasing the supply of houses to create more affordable housing – including the introduction of legislation to ensure councils decisions on notified projects are made within six months.
6. The RBNZ wants restrictions on the number of properties an investor can own before paying commercial interest rates.
7. New homes. National is clear it won’t build houses, but wants to provide an environment conducive to private building by encouraging and incentivising the creation of more affordable houses. Labour says it will build 100,000 houses over 10 years.
8. Non-resident purchases of property. Maori, Labour and Greens would restrict the purchase of residential property by non-residents.

These are the major proposed policy changes each of the parties and the Reserve Bank are suggesting along with thoughts and actions around – Immigration, The LVR scheme (bank lending rules) and The Reserve  Bank Act itself, and some emphasis on the Residential Tenancies Act (RTA) and the Housing Accommodation supplement.

Whilst I’m sure some dyed in the wool property investors and property investor associations, coaches and real estate advisers will remain fully committed to maintaining the status quo – it is clearly evident to me that what was once a wealth creation strategy with some manageable risks, is now a possible wealth creation strategy with a number of unmanageable risks. In other words it is more speculative than mainstream investment.

For that reason I would countenance extreme caution to my clients looking to embark on residential investment property as a major wealth creation strategy, at least until after the next election (that’s in three years time) at which point we are likely to know the outcome of these major political decisions. After all – if property is to be an investment strategy it has always been a long term proposal and it may remain so – but time will tell.