There's a riot going on

Markets are crowds and behave like crowds. Both are simply collections of people and both can be wise or irrational. The behaviour of the Auckland housing market is starting to resemble a crowd gone rowdy and riotous; not too different from a few hundred teenagers on a Coromandel beach on New Year’s Eve. It may not be at the drunken, bottle-throwing stage yet but by all appearances, one more step and it’s out of control. The Reserve Bank is shouting for everyone to go home, property investors and other interested parties are still handing out the liquor.

Crowds of all kinds become extreme because they work on social approval: when one person throws a bottle it is OK for others to so; one person paying $1 million for a dilapidated shack justifies others to do the same.

I am always looking for good investments but I have chosen not to join the Auckland housing riot – the hysteria in no way reflects underlying value. This is a speculative binge where people are paying fortunes for houses because everybody is doing it. By any sensible measure, this bash should have ended years ago and it should never have spilled out on the streets with cops involved. I remain hopeful that it will end nicely but when a crowd gets to this stage, you just never know how the party will finish up.

Article from Sunday Star Times, 31 May 2015 – Martin Hawes

Reserve Bank right to fight housing bubble

There has recently been considerable commentary and even criticism of the Reserve Bank of New Zealand for holding interest rates above other countries despite CPI inflation being temporarily below the 1-3 per cent target range. The RBNZ has also been criticised by Treasury for failing to make a robust case to “intervene” against the housing market with policies such as LVR that attempt to curb the most aggressive lending practices.

Some have even called the RBNZ Muldoonist. Is the criticism justified? Should the RBNZ simply leave the market to its own devices and allow Aucklanders to indulge in our favourite pastime of swapping debt funded houses among ourselves at ever high prices? There are many arguments and stories justifying the Auckland housing bubble. Immigration is perhaps the most frequent 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.

The Auckland bubble is big. Deutsche Bank estimates overall NZ housing is 30 per cent overpriced relative to income and 82 per cent versus rent, with Auckland presumably being worse. However such extremities are nothing that the world has not seen before and nor are the usual stories that temporarily justify it.

A recent study involving the Federal Reserve Bank of San Francisco looked at 17 advanced economies since 1870 and examines the long term economic impact of housing bubbles, equity market bubbles and bank loan booms. The findings are that the financial stability risks of a moderately leveraged equity market boom/bust are very small but the risks from a loan financed housing boom are huge. In recent times, the impact of the Nasdaq crash in 2000 was painful for those who paid absurd prices for companies specialising in vapour ware but the wider economic impact was limited. Indeed, the sharp interest rate cuts by the Fed to limit its aftermath arguably paved the way for the remarkable housing and credit boom that followed and whose bust in 2008 is still being recovered from today. The study finds that over time, real house prices experienced a number of booms and busts but largely trended sideways from the 1870s to the 1950s, after which they have risen substantially in conjunction with bank loans. Examples of past boom/busts include the Australian real estate boom of the 1880s financed by overseas inflows and immigration which blew apart in the early 1890s and caused a deep recession verging on depression.

A US real estate boom/bust in the 1920s centred on outside money investing in Florida and preceded the equity market crash of 1929 by several years. Rather than immigration financial deregulation was the driver of the Scandinavian boom of the 1980s and bust of the 1990s.

Japanese real estate peaked in 1991 and the study points out that by 2012, the nominal value of real estate was about half of its 1991 level. House prices always go up … yeah right. Contrastingly, the study finds numerous examples of popped equity bubbles that did not turn into wider financial crises because they had very little bank finance underpinning them. Without a parallel credit boom, equity bubbles have no statistically significant effect on the depth of the economic recession that follows their bust or the speed of recovery.

The study finds that when an equity bubble coincides with a credit boom, the subsequent economic recession lasts a year longer than it would otherwise have and there is a 3 per cent drag on the level of GDP per capita after five years; that is, the economy is 3 per cent smaller than it would otherwise have been. As an example, NZ in the aftermath of the 1987 crash springs to mind. Conversely, house price bubbles have been less frequent but their busts have been far more damaging due to their loan financing frequently taking the banking system down with them. A house price and credit bubble crash, “can sink the economy for several years running so that even by year five the economy is still operating below the level at the start of the recession.”

Spain and Ireland since 2009 are clear recent examples along with those cited earlier. Hopefully, NZ will not join them in the period ahead. These findings are stark. Auckland’s credit financed housing bubble is a grave threat to the NZ economic outlook – never mind the “reasons” of immigration, building costs, land availability and so forth. Every bubble in history has had its reasons. These pass but the permanent effects of the bubble bursting most certainly do not. Immigration may weaken; planning rules can change but the mortgage debt that has funded the price bubble remains. Thank goodness that Graeme Wheeler and the RBNZ are beginning to pay attention to the issue. It is simply bizarre that they are being criticised for being the one official institution to show some leadership and tentatively use their limited tools to lean against Auckland house prices.

The RBNZ’s tools need to be sharpened rather than tempered, with other countries providing plenty of evidence for the success or failure of tools such as stamp duty, removing the tax advantages of so called investors, overseas investment restrictions, loan restrictions et al. The evidence is compelling that the aftermath of a credit financed housing bust is dire. Those who do not learn the lessons of history are doomed to repeat them.

Article from NZ Herald Thursday 2 July 2015 – Matthew Goodson

Commercial Investment Property

Across Australia and New Zealand, investors seeking stable, long term returns in volatile markets, are considering commercial real estate. Once reserved for speculators, developers and ultra-rich, commercial property investment is becoming an increasingly mainstream choice.

At first glance, the attractions of commercial over residential property are obvious, Landlords of commercial property achieve higher yields, longer leases and have more power when it comes to dealing with troublesome tenants. But, as in all asset classes, the benefits are offset by risks. In this case, unpredictable capital growth, higher vacancy rates and complicated leasing agreements.

Investors who prefer the security of blue-chip tenants such as banks, petrol stations and fast-food chains may also find themselves in fierce negotiations with professionals trained to squeeze every last dollar from the deal. As with any form of investment, it’s crucial to approach the commercial property market with your eyes wide open. There are potential pitfalls that cannot be ignored.

Lease upside

The structure of leases is a key advantage of commercial property investing over residential. While residential leases usually run for six to 12 months, leases on commercial property run for three to five years, or longer, with built-in options for the tenant to renew. Commercial tenants spend considerable sums fitting out the premises and they’re typically keen to stay put once they’ve set up in a particular location. Fixed rent increases are incorporated into most commercial leases, so the tenant’s rent rises by the inflation rate, an agreed percentage, or a mixture of CPI plus a set percentage each year. These terms are agreed at the start of the lease.

Generally, commercial leases are underwritten by a personal director’s guarantee or a bank guarantee. If the tenant defaults on rent, the landlord has the guarantee to call upon. With a residential property, the only guarantee the landlord has is the bond, which may be eaten up in cleaning or repairing the property after the tenant has vacated. Commercial leases usually include a “make-good” clause. If the tenant does not extend the lease at the end of its term, they are obliged to reinstate the property to the state it was in on the day they took occupation. That’s important for commercial properties as it might involve recarpeting, repainting or removing the fit-out. Unlike residential leases, commercial leases are typically paid net of expenses. That means the tenant pays outgoing costs such as council rates, land tax, utility bills, insurance, repairs and maintenance, security, gardening, and sometimes property management fees too.

Gross rent is quoted before those outgoings, but the net rent is what the landlord receives and what is used to calculate the property’s yield. If the lease is quoted as $200,000 a year gross, and outgoings cost $50,000 a year, most commercial property agents will advertise the net rent as being $150,000. If council rates suddenly jump or insurance rates go through the roof because a storm has gone through the area, or land tax is reassessed and doubles in value, [landlords] don’t have to wear the cost. The tenant wears the cost. In residential investments, rents are charged on a gross basis, so the landlord is responsible for covering costs such as strata fees, water bills, insurance and council rates from the income, and that erodes the yield.

Deciding which costs are included in a commercial lease is an important part of the initial negotiations between the tenant and landlord. Many landlords appoint a professional manager to negotiate the lease on their behalf and have a specialist lawyer look over the documentation.

Major tenants will have dedicated teams that handle negotiations from their side and have experience getting the best deal for the tenant, so it’s wise to get individual advice on establishing a lease. Commercial property landlords whose leases do not include management fees can expect to pay about 2 per cent to 5 per cent of the rental income as a fee, depending on the property’s size and the number and quality of tenants.

(Smart Investor Magazine, Commercial or Residential, August 2013, p32 and 33)