Where to invest if not in property?

Property

Where to invest if not in property?

This article is last of a series aimed to address some of the common questions regarding investing in New Zealand residential property. I hope the information provided will be useful to readers when contemplating financial decisions. Note the information provided is not personalised financial advice and does not consider your personal circumstances. I encourage you to take advice from an Authorised Financial Adviser before taking investment decisions.

Before I embark on answering the question above, it is worthwhile to recap what I discussed in my previous articles. The first article identified record-high net migration, easily obtainable and cheap credit (mortgages) and a lower supply of residential housing all contributing to a shortage of residential property, which in turn put upward pressure on property prices. I commented at the time how I felt these ‘tailwind’ factors may unwind easing the demand-supply imbalance and create a ‘headwind’ for growth in property prices. Read more at: https://saturnadvice.co.nz/whats-driving-capital-gains-residential-property/

The second article discussed five government policies aimed at housing and what these policies potentially mean for current and prospective property owners, particularly property investors. The policies discussed include a ban on foreign buyers, extension of the bright line test, ring-fencing of rental losses, favourable policies for tenants and the KiwiBuild programme. I commented that these policies may subdue demand for and increase supply of residential property thereby slowing growth in property prices. You can read more at:
https://saturnadvice.co.nz/implications-of-government-policy-changes-for-investing-in-residential-property/

In summary, I concluded that the drivers of higher property prices are starting to wane and that government policies are expected to decrease the overall demand for properties while potentially boosting the supply of properties. Accordingly, I expect New Zealand property prices to at best experience low growth for the foreseeable future, with the more likely scenario of flat prices or even declining prices in some parts of the market.

The third article then estimated the net return on capital for an investment in a “typical” residential investment property in the absence of capital gains. I assumed a “typical” residential property to be a 3-bedroom property in Auckland with a market value of $850,000, returning $620 in weekly rent, approximately vacant for 2 weeks per year and requiring maintenance of approximately $90 per month. I also used the market mortgage rates, insurance premiums, property management fees and council rates in my estimation. In conclusion, the net return on capital for an investment in a typical residential property with no mortgage outstanding was estimated to be 2.86% per annum, which fell down to just 0.2% per annum under the assumption of 65% LVR (the prevalent maximum allowed by banks). You can read the full article at https://saturnadvice.co.nz/investing-in-residential-property-when-prices-are-flat/

It is fair to say that these returns are less than what can be currently achieved from bank term deposits with the four largest banks in New Zealand despite the hassle that comes with owning and managing a residential investment property. In this article, I cover some of the alternative investment options available to investors and discuss the pros and cons of each.

Term Deposits

According to the Reserve Bank household balance sheet statistics, households had $177 bn on deposit with registered banks as at December 2018. Term deposits are familiar to most New Zealanders. For this discussion, we look at term deposits offered by the four largest banks in New Zealand.

Advantages of investing Risks to consider
  • Easy to understand so generally no need for advice
  • Return is known in advance
  • Generally safe, however the capital invested is not guaranteed
  • No cost of investing.
  • Not diversified – funds are invested in instruments of just one company from the financial services sector of one country i.e. banks of New Zealand
  • Low liquidity – locked for the fixed term though can generally be broken at the cost of losing some or all of the accrued interest
  • Low return in the current environment – at the time of writing, rates range from 2.65% for 3 months to 3.35% per annum for a term of 5 years! (www.depositrates.co.nz)
  • Deposits can be frozen and used to help the bank if the bank gets into financial strife (www.rbnz.govt.nz/regulation-and-supervision/banks/open-bank-resolution).
Directly held shares and bonds

Shares are ownership certificates issued by companies which provide the holder ownership rights proportionate to the value of the shares held. Bonds represent a loan made by the bondholder to the company i.e. the bondholder is a creditor of the company that has issued the bond. For this discussion, shares and bonds refer to those listed on share and bond markets and can be bought and sold by investors.

Advantages of investing Risks to consider
  • For shares, there is virtually unlimited potential for capital growth through underlying companies’ expansion and profitability e.g. Amazon’s shares have risen from US$1.73 in 1997 to over US$1,900 at the time of writing!
  • Source of income through dividends paid for shares and coupon payments for bonds or by selling the securities at the profit. In New Zealand, the average dividend yield on shares is currently around 3.5% per annum for companies in the NZX50 index (Saturn Advice Research)
  • High liquidity – can be sold and converted to cash quickly under normal market circumstances
  • High visibility of daily share and bond prices.
  • Requires research and analytical skills as well as time commitment to choose the right shares or bonds
  • To achieve adequate diversification, investors need to choose shares or bonds across a range of  companies which adds complexity and increased administration time
  • Wide range of potential returns in a given year e.g. A2 Milk’s share price went from NZ$2.13 to NZ$8.07 over 2017 while Fletcher Building’s share price dropped from NZ$7.60 to NZ$4.88 over 2018
  • Loss of capital if companies invested in go bankrupt
  • Sharp movements in share and bond prices can be stressful for investors.
Managed Funds

A managed fund is typically an unlisted investment vehicle where investors pool their money to be managed by professionals for a fee. Typically, a managed fund has one or more fund managers and a team of analysts responsible for conducting research and analysis to identify investment opportunities suitable for the mandate of the fund. Some funds invest specifically in one type of investment (e.g. shares), in a specific geographic region or in specific sectors of the economy. Other funds invest more broadly across a range of sectors – often referred to as diversified funds. Some managed funds can be traded on markets and commonly known as exchange traded funds. For the purposes of this article, I will focus on unlisted managed funds.

Advantages of investing Risks to consider
  • Long-term capital growth – some international shares fund managers have achieved returns greater than 10% per annum over the long term
  • Can provide income through distributions or units can be sold periodically to create the income required
  • Optimal diversification can be achieved by developing a portfolio of managed funds covering different asset classes and geographic regions
  • High liquidity – can be readily sold and converted to cash under normal market circumstances
  • Transparency of costs – managed funds are required to declare their fees
  • Visibility of portfolio value on a daily basis
  • While funds are managed by qualified professionals, they have different styles of investing. Creating an optimal mix of fund managers with complimenting styles and asset allocation is not straightforward
  • There is potential to incur a capital loss over short to medium term, however due to greater diversification, chances of capital loss over the long-term are lower
  • Movement in portfolio value on a daily basis creates a perception of risk

 

Verdict – Term deposits are easy to understand and generally safe, however, are not diversified and the returns on offer in the current environment are at or near historical lows and could likely be so for some time yet.

Investing in shares and bonds can achieve better diversification than residential property, can provide potentially higher income than the average net rental yield on New Zealand residential property and can be cashed up faster and with less hassle than residential property. Also note that small parcels of shares or bonds can be sold as needed unlike residential property where the property must be sold as a whole. However, successfully investing in shares and bonds requires research and knowledge, skills to financially analyse the fundamentals of the companies being invested and time to continuously monitor the ever-changing dynamics of the companies, industries and the financial markets. Furthermore, the volatility that comes with direct investing is not for everyone.

In my opinion for most people, managed funds provide the most viable alternative to investing in residential property. These provide the benefits of investing in shares and bonds while not requiring hands-on research and analysis of the industries and companies. That said, not all managed funds are equal. There are differences in the style of investing as well as the processes followed to identify investment opportunities. Therefore, professional advice from a qualified Authorised Financial Adviser is recommended to help create a portfolio with an optimal mix of funds with complimentary investment styles providing exposure to different asset classes and geographic regions for diversification. A good Authorised Financial Adviser will also be able to help tailor the asset allocation to suit the individual investor’s financial goals, objectives and the investment timeframe.

Shahrukh Abdali is an Authorised Financial Adviser and an employee of Saturn Advice, an impartial financial advisory firm based in Auckland. Shahrukh holds the Chartered Financial Analyst (CFA) designation and can be contacted on +64 21 024 36542 or shahrukh@saturnadvice.co.nz.

Shahrukh would be happy to answer your questions.

The views expressed in this article are the views of the author. The information provided is of a general nature and is not intended to be personalised financial advice. You may seek appropriate personalised financial advice from a qualified Authorised Financial Adviser to suit your individual circumstances.

 



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