Is it a Good Time to Buy Investment Property?.. PLUS Associated Persons Update

Many clients have been asking me if I think this is a better time to be investing in property in New Zealand. I think the answer is yes, but you need to be careful.

The Good News:

• Immigration is on the rise - annualising at close to 20,000 people, nearly double our 10-year average (which is closer to 11,000 average annual 'net' migration inflows into NZ). This means real demand for housing in New Zealand is picking up all around us as we speak. Great for rents, great for mopping up surplus housing stock and land.
• Building consent applications are at at rock bottom, meaning supply of housing stock is slowing.
• There are bargains around - lots of distressed vendors and mortgagee sales.
• Short-term interest rates are low, albeit the long-term rates are up. Rents never get closer to covering interest and outgoings than they do at present.
• NZ is weathering the global recession 'better than most countries', with many feeling more optimistic than they did six months ago and a bit of business confidence returning. Perhaps one of the reasons is because one of our largest trading partners, Australia, is doing so well. Perhaps another reason is our banking system is less sophisticated, so we have less subprime/derivative exposure fallout, and corresponding stability in banking. Or perhaps it's America printing cash, flooding liquidity into the global banking system. And perhaps it's the influence of the government underwriting interbank lending and deposits, which has kick-started things. A lot has been done in the last 9 months globally, and business is recovering.

The Bad News:

• The Government have last week announced immigration policy is to be tightened, slightly. (Boo.)
• Everyone is asking how America and Europe can print all of this money, and not cause an inflation bomb in the next couple of years. I am certainly concerned about that.
• Exporters are not getting a traditional 'recessionary' low exchange rate, which should prevail and produce much needed exporter relief. Why is our exchange rate staying so high at USD $63-65c, killing our exporters margins? Because NZ is doing better than our trading partners - this is a global recession. The upshot is employment and recovery prospects are muted.
• We must seriously ask ourselves, is America delaying the inevitable by paying interest and debts with printed money? Or will they 'inflate their way through debt', with super-high inflation undermining the value of debt over time? Is this their strategy - inflate asset values and erode the value of debt? I don't know the answer, but it is an interesting question.
• Of course with high inflation will come high interest rates. Lock up your interest rates long at the first sign of inflation emerging globally.

Economists' Comments Intrigue Me

What intrigues me is the economists' view of things in the middle of quagmire. Statements like, "housing is down 12% and we think it has a bit further to go, perhaps another 5%" said one prominent bank economist five months ago. So his conclusion was don't buy, where I formed exactly the opposite conclusion from the same information. I felt a falling market full of fear = great time to buy.

Economists assume you are going to achieve the average. So if the market is down 12%, you will buy at 12% off the 2007 peak, and lose 5%....right? Well I guess that's right if you go about things in an average orderly way.

Buy at a Discount - Cliché but True

My clients know this is bargain season, soon to be followed by recovery season. (Whether it's a year, or 6 years, who cares? We are long-term investors, right?) So we know that if things are down 12%, we would be buying 10-20% below that...which means about 20-30% off the 2007 price. So then we are well below the historic peak price of 2007, and well below current market value. Which makes us safe, if things go down that extra 5%.

Cashflow is Always Key

If we buy properties with good cashflow (there are plenty around at present that at the very least are positive cashflow post-tax (refund), and some even positive cashflow pre-tax (refund)), then the recovery period is free capital growth. You do not have to fund the property, so the recovery to former peak value (however long it takes) is free growth. Then in the next boom, we get real growth again beyond the former peak.

Be Careful Though

The auction houses are full of new home buyers and investors drunk on low interest rates and recently relaxed lending criteria....you need to buy at large discounts, or you will not get growth for a very long time. That means you need to investigate the peak value in 2007, then take 30% off. That may mean that 99% of the deals don't work. But when you finally get one - well it's worth the effort.

GRA clients are bringing in great deals all the time at present...so get back in the market and start bargain hunting.

My advice is get off the beaten track and stay out of the overly populated auction houses. Look for things that are outside the square, like leaky houses for renovation, properties to land bank (if you have the cashflow to support, there are some great buys), coastal property, and distressed development property. Knock on the door of finance companies and developers....they like dealing direct with no agent.

Associated Persons: Update

The much talked about new Association Rules are back before Parliament, and unfortunately for those in the business of dealing in or developing property or erecting buildings, the Bill has not been substantially changed. The new expanded definition of association has largely survived the Select Committee process and the new rules are likely to come into force in August, potentially from early August.

We are currently working through the rules so if you are looking to buy a rental property in August please contact us for advice if you are concerned about potential tainting.

Holes In The Legislation Revealing Opportunity To Break Tainting

Contrary to previous media releases we have made about the new associated persons rules, we have found the latest rules released (which are expected to be implemented) do provide some opportunity to crack tainting. Talk to us if you are interested in how to break the new associated persons rules. There are some limited situations where this might be possible.

Important Note for Builders

If you are in the business of erecting buildings, this is the one activity that could lead to tainting of existing properties. To explain, if you are a dealer or developer only (i.e. not involved in the business of erecting buildings), any rental property that you own now and that was not tainted under the existing rules will not be affected by the new rules. Further purchases could be, but your existing rentals will not be.

On the other hand, if you are in the business of erecting buildings, existing rental properties that you have could be tainted if you carry out improvements on those properties. If you are in the business of erecting buildings and are looking at making improvements to a rental property, contact us immediately as you need to know the implications of this.

Changing Use on Existing Stock

The other major impact that the change in Association Rules has is for those of you who have property purchased for dealing and development purposes where you are considering a change of use. If you have a property bought for dealing and development purposes and you are considering holding it (i.e. making a complete change of use in respect of that property) you need to contact us urgently and consider restructuring the ownership of that property in the next two weeks before the new rules come into play.

Summary

In summary, the new Association Rules are coming in and, as feared, they are wide-reaching and going to make it very difficult for those engaged in a business of dealing in or developing property or erecting buildings to prevent future rentals from being tainted. More immediately than that though, if you have property owned by your dealing and development entity that you now wish to hold long-term, you may need to take action within the next two weeks to restructure the ownership of that property before the rules change. If you are in the business of erecting buildings, you also have to be extra careful if making improvements to existing rental properties.

If you want tax advice in relation to associated persons, please request an interview, contact the writer Matthew Gilligan (mg@gra.co.nz) or Anthony Lipscombe (anthonyl@gra.co.nz) or call 09 522 7955.

Thank you,

Matthew Gilligan
Director