There have always been two distinct housing markets: buying a house to live in and buying one to rent out. If you took the daily headlines at face value, you’d think there couldn’t be a worse time to buy an investment property.
It’s true that residential real estate investors have taken a hit recently. Everything, from the loss of tax deductibility, extended bright-line tests and the current credit crunch to higher interest rates and inflation running at 5.9%, has knocked their confidence.
Even though Wellington rentals continue to be among the highest in the country, in the past year many “Ma and Pa investors” have cashed up and sold their investment properties because they no longer want to be landlords.
Whether it’s the financial burden of meeting Healthy Homes requirements or the perception that Tenancy Tribunal decisions favour tenants at their expense, they’ve opted to invest their money in assets with fewer hassles and headaches.
It’s a popular misconception that investors have driven Wellington’s current housing boom. True, there was a lot of investor activity in the first half of this boom, which began in 2015. But most of it has been driven by first-time and second-time buyers: people buying their first home or trading up to their second or third home.
Yet the measures the government has taken to take the heat out of the housing market have targeted the investment sector.
At one point you needed 40% equity in your home to buy a second house — and that pretty much killed the demand for rental properties in Wellington. Suddenly, multi-flat, purpose-built rental properties became much harder to sell. But house prices kept going up and up.
Of course, no one wants to blame first-home buyers when they’ve been the victims of property prices jumping 30% in a year. Society doesn’t benefit when fewer people can’t afford to buy a home and the wealth disparity widens.
But the irony is the problem was created by a gold rush of first-time buyers who all wanted a home at the same time – not investors who suffered a double-whammy: the removal of tax deductibility at the very time the rental market in Wellington was weakening.
It’s now clear that government intervention didn’t slow down the property market. In fact, it recorded the biggest hike in prices 12 months after the policies were introduced.
Investment properties became much harder to sell at a time when three-bedroom houses with indoor-outdoor flow to a flat garden were flying out the door. These properties were getting up to 10 offers, and sometimes 2-3 times as many!
Even home-and-income properties have suffered. Twenty years ago, these properties were the most popular. If you had a home-and-income on a hill in Wellington, with a sea view and one-bedroom flat underneath, people would be thinking, “Wow! I can get this sea view and have someone else pay for it.”
Along with the new financial challenges landlords face, there’s been a cultural shift: younger people don’t want to be seen as landlords because of the negative associations attached to them and the perception that baby boomer landlords buying a second house have squeezed them out of the market.
Consequently, home-and-income properties no longer have the same currency. Indeed, we’ve sold a few recently where the flat was almost discounted to the point where it wouldn’t matter if it were there or not.
Despite this, the fact that mortgage interest on rental properties is no longer tax deductible and that it’s much harder to borrow money, which investors rely on for a leveraged asset, make it a good time to reconsider becoming a landlord.
Professional investors will always tell you that you don’t want to buy in the peak of the market but when things are hard and tough. “Buy in the gloom, sell in the boom,” is a mantra that has served many well.
Undoubtedly there is more opportunity in this space going forward: after all, even though the environment has become harder, there are fewer people playing in it. So, you would expect to see yields rising for the risk. And you can factor in the consequences of these changes so the sums still make sense.
A good example of this is with tax deductibility. This is a one-off hit to your cash flow. It changes the calculation but in economic theory that would just be a change to the total value of the property. You could factor that in when buying. If you can get a property for slightly cheaper, then your cash flow becomes the same. If you can capitalise that loss of income and quantify roughly what it would have done to the value of that investment property, then the net value is about the same.
So, I think it’s a reasonable time for investors to be looking, especially when inflation is turning into what Warren Buffet dubbed a “gigantic tapeworm” that chews up the purchasing power of your dollar.
If you put your money into the bank, you might earn 2%. But if inflation is nearly 6% then you’ve lost 4% of your buying power. Until interest rates rise, people will be looking for alternative investments that cushion against inflation because cash is just going to get killed.
When it comes to protecting your wealth from inflation, real estate is a good hedge.
The key for investors is to focus on cash flow. People looking at capital gain only risk ending up in situations where they don’t have enough cash in downturns to cover further investment.
There’s an opportunity cost to focusing on capital gain that is unseen but very real and means you can’t take advantage of buying opportunities.
I’d encourage first-time buyers to take another look at the benefits of home-and-income properties. When prices are higher, why not have that extra income stream to cover your interest and other expenditure, especially when rents are so high? It is possible to both capitalise on the downturn and be a responsible landlord who wants the best for their tenants.
Moreover, society always needs rental properties. So why not embrace being a landlord, treat tenants well and get, say, $450 a week from a home-and-income to pay the mortgage cost and eventually use this to buy a second property?
I think it’s a good time to be an investor, to focus on cash flow, to take the contrarian view and go against the crowd to play the long game. After all, we could be entering a period when prices aren’t booming, which means more buying opportunities.
As New York real estate queen Barbara Corcoran, the founder of The Corcoran Group, once said: “A funny thing happens in real estate. When it comes back, it comes back up like gangbusters.”