Investors learn the perils of property investment the hard way
Downunder mums and dads-type investors have long been comfortable with the idea of investing in property.
“Safe as houses” apparently has its origins in Victorian Britain, and it seems our ancestors brought the maxim with them to Australia and New Zealand when both countries were being colonised.
But several times in just my own lifetime, this degree of comfort has been used by the unscrupulous to lure retail investors into what turned out to be very dodgy property-based investments.
I remember when I was working in Sydney in the early 1990s talking to one of the unfortunate investors in a fund that owned No 1 O'Connell Street in Sydney about how they'd been attracted to the fund because of the tangibility of such a property.
They learned to their cost that owning securities in a fund that owned the property turned out to mean they actually owned a pile of debt, and when property valuations fell, that meant the banks actually owned the building.
Waves of investors in NZ have learned that same lesson when they were caught up in the property syndicates that failed in the early Naughties and then the finance company collapses in the late Naughties, such as Bridgecorp, Capital + Merchant and Hanover, which mainly financed buildings.
Bashing landlords
Small wonder then that so many such mums and dads have turned to residential property investment, most owning one or two houses.
They were roundly abused by the previous government for being property “speculators,” even though the typical investor tends to be a lowly-geared landlord, and penalised by that government taking away the right to book mortgage costs as a business expense for tax purposes.
To be clear, that was the only form or economic activity that was stripped of the right to claim interest as a tax-deductible business expense.
The new government has pledged to restore what's known as the tax deductibility of mortgage interest costs, and should be considerably kinder to landlords, but they've still suffered in the meantime.
Back when ZIRP (zero-interest-rate-policy) ruled post-covid, many of those approaching retirement or already in retirement, those who can least afford to lose the capital accumulated over a lifetime, were effectively forced by the Reserve Bank to take greater risks.
Even pre-covid, RBNZ governor Adrian Orr in 2019 urged those in term deposits to “invest more actively,” actually a euphemism for taking more risks.
He told Parliament's finance and expenditure committee back then that such people should be "putting your capital more to work, which is about creating real investment rather than just sitting in the bank account with all of the returns going to the owners of the bank."
Path of least resistance
So, when RBNZ pushed interest rates even lower after the onset of covid, rather than buying safe but extremely low-yielding term deposits, a natural home for such investors, many of them followed the advice of financial advisers and did what RBNZ had been urging.
Given these are exactly the sorts of investors who want income as well as safety, many financial advisers would have recommended that they invest in dividend-paying shares, such as NZX-listed property stocks.
Even those luckly enough to have chosen the best performer in the listed property sector, Goodman Property Trust, which invests in and develops industrial property in Auckland, would have seen their investment perform about twice as poorly as the benchmark S&P/NZX Top 50 Index over the last two years.
The index shed 10.5% over the past two years while Goodman was down 18.9% yesterday from two years earlier.
Those unlucky enough to have bought Kiwi Property Group shares would have seen their capital worth 29.1% less than two years ago.
The reason why the listed property sector has performed so badly is that valuations of properties are inextricably ked to long-bond yields and values fall when bond yields rise, and vice versa.
The impact
You can see the impact in what happened in November when NZ 10-year government bond yields fell from a peak of about 5.6% in October to about 5% by the end of November and the NZ real estate index gained 4.2% for the latest month after three consecutive months of negative returns.
As property values fall, those listed property vehicles are subject to reasonably steep increases in gearing levels, even if they don't borrow more.
Kiwi's gearing, for example, climbed to 35.3% at Sept 30 from 35% at March 31, even though its actual debt actually fell slightly over the six months – the company's policy is to keep gearing under 35%.
But even though the value of Kiwi's properties, net tangible assets (NTA) per share, was put at $1.17 at Sept 30, down from $1.26 at March 31 and compared with $1.42 at Sept 30, 2021, the shares closed Monday at 84 cents, a 28.2% discount to NTA.
Kiwi is far from the only company suffering from market scepticism about value at the moment; even Goodman's shares ended Monday at $2.13, a 7.6% discount to Sept 30 NTA of $2.305.
Not dodgy investments
Don't get me wrong, I'm not saying either Goodman or Kiwi are dodgy investments.
I am questioning the wisdom of government and RBNZ policies that have effectively forced too many older citizens into their current predicament of owning such shares.
Seasoned share market investors know that both Goodman and Kiwi are likely to start performing better once RBNZ starts to cut its official cash rate (OCR) and the key thing is to hold on until the economic environment improves.
The key difference there is risk; the types of investors RBNZ and the previous government forced down this path are the ones least ready to bear such risks.
Unfortunately, another factor Kiwi's investors are going to have to wrestle with is the likelihood it will have to reduce its dividend.
Kiwi's dividend, an annual 5.7 cents per share, is safe for the current financial year.
But Forsyth Barr analyst Rohan Koreman-Smit is convinced it will be cut to 5.2 cents for the 2025 and 2026 financial years.
Koreman-Smit's reasoning includes Kiwi facing higher tax (due to changes to depreciation rules, although the new government's policy is another area of uncertainty).
Good BTR returns?
As well, continued interest cost pressure and low initial returns from developments such as the build-to-rent (BTR) apartment building at Sylvia Park, which is expected to be completed by May next year, are factors.
Kiwi is expecting the building will take 12 to 18 months to be fully leased.
“In the short term, there remains a number of questions around the success of BTR, the main one being the level of rent required to meet already low yield on cost targets,” Koreman-Smit says in a recent note.
Kiwi is also planning to sell residential and retail lots at Drury, the site of what it wants to become a new multi-use town modelled on its successful Sylvia Park shopping centre, entertainment, office buliding and BTR development.
While selling sections at Drury will bring in cash, Koreman-Smit says the one-off nature of such sales shouldn't be distributed as income.
Jarden analyst Arie Dekker is expecting Kiwi to hold the dividend steady at 5.7 cents for the 2025 financial year but “we see the possibility that the dividend may need to be re-based a second time, down to 5.3 cps.” Kiwi paid 5.6cps in dividends in the 2022 financial year.
Macquarie is forecasting a dividend cut to 5.5cps for financial 2025, based on the same factors Koreman-Smit cited, but says the company might choose to maintain dividends based on an improving outlook.
Dividend cut?
Craigs Investment Partners analyst Nicholas Hill is also expecting there's “a real risk” of a dividend cut, although he's maintained his forecasts for financial 2025 and 2026 at 5.7cps for now.
Hill is scepical about the Syvia Park BTR outlook too, thinking that Kiwi may not be able to lease it “at its desired price points … [which] we see as ambitious although not impossible.”
The units in the building will range from studios to three-bedroom apartments, but most will be one and two-bedroom.
Hill says his information is that Kiwi will be asking $660 per week rent for the one-bedroom and $830 for the two-bedroom units, and notes that other BTR developments in suburban Auckland are priced at up to 35% cheaper.
These include New Ground's developments at Glen Innes and Hobsonville Point and Simplicity Living's Ellerslie and Point England developments.
“We acknowledge that Kiwi's BTR product will be a more premium offering than those projects mentioned above and likely to command a higher price, but the key point we wish to emphasise is that the difference between current BTR market rents for non-central locations and Kiwi's target pricing is substantial,” Hill said.
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