Peter's Perspective
6th June 2014 by Peter Churchouse

Real Returns in New Zealand Property

We recently received an email from a New Zealand-based subscriber to The Churchouse Letter (then the AHA Report).

For our latest Peter’s Perspective (previously the AHA Digest), I will explain how a meeting in Hong Kong in March with New Zealand’s Prime Minister John key gave me the answer to this particular subscriber’s main question.

We reprint our subscriber’s email below with his kind permission:

Regarding your newsletters, I did have one big question on my mind with regards to your thoughts on rental property since you first mentioned the huge opportunity mid-last year [Note: See our AHA Digest Piece “What’s Happening in the Land of the Long White Cloud?”]. Do you still see the current environment as ideal to make sure purchases – even though you put your REIT recommendations on hold? How do you view the NZ property market since they have introduced measures to slow the “bubble” in Auckland – not to mention their intention to continue raising rates?

A lot has changed in the last year no doubt but as someone looking to produce long term yields for their family and who is quite heavy in cash at the moment, I (and probably many like me) am trying to balance the idea either waiting for a correction before putting that cash to work (in property or shares), or, should some be invested in good yielding property now – the decision is always whether to go through a REIT vs buying your own and managing it. With you putting REITs on hold because of a rising rate environment – it makes me wonder if that has also caused a change in your opinion of physical property acquisitions.

These are excellent questions. These are also exactly the kind of questions we look to provide answers for in the AHA Report and Digest.

Let’s quickly get the REIT question out of the way first.

The table below shows how our picks have fared over the past 11 months. (Note: Fletcher Building Ltd. is a developer, not a REIT).

AHA Digest NZ REIT picks from 19 July 2013. Precinct Properties New Zealand Ltd, Reference Price: NZD 1.07, Total Return: 6.38%, Status: Hold, Dividend Yield: 5.53%. Kiwi Income Property Trust, Reference Price: NZD 1.12, Total Return: 11.07%, Status: Hold, Dividend Yield: 5.45%. Goodman Property Trust, Reference Price: NZD 1.04, Total Return: 8.41%, Status: Hold, Dividend Yield: 6.33%. Fletcher Building Ltd, Reference Price: NZD 8.48, Total Return: 11.91%, Status: Hold, Dividend Yield: 4.65%.

We’ve returned on average just over 8.5% with our REITs in New Zealand dollar terms.

Our reader is absolutely right that the Reserve Bank of New Zealand raising rates is likely to mute REIT returns going forwards. However, I do believe rentals and yields look pretty safe.

So why have we changed our stance to ‘Hold’ on NZ REITs?

A few months ago I attended some closed-door meetings here in Hong Kong with New Zealand Prime Minister John Key, and Finance Minister Bill English.

These meetings revealed that the continued strength of the New Zealand dollar is a major concern at the very highest levels.

The Kiwi dollar is very much a ‘risk on’ currency. As you can see from the chart below the kiwi dollar strengthened dramatically in the lead up to the global financial crisis before collapsing by 40 percent against the US dollar. It has since rebounded strongly.

USD per NZD Historical, from Jun 2006 to Jun 2014.

I should point out now that when it comes to currencies, the New Zealand Prime Minister knows what he’s talking about. Prior to a career in politics, Mr. Key was the Global Head of Foreign Exchange for former U.S. investment bank Merrill Lynch. He was a member of the Foreign Exchange Committee of the New York Federal Reserve Bank.

Given this sentiment, we feel the Kiwi dollar is likely near the top of its range despite interest rates increasing (note: usually higher interest rates attract more investors to the currency and hence it can strengthen).

Also, most of our readers and many investors in the New Zealand market are USD based.

The Kiwi dollar has appreciated by over 7% since our recommendation.

This gives us a nearly 16% total return for our NZ REITs in our USD based portfolios.

Right now I think the Kiwi dollar is looking a little toppy. I’m happy to hold my NZ REITs here and keep collecting my yield, but it’s just too hard to advocate buying the Kiwi Dollar at these levels right now.

Moving on…

Do you still see the current environment as ideal to make sure purchases [in Auckland] – even though you put your REIT recommendations on hold?

As we all know, the only ‘sure’ things in life are death and taxes! Real estate offers no such certainties. Auckland’s prices are up around 12 to 15% (depending on whose statistics you use) since our AHA Digest piece in the middle of last year.

I do remain bullish on Auckland’s residential real estate market BUT I expect the pace of price appreciation to slow.

As our reader points out, the Reserve Bank of New Zealand is at the start of a tightening cycle which will dull buyer enthusiasm. In addition, banks are now being required to lower their loan to value ratios. This means that buyers need to stump up with a larger down payment. We’ve also seen supply starting to increase again.

This combination of factors is likely to lead to a slowdown in the rate of price appreciation.

At this stage there is no early prospect of an oversupply it seems in the Auckland residential market, and demand still seems pretty robust.

What we are looking at is a mid-cycle slowdown. Not a cyclical reversal of the trend.

But let’s put this into context….. (Note: we do not provide personalised investment advice but we are taking this reader’s situation as a general example).

….as someone looking to produce long term yields for their family and who is quite heavy in cash at the moment, I (and probably many like me) am trying to balance the idea either waiting for a correction before putting that cash to work (in property or shares), or, should some be invested in good yielding property now…

So you have some cash and are looking for long term yield (and I presume capital appreciation) for your family?

An investment property is absolutely the very first step I believe people in this position should look at.

I have banged on about this time and again in previous AHA Reports. I am continually amazed at how few of my contemporaries (i.e. in our fifties and sixties) have done what this reader is looking to do – buy straightforward investment real estate.

Forget trying to ‘time’ the market right now.

I would suggest focus on something like this: finding a one-bedroom apartment in a well maintained building. A property with good freehold title. The leasehold system in Auckland is a potential “value destroyer”. An apartment in a location where people wear a suit and tie to go to work. Located within easy access of jobs and/or transport to jobs. Use some leverage, but not too much! Make sure you know your sensitivities in this rising interest rates environment.

It doesn’t matter if the market softens a little next year or the year after….we’re thinking in terms of decades, not years!

We’re not flipping properties here, we’re looking for a long-term investment that will provide us some yield (and a rental income that should increase over time), some capital appreciation, and a roof over our head if we ever need it.

As I have written before, my first real estate purchase in London, some 25 years after I bought it, was producing an annual rental equivalent to 1.25 times what I paid for the property all those years ago. There could be a similar outcome for you in Auckland. Why not?

….the decision is always whether to go through a REIT vs buying your own and managing it.

REITs versus physical property? Give me the apartment any day of the week! When it comes to real estate I agree with Warren Buffet… “our favourite holding period is forever.” There is a role for REITs in a conservative, income producing portfolio. But if I have the cash available for outright purchase of physical property then that would be my first choice (assuming I do not already necessarily have a portfolio of comparable properties.)

So maybe you buy a small investment property and have some cash leftover? Well, as a Kiwi living in New Zealand, you are fortunate. In fact you are beyond fortunate. You have something that hundreds of millions of people in the Western World are desperately crying out for….. and I’m not talking about great wine, a beautiful country…..or the All Blacks, the world’s greatest rugby team who are set to thrash England this weekend…….no…..

…..I’m talking about positive real interest rates.

The rest of us in the most parts of the world, Asia, across Europe and the United States are watching our cash savings eaten away year after year by inflation. Our bank deposits earn us nothing.

ANZ Bank in New Zealand will pay you 4.2% for a 12 month time deposit. The latest inflation figure in New Zealand was 1.5%. So you can park your cash for 12 months and earn a REAL (i.e. inflation adjusted) return of 2.7%.

This may not sound like much, but this is more than the current 10 year U.S. treasury yield…. and your 2.7% is REAL…just by leaving your cash on deposit at the bank! And if you don’t want to tie up money for a year, you can deposit for 6 months and still earn 4% annualised!

For us in Hong Kong? Well, for roughly the same amount of money, HSBC pays us 0.15% for a year on our cash. Inflation here is 3.7%.

So we are losing 3.55% annually….Every year just by holding cash we are hemorrhaging wealth.

This is the destructive nature of financial repression. We don’t need to go into how crippling these zero rates are for prudent savers and retirees. It gets me angry just thinking about it.

So the Kiwis are over 6% per annum better off than us in REAL terms! (Yes, currencies are not necessarily comparable but the distinction is important to make).

And as for any further investment ideas for your portfolio? As a paid-up subscriber you can see our current recommendations and performance for your consideration.

Finally, I would like to thank this subscriber for taking the time to email us at the AHA Report. We thrive on questions and feedback from our subscribers and I would encourage you to drop me a line at any time. I try to respond to as many as possible but please forgive me if I don’t address every one of them.

Good investing and have a great weekend,


P.S. We’re investing heavily in a brand new platform to launch later this year (more about that later).

P.P.S. If you’re interested in more specific investment recommendations, try a 50 day risk-free trial of The Churchouse Letter.

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