Peter's Perspective
5th August 2013 by Peter Churchouse

Red Flag. An Auckland Update.

“I’ve got Hong Kong on the phone. They want to buy this prime real estate”

So went the auctioneer’s patter at last Thursday’s auction of a brace of residential properties in Auckland, New Zealand. My friend in Hong Kong heard this over the phone during his telephone bidding for a piece of Auckland real estate action. Never mind that he had expressly asked the estate agent he was bidding through NOT to reveal where the bidder was located.

“I was standing next to the auctioneer and he saw the information on my phone” was the agent’s disingenuous response. Yeah, right! Another example of why real estate agents have the reputation they do. But that is not the point of the story.

Oh, by the way, the eventual winner of the auction paid a price almost 50% above an independent valuation figure. A price that was 20% higher than the “guide” price set by the local agent community. It was a nice bit of bricks and mortar though.

Recently I commented in our AHA Digest on the investment qualities of the property market in Auckland, New Zealand. I like the market and have been adding some small investment properties to our portfolio there. It seems I am not alone in my positive view of that market. Things have definitely been heating up in recent months and we are hearing the “B” word mentioned increasingly in Auckland dinner party circles.

While I am not convinced that the market is in bubble territory yet there are certainly early signs of bubble-like characteristics in the housing market.

New Zealand is playing host to significant numbers of visitors from Asia. Many are setting up businesses there, or attending schools and universities. They are becoming a significant force in the local housing market.

Supply is tight as there has seen a sharp slowdown in new building since the onset of the Global Financial Crisis in 2008. The “open homes” that I attended in my latest visit a couple of weeks ago made me feel like I was back in Hong Kong. Most of the viewers trawling through the properties were Asians – young and old, families from Singapore, Taiwan, Korea, Hong Kong and increasingly from China. Many of these potential buyers are able and prepared to pay prices that many locals find excessive. Similar experiences are being felt in many other larger western world cities.

An email I received last week from New Zealand started:

“Dear Peter, I am sorry to inform you that you were unsuccessful in your bid for the property in Queen Street. The offer that succeeded was $XX. Better luck next time, Livia.”

Livia, herself from Asia, had been masterminding the sale of one of the properties that I had visited during an “open home” session a couple of weeks ago. My bid was well away, and was heartily trumped by an Asian buyer who was prepared to cough up nearly 20% more, and somewhat higher than the independent professional valuation. The winning bid implied a rental yield that was lower than my hurdle rate taking account of renovation costs and prevailing current rental potential.

While such examples are not necessarily the norm as yet, they do however raise the bar on expectations of sellers and buyers alike. If such price increases do become the norm, the next question for investors like us will be to see if rentals rise in a similar fashion. If so the expected yields for investors would remain more or less intact. But the jury is still out on that just yet.

Balance the Apexes of the Price, Rent & Interest rate Triangle.

Rental yields for downtown residential apartments in Auckland, net of property management fees and local government taxes, have recently been a relatively attractive 5.5% to 7% or even higher, depending on location, quality and property type. These are some of the highest in the major cities of the developed world. With interest rates of around 4 to 4.5% such yields can make good sense to investors.
However, if the recent jumps in prices become the norm, then net rental yields at current rents fall to levels at or close to the cost of borrowing. That would start to makes the investment case a little less clear. And as we know, interest rates have only one way to go from here over the medium to longer term.

For me, the yield equation still has to stack up. In bubble markets most investors push yield considerations to the back burner. Perceptions of endless upside to prices transfix them. For me, balancing the three apexes of the price, rent & interest rate triangle is critical.

It is quite possible that given the lack of supply, and the pressure of population in the city, rentals will rise, but the evidence is not there yet.

As an aside, I did manage to succeed in winning some prime downtown floor space with expected net yields of around 6.2% to 6.7%. That still makes sense to me.

What this experience in Auckland, and also London (I was there last week taking delivery of some real estate that we have purchased) is telling me is that although the underlying long term case for acquiring real estate assets in these prime markets is still intact, we need to be increasingly discerning and remain prudent when calculating our numbers.

The issue they face is that the recovery in property markets in these countries is far from even. It is largely concentrated in a handful of capital or core cities. Real estate prices in a great many towns and cities are still on the skids, and distressed assets are still all too common in this sector.

It is indeed a bi-polar condition in many housing markets in the western world.

Foreign Buying Pressure Raises the Prospect of Policies Aimed at Deterring Foreign Buyers of Residential Property.

There are several forces at work in the new surge in property values in “focus cities” like Auckland.  London, New York, San Francisco, Vancouver, Toronto and Sydney all fall into a similar category.

First is the Bernanke & Draghi effect. Sustained low interest rates around the world make borrowing for asset purchases such as real estate cheaper than it has been in two generations for most countries in the western world.

There is little incentive to keep money on deposit. Savers continue to lose money in inflation-adjusted terms by keeping money in the bank. Investment in real estate can at least produce a decent rental yield, these days well above the rate of interest earned on deposit. Yields in Auckland have been significantly higher than typical yields in most other major western cities. That has not gone un-noticed by some investors.

Second, focus cities like these are proving attractive for many foreign investors for political and social reasons. Much “new” money is being made in emerging countries with dubious political and legal regimes, often rife with corruption. Families are looking for insurance policies in the form of residency, passports, assets and education in secure countries where the rule of law prevails. For many it certainly does not prevail in their home country. Countries like the US, UK, Canada, Australia and New Zealand provide this security and are countries generally open to investment, immigration and education. These are all things that vulnerable (yet wealthy) families in many developing nations desire.

The scale and impact of foreign buying of housing in these markets is generating increasing mutterings of anti foreigner sentiment in local media.

Locals see foreigners driving up housing prices to levels that they cannot afford.

Foreigners are seen increasingly as unwelcome competitors in local housing markets.

We see such sentiment expressed in many markets, even in Asia. For example, both the Singapore and Hong Kong governments have recently imposed rules and conditions that make buying residential properties in these cities more difficult and/or more expensive for foreigners. For Hong Kong the main target has been buyers from China, and for Singapore the target has been buyers from China and Indonesia primarily.

The UK has also this year proposed legislation aimed at making ownership of certain types of housing more expensive for foreigners.

Politicians score easy voter points by targeting foreign buyers of housing, and also find them an easy source of much needed tax dollars. Foreigners don’t vote. Locals do, and tend to vote down politicians who raise their taxes.

I would not be surprised to see New Zealand enact legislation targeting foreign buyers of housing in these markets if local discontent at the perceived impact of foreigners buying into local housing markets grows into a groundswell. It will likely take the form of imposing higher taxes, stamp duties or annual taxes on foreign buyers of housing. Already New Zealand has a small tax imposed on offshore borrowings used to purchase residential property in the country. It could easily raise this if it saw excessive foreign borrowings creating bubbles in local property markets.

While I am still a buyer in these markets, I am paying increasing attention to my underlying assumptions on the investment case in deals I am contemplating. In addition, it is probably time to take a closer look at properties either outside the very inner city “Zone 1” sites to other locations or cities that have not yet really started to attract as much of the cheap money that is still washing through the system.

Other sectors such as retail, commercial and industrial properties have largely been passed over by the stampede into residential assets by foreign buyers. These also deserve attention.

Thanks for reading, and have a great week,


P.S. If you would like more specific investment ideas, get your 50 day risk-free trial of The Churchouse Letter today.

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