It's not risky or hard work

Landlords aren't really taking great risks and working hard. Falling interest rates, chronic under-building, rapid population growth, huge tax breaks and a state guarantee make it an easy, sure thing

Despite what they might tell themselves and others, landlords aren't actually taking great risks and working hard. Bernard Hickey argues falling interest rates, chronic under-building, rapid population growth, huge tax breaks and an effective Government guarantee against a market bust make rental properties the easiest, most lucrative and lowest risk investment choice for home owners. And that’s unlikely to change.

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Reading about Christchurch property investor and influencer Ana Meredith’s ‘journey’ towards owning 25 rentals by 2025 this week made me feel two things that shouldn’t go together in one stomach — sick for the future of first home buyers, and hungry to get me some of those juicy tax-free capital gains she was promoting.

Meredith pitched her story as an uplifting trail of hard work, risk taking and a get-up-and-go-ness to personal wealth and fulfillment. She explained how she had worked her way up to owning five rentals in the five years before Covid-19 struck in early 2020. Then she had something of an epiphany, and her ‘business’ of helping others into rental property investment “went bananas,” along with her own appetite for rentals.

She bought five more rentals last year during and after the Covid-19 lockdowns and is now promoting her aim of getting to 25 rentals by 2025 on her own Instagram account.

“While everyone else was sceptical around the house market during Covid, I took the opportunity, or the risk if you like, and went out and purchased property against all the economists’ predictions,” Meredith told Stuff’s Kylie Klein-Nixon this week.

She said her risk-taking has “really paid off” and now she was enjoying helping other rental property investors to snap up properties in Christchurch through her Investment Property Consultants business.

“I am based in Christchurch where it is still very affordable and there is a huge rental demand,” said Meredith, who is pictured above in a photo taken by Stuff’s John Kirk-Anderson.

I wrote last year about how Christchurch has been the exception to the rule of ever-rising New Zealand house prices over the last decade. The then-National Governmet broke the two cardinal rules of Government in the immediate wake of the 2010/11 earthquakes by effectively suspending the Resource Management Act and paying for local infrastructure to kick-start a massive house building drive. That worked to increase supply and both flatten house prices. Rents even fell as much as 20% from their immediate post-quake highs and prices were flat from 2016 to early 2019.

But Christchurch’s affordability improvement relative to New Zealand’s other fast-growing cities (Auckland, Tauranga, Hamilton, Wellington and Queenstown) drained away in late 2019 and early 2020. Now it is catching up again with the rest, thanks to a surge in buying by landlords and a reversion to under-building. The RMA is back as a tool to stop new houses being built and infrastructure investment by the central Government has fallen back to non-emergency levels.

The buildup of relative affordability of Christchurch between 2016 and 2019 was promoted as a feature by Christchurch’s business promotion agency and larger companies hoping to attract staff priced out of buying their own homes in Auckland and Wellington. National Housing spokesperson Nicola Willis has touted the Christchurch example as a model for an emergency suspension of the RMA nationally and help from the Beehive to kick start more local infrastructure.

But it also made the rebuilt city more attractive to property investors looking for a bargain. The feature became a bug and Meredith saw an opportunity.

“[I work with] a lot of Aucklanders, Wellington people, Dunedin, a lot of clients all around the country, even ex-pats overseas, wanting to buy in Christchurch. I am here on the ground, doing it for them, giving them my tips of the trade,” she said.

CoreLogic economist Kelvin Davidson has documented the rise of property investors in Christchurch over the last 18 months and how they have increasingly being competing with first home buyers to bid up prices. They are now jostling with first-timers to be the biggest buyers, Davidson said this week.

“First home buyers have been the key buyer group for the past three years now, and accounted for 27% of purchases in 2020, but a fair degree of the recent price momentum is likely to have come from mortgaged investors – now 26% of the market, up from 23% in 2019,” he said.

Meredith said this week there was no easy answer for first home buyers, other than hard work and risk-taking.

“I guess when you want your goal that much, things just fall in place,” she said of her business’ boom over the last year.

“Truth is, I work very hard, I have always been a hard worker. I have a day job. I save my money. Then I am also a bit of a risk-taker. I guess the confidence also comes from knowing a lot more about the market,” she said.

“I really feel like I have found my purpose. I feel really contented when I am helping these people get into investment property.”

Hard work? Risk-taking?

But is she and her fellow investors really taking that many risks and working that hard for that much money?

They’re certainly making a lot of money, most of which is not taxed, unlike investments in term deposits, KiwiSaver and listed companies. The collective equity in residential property has risen almost $200b in the last year to over $1t, with about a third of that applying to privately owned rental properties. If that nearly $70b of capital gains had been realised and taxed at the top income tax rate it would have paid for the $14b of Covid-19 wage subsidies twice over.

Rental property investors argue they are taxed at the same rate and in the same way as everyone else. That’s just not true. Income from wages and company profits are taxed through PAYE and spending is taxed through GST. Income from capital gains are not taxed in the same comprehensive way other income is taxed.

Then there’s the issue of leverage. Meredith and her clients are able to borrow up to 70% of the value of the assets they are investing in, while other investors in shares and unlisted companies won’t get the same loans from their banks. Term depositors have to pay withholding tax and Portfolio Investment Entities are forced to pay up to 28% in income tax.

Landlords also have access to tax breaks that competing first home buyers can’t get. They are able to claim the interest costs on their mortgages as a cost of doing business, along with maintenance, rates and management fees. An owner-occupier doesn’t have that benefit to use when calculating how much they can pay.

Landlords are also paying little through the extended five-year ‘bright line’ test for making capital gains from trading. It is barely complied with across the country, let alone policed. The Inland Revenue Department reported last year that less than a quarter of the transactions it suspected of making capital gains from property trading had paid tax on those transactions.

The key advantage investors have is the ability to leverage up the already-leveraged and untaxed gains from their own homes and other rental properties. Those gains may not be realised, but they are very real when the landlord approaches the bank for a pre-approval to buy another property, especially when the debt can be smeared across a range of properties.

Meredith did not disclose her equity gains over the last five years, but a simple exercise for a Christchurch home owner illustrates how the engine of capital gains can be turbocharged and replicated with the magic of leverage.

The average house price in Christchurch in 2015 was around $450,000. An average mortgage of $200,000 would give the home’s owner-occupier up to $160,000 to use as a 30% deposit on a rental property, given they could gear up their own home to 80% and use their regular income as a guarantee for the next loan. Low interest rates allow this gearing.

That $160,000 could be geared up with a 70% Loan to Value Ratio to buy a $530,000 rental property. That’s just a start because once house prices keep rising and interest rates keep falling there is room to buy one or two more properties each year with the equity building up in multiple properties. No wonder 25 by 2025 is possible.

But there’s another reason this is possible without too much risk-taking or hard work, relatively to other forms of investing or what most would consider work. Residential investment has a special status in New Zealand that mean it has an effective Government guarantee.

Unlike investing in shares or other types of businesses, the Reserve Bank and the Government have shown repeatedly they will intervene to stop house prices from falling substantially, both to protect banks and the wider economy. Meredith have stumbled onto the biggest dirty little secret of investing in New Zealand: it is Government guaranteed.

Politicians from both sides refuse to consider taxing the capital gains properly or bring in a wealth or inheritance tax that would crystallise some those gains as income to be taxed, as other forms of income are taxed. The Reserve Bank will cut interest rates and rescue banks to stop any spiral downwards in house prices. The Government will also avoid flooding the market with extra housing supply to avoid downward pressure on the asset values of most voters.

The cherry on top is the $4b worth of taxpayers money paid each year to renters as Accommodation Supplements to help them afford the rents, which are the most unaffordable in the OECD. The Government subsidises and guarantees landlords to the tune of $10b-plus each year in taxes not collected and subsidies delivered in acccomodation supplements.

When Governments of the pre-1984 era gave that much in subsidies to one sector — guaranteed minimum prices for sheep farmers — there was outrage among taxpayers in general and eventually they were abolished as unaffordable.

Property investing is a sure thing, as Meredith has not-so-quietly realised. Unlike the volatility of other assets, buying residential property means support from a bank that won’t be allowed to collapse and support from a Government that doesn’t want prices to fall.

Prime Minister Jacinda Ardern said as much late last year when she said the Government’s aim was moderate house price inflation of around 4% per year, and that she did not want prices to fall. Her Government and the Reserve Bank acted aggressively last year to ensure just that.

Many landlords also claim their capital gains are hard earned and should not be given up to those unwilling to take the risks of investing or saving deposits. However, as demonstrated above, the equity that most investors use for their deposits has come from the untaxed capital gains on other properties.

Those gains are largely due to the rising tide of the market and broader factors that no landlord can claim credit for. A Reserve Bank study published in late 2019 found almost all of the 80% rise in house prices since 2009 could be explained by higher tenant incomes and lower interest rates.

That’s not how landlords see it. They argue their renovations and good selection of suburbs and streets explain the rise. They see their gains created by their own work and judgement, when that simply isn’t true. They are riding a tide higher and into a very inviting shore. They may think they are a perfect surfer and chooser of the perfect waves, but the real story is the tide will bring them in anyway.

Meredith certainly sees plenty of skill and hard work in her story.

“You have got to have drive. It is not easy. A lot of people think this is the easy route, the easy investment. I have had someone call me lazy before but you have still got to keep things in check and you have still got that huge, huge risk hanging on your shoulders,” she said.

But the facts are she and other rental property investors have ridden a Government guarantee, lower interest rates, much faster population growth and endemically low house building rates for 30 years to extraordinary and untaxed wealth.

And there are no signs it will change. The best any first home buyer can hope for is they don’t have to bid against an investor supercharged with fresh equity and debt, and that their current landlord doesn’t put up their rent faster than their incomes.

Christchurch’s first home buyers have fared better than most for most of the last decade, up until late 2020, because their incomes have risen faster than house prices and rents, meaning their time to save a deposit have not increased much.

That may not last long if Meredith and her many clients go even more “bananas” in Christchurch.

ends