Property Making a Comeback
When we started TBK Capital a year ago both residential and commercial properties were still in the doldrums.
There is a house in New Orleans
They call the Risin' Sun
And it's been the ruin of many a poor boy.
And God, I know I'm one.
To see the original Animals song click here
When we started TBK Capital a year ago both residential and commercial properties were still in the doldrums.
The excesses at the beginning of the new decade - arising from cheap money and easy credit - came from the belief that property values could only go up. This led to the so called Ninja loans and securitisation which then led to the start of the Global Financial Crisis in 2008 with the bankruptcy of Lehman Bros (and 2007 in New Zealand with the demise of the finance companies).
Of course this is not new. Niall Fergusson’s Ascent of Money – which includes many property collapses in a special chapter called Safe as Houses - shows it has been going on for centuries.
By the way, to read Niall’s wider view of where the Western World is heading now, read John Maudlin’s article entitled “Western Civilisation: Decline – or Fall?” here. Can I convince you to read this by quoting a passage which says “For hundreds of years, these killer apps were essentially monopolized by Europeans and their cousins who settled in North America and Australasia”? Go on, have a read.
But I digress.
Residential on the Rise
Long time readers of my newsletter will know I have the view that the residential property market leads the New Zealand economy. So where is that going?
In the February CAPITAL COMMENT I quoted Rodney Dickens’ Rodney’s Ravings in which he addresses the question “Is a house price bubble brewing”. To see that issue click here.
BNZ economist Tony Alexander has just published the results of his Residential Market survey. These show “Auckland sticks out as having more motivated buyers than sellers and these plus other results show clearly that as was the case in the 1990s it is Auckland leading the country’s housing cycle upward:
“Wellington continues to be perceived by responding agents as having more motivated sellers, but prices nonetheless are near unanimously seen as rising. Investors are perceived as unusually active in Tauranga and Taranaki while first home buyers are perceived as active throughout all regions reported here”.
He concludes from this that more people are going through open homes, the proportion of written sales going unconditional is increasing, auction clearance rates are improving, more potential vendors are requesting property appraisals and more first home buyers and investors are entering the market.
In response to an article by Bernard Hickey in interest.co.nz, chief executive of realestate.co.nz, Alistair Helm, disputes the idea that we are on the brink of another property price bubble. This article contains some very interesting statistics and is well worth reading here.
His conclusion is “The froth in the property market which catapulted the house price bubble from 2003 to 2007 was more likely to have been driven by the highly active demand from buyers anxious to “get onto the property money train” at that time, certainly influenced by low interest rates, but not solely the action in cutting OCR. Property sales had started ramping up well before 2003, in fact they started to rise in 2001 and kept on rising to peak at over 120,000 sales per year in 2004.”
REINZ reports that sales volumes rose 37% in Feb from a year ago. Auckland dominated the auction market, representing 63.7% of the national total of auction sales, with 21.1% of all sales in Auckland by auction. And the Auckland Price Index is 0.7% above the previous peak recorded in July 2007 and up 8.7% from a year ago. Read the article here.
The government’s recognising the impact of shortage of supply – especially in Auckland. Finance Minister Bill English says the Auckland City Council needs to ensure the settings are in place to ensure more low cost housing is built in New Zealand's biggest city. Read the interest.co.nz article here.
And Property Guru and veteran Olly Newland is sure now is the time to buy. See his February article “I have good news for you: Now is the time to come out of hiding and get stuck in to property investing” here. The article gives good warnings about what to watch out for when investing in residential.
So all this looks pretty good for home owners and residential investors.
Price, Return and Cap Rates
The sales activity and pricing of commercial property are not driven by the same (emotional) factors as residential.
Location is the by far the major factor that drives the price of residential property. And if you’re a landlord it does have an affect in that higher rents are obtainable in more sought after areas. But the cost of owning your own house, or the return from renting it out, do not make good sense on their own. Demand for residential ownership or investment is driven by the increased price the house will be worth in the future due to owner occupiers seeking that location.
Now of course location also means a lot in determining the price and return you obtain from owning a commercial property. The “value” of commercial property is driven by the ability to obtain and retain the tenant(s) so obviously there’s no point in owning a commercial property where you can’t attract them.
Now “value” is an interesting expression when it comes to commercial property. It tends to be dominated by the capitalisation rate (being the annual net operating income divided by the purchase price or value of the property). With commercial property the cap rate is affected by other important factors being the quality of the tenants, the length of their lease and its terms (right of renewals and rent reviews). For a rather technical commentary of the benefits and pitfalls of cap rates click here. The return on capital invested is then affected by and the amount borrowed and the terms.
Another factor in assessing the value of a commercial property is the amount of the investment. This is important because there are not that many investors with say $20 million plus in their back pocket.
Accordingly the demand for commercial property in the up to say the $2 million range is strong and cap rates (or return on investment) lower than for larger ones. Cap rates under 6% are not unusual in this price range. Recent sales reported in Bob Dey’s Property reports were in the 6.4% - 7.65% range. See typical reports here and here. Good commercial property over $5 million is more likely to be in the 7.5% - 9% range.
Of course investors with limited funds can participate in larger property acquisitions by way of “syndication” (or technically a Proportional Ownership structure) where returns can be better. These have been popular in recent years and usually offer 8% - 10% plus pre-tax cash returns. Benefits other than the better return are professional management (many have multiple tenancies) and spread of risk where an investor can participate in a nunber of in a number of different syndicates and properties.
They have come into some criticism where properties have been bought at inflated values and the difficulty of selling your “share” in the event the money is needed. The structure works best where there are a few larger investors with a planed management strategy culminating in an exit in a few years time. We have an example on our website - projecting a 12.25% pre-tax return - here,
Financing Property
Property is probably the easiest asset to borrow against. In fact most businesses start off with the proprietor borrowing against his own residence.
We’re noticing banks back chasing residential loans and offering high loan rations – yes 100% loans are available – and low interest – one bank is offering a one-year rate of 5.9%.
My banking contacts tell me they are approving plenty of commercial property loans and there is no shortage of money for the right proposals. Their criteria are (rightly) tougher now than before the GFC, so the way a proposal is negotiated and presented can mean the difference between a yes and a no.
While some of the non-bank lenders that survived the GFC have ceased business or merged, there are a number still active and new ones are appearing. These tend to lend shorter term interest only loans just outside the banks’ criteria which are useful for shorter term financing and refinancing. On satisfactory performance loans can usually be renewed.
Sometimes it is beneficial to look at moving loans to a non-bank lender. A major advantage is the isolation of the security required so performing assets cannot be called upon if a non-performing one comes under pressure. Also cash flow servicing requirements for interest only loans can be less that P&I requirements, even at higher interest rates.
We also have access to private lenders. One in particular is interested in providing first mortgage, interest only finance for property in the $2 million to $5 million range. There are not many non-bank lenders who are willing or able to make loans of this magnitude.
Finance for development and subdivisions has been very difficult to obtain and in some places still is. But the improvements in the property market and the shortages in certain areas, means sales and exit strategies are becoming easier to obtain, and therefore the ability to raise the finance to do them. We have lenders who will provide development finance.
In summary, at TBK Capital, examples of loan finance we can arrange include.
- Residential and commercial real estate.
- Finance for developments and subdivisions.
- Almost completed developments requiring short term funds to finish for bank takeout.
- Growing businesses strapped by lack of working capital. This can be resolved through bank and non-bank lenders.
- Buyers or owners of properties looking to add value by re-furbishing and/or re-tenanting. Banks are reluctant as this falls into “development” territory but happy to re-finance when completed.
- Plant, equipment and debtor finance. Good for financing expanding businesses.
By the way, we’re looking to expand our debt broking operations so if you know of anyone who might be interested get them to give me a call.
Cheers
JP
John Paine
TBK Capital Limited
Level 15, BDO Building
120 Albert Street
Auckland 1010, New Zealand
Phone +64 9 307 3257
Fax +64 9 309 4519
Mobile +64 21 902 901
Email john.paine@tbkcapital.co.nz