News } TBK Capital

Re-distribution of Capital into Productive Assets

There’s been plenty of news recently about the rampant increase in Auckland house prices and plenty of discussion as to why. How far will it go? Is it a bubble and if so when will it burst? This sort of conversation is certainly not new news. We’ve seen it all before and we’ll see it all again.

Everything will be all right in the end.
If it’s not all right, it is not yet the end.

Patel, Hotel Manager - The Best Exotic Marigold Hotel

There’s been plenty of news recently about the rampant increase in Auckland house prices and plenty of discussion as to why. How far will it go? Is it a bubble and if so when will it burst? This sort of conversation is certainly not new news. We’ve seen it all before and we’ll see it all again.

First let’s recognise the residential property market is a key indicator of confidence in the economy and was a major contributor to the confidence here at the beginning of last year. The recent Budget has – in my view rather cleverly – dealt with a number of difficult subjects. See Bernard Hickey’s article in the Herald. Not the least of these issues is of course the increase in house prices which are largely localised to Auckland - Christchurch being a special earthquake driven case.

I rather liked BNZ economist Tony Alexander’s Sporadic newsletter (which came out before the pre-Budget and Budget announcements) in which he says “I have just about exhausted the key messages which I wish to get out regarding the Auckland.” This is an article well worth reading – with a great introduction defining “what we mean by the Auckland housing situation.”  In his view – and mine too by the way – “there is no “solution” as such because the factors propelling Auckland house prices higher are too massive for any reasonable policy changes to offset them”.

Tony goes on to say there are eight “records” helping to explain why Auckland house prices have risen so much, why they will rise further, and why the rest of the country will never catch up. He lists these as record;

  • Low interest rates,
  • Net migration inflows,
  • Migrant wealth,
  • Aging bulge,
  • Leap ahead of Auckland as a global city,
  • Physical land pressure,
  • Delayed purchasing catch-up, and
  • Under-building.

Have a good read of the Sporadic 8 issue - it’s well worth it. (It will make you want to read Sporadic 7 too).

Of course, Tony’s articles were written pre the pre-budget announcement cracking down on property traders. While the restrictions introduced at that time were unexpected, they were not really new. The equivalent of the “bright line” test of 2 years was introduced by Muldoon in the 70’s and called a Property Speculation Tax. It didn’t last long. See Olly Newland’s article.

In any event the “bright line” test is really a clarification of the intention of “trading” in property, which was always taxable. Research by CoreLogic, a leading property information, analytics and services provider in the United States, Australia and New Zealand, shows there is a definite difference in hold period between Auckland and the rest of the country, with almost a third of properties sold within 5 years.  The author, Nick Goodall, found “there are clear signs of speculation in the Auckland market.”

The same tax principles apply to owning shares, jewellery or art. In simple terms, owning these assets as an “investment” means the income – if any - is taxable and any increase in “value” is not. But if you’re trading in these assets any gain in value is.

Will anything in these pre-budget announcements make any difference? Not really – although I do like the idea of identifying offshore buyers (for all sorts of reasons including more reliable statistics). There is however one aspect of the new rules that could be counter productive - the ability for developers to acquire pre-sales to obtain the bank finance to build apartments and houses. Anecdotally many pre-sales of apartments (not just in Auckland) have been to offshore buyers.

Finally, before we get off the subject of house prices, let’s recognise it’s not cheap to build a house here. I liked the article in the Herald by Andrew King of the New Zealand Property Investors Federation. This highlights the red tape, time and cost of council requirements to get subdivisions approved and new homes built. And then there’s the high cost of materials and labour here in New Zealand.  Is it surprising then that house prices remain strong when it’s not cheaper to build than buy? And while land supply is short and building costs are high that is likely to remain so.

Residential Property Investment

The rise in house prices gives existing owners more equity in their house for no effort and therefore more collateral security when borrowing to purchase other assets. For the home owner who has a real job, the natural way to achieve passive income from this new found wealth is to buy another house and rent it out. 

I was looking at an article in saying “Rental yields drop below 5% in most parts of Auckland and under 6% in much of the rest of the country”  Now this February 2015 article may be a little out of date (update here) but the yield does not take into account any management fee or,  as Greg Ninness says “the effect of vacancy rates and regular costs which landlords face such as rates, insurance and maintenance, which eat away at the net returns that they would receive".

He goes on to say “This means residential property in Auckland is increasingly likely to be a low yielding investment when compared to other property assets such as listed property stocks, many of which have been providing dividend yields around 5-6% and commercial property syndicates which can provide cash returns of 8% or more. It also suggests many people investing into the Auckland property market will be relying on future capital gains to make a reasonable return on their investment.”      

Inside Every House is a Business

There is however, the opportunity to use the home equity to assist in the purchase of asset classes different from residential (or commercial) property – for example a business.

Recently our sister company Tabak Business Sales concluded a sale in which the buyer 100% funded the purchase of a business through borrowings on the business and the equity in his house. Raising debt finance on property is of course the most common way to assist in purchasing a business or raising working capital for its expansion – especially for new businesses or those that do not have a strong balance sheet.

Three of the major advantages of owning – or investing in – a business are:

  • The Income return on investment on a successful business is typically 20% - 40%. This is much higher than the return on residential property, say 5% to 8%, or the dividends on listed shares (in New Zealand zero to say 11% with the occasional anomaly higher) or art and jewellery (zero).
  • The Capital return – the increase in the “value” of the asset over time – can be very high. A business can go through 5 stages in its life; start-up, growth, expansion, maturity, and decline. See Owners and investors participating in the early stage stages of a business can make extraordinary capital gains.
  • Re-distribution of capital into productive assets – as opposed to passive investments.  Business growth and investment have far reaching benefits to the economy and the country as a whole.

The last two years have seen good growth in SMEs here in New Zealand. Accordingly strong EBITs will give confidence to business owners offering them for sale or raising new capital; and to investors buying businesses or subscribing for new share offers.

Cornerstone Shareholders

The businesses we work with in TBK Capital are usually looking to find a key cornerstone shareholder who may be seeking some form of active participation – be it, actually working in the business, a seat on the board of the company, or even a “merger” of their businesses. (Of course "passive" investors are also welcome and can form a vital part of the shareholder structure of a company.)

For those looking for large expansion of their business early “private” capital raising in this manner will ultimately assist businesses to reach the level where they can raise further capital and attract an exit strategy such as a trade sale or “liquid” equity via the NZX, ASX or other listed exchanges.

Tomorrow I'll send you an update on some of the businesses we have looking for investment.

Happy to hear from you

I’m always happy to hear from you if you’d like to comment on the matters raised in our newsletters – or of course it you’re looking to raise debt or equity for business or property or would like to invest in either.

The best way to keep in contact is to phone me on +64 9 307 3257 or +64 21 902 901, or simply email.



John Paine B.Sc., Dip BIA
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

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