By Elizabeth Kerr
This week I won’t make much sense to you if you didn’t read last week’s column about rent-to-buy property investment and ownership.
You can catch up by clicking here.
This week's column is divided into three sections.
These are as follows: 1. The Investor Landlord (IL). 2. The Tenant Buyer (TB). 3. The House.
Why would I invest in Property this way?
The most common question is by far why would you even bother when you could just buy a property and have it rented the traditional way?
The answer is nearly always ‘cash flow’ and could also be any or all of the below:
- You can’t support a negatively geared property by topping up the rental payments to pay for the mortgage from your own income.
- You need the positive cash flow to balance out another property investment that is negatively geared (but well positioned for rental or capital gains in the future).
- You are a bit philanthropic and want to feel like you are using your wealth to the betterment of your community, or
- You would like to create a money machine without having to put any money down physically yourself, or
- You will use the proceeds to pay off your own personal home mortgage quicker.
- You want to grow your property portfolio and supporting negatively geared properties is too risky for you.
- You want to help your kids/grandkids into a home and have a contract in place to support the arrangement, which also outlines when/how you will get the money back again.
I’m sure you might think of others but those 7 should cover the majority of situations.
Some investors will argue that the house was brought with the “option” for a TB to purchase, not the “intention”.
Those waters are muddy but in my opinion, at the time of purchasing the property the IL obviously does have every intention of selling it to the TB, therefore would be expected to pay tax on the sale profits.
The rental credits are probably going to be taxed at the time of receipt as rental income and the expenses are deductible as per a normal investment.
How much tax you have to pay is really dependent on how your investment is owned and how that ownership entity is structured.
The team at GRA have provided accountancy advice for these types of investments, so, if you have any questions I encourage you to use an accountant who is at least familiar with how the arrangement works.
What happens if the market stagnates or declines?
Okay, good question.
If the market stagnates or declines and the house is not worth the contracted future TB purchase price then it’s nothing to get all worked up about.
Remember the entire investment was arranged so that the TB could secure finance at the agreed future purchase price.
The purchase price has been determined by a conservative forecast in market value, and the rental credits and initial deposit have been set based on achieving that purchase price.
The increase in market value is not crucial to the deal being completed successfully; it’s just nice to have.
The TB probably doesn’t want to overpay for a property and would like to know that the house they are purchasing is of fair market value.
The only thing that could get in the way of this is if the bank did not want to lend to the TB based on the purchase price being too high.
However, people overpay for properties all the time, so all things being equal I don’t think that would be very likely.
If that did happen there are only 2 real options left:
- Sell at a cheaper price
- Extend the term until prices picked up again and the house can be purchased for the agreed price
Option 1 would work but the IL would forgo some of the end profit.
For option 2 the TB and the IL could decide to keep the rent at the contracted rate and continue to add rental credits to their deposit making the TBs position even better come settlement time again.
The key message here is that variations to the agreement can be made if both parties are agreeable. If they are not agreeable then the contract would have to stand.
If you’re a tenant buyer why would you bother?
Well that’s a lot easier to answer:
- You have enough of an income to service a mortgage but without a deposit you don’t have a shit-show of getting finance from a bank.
- You might live and work in a high growth area where house prices are increasing faster than you can save for a reasonable deposit.
- You might be new to NZ, new to your job, self employed or have run into a few credit issues (and have learned your lesson!!!).
A few other things you might want to know:
- If you are a TB, ideally you will feel good about your job and be prepared to stay employed for the term of the contract.
- This is a private contract between you and the IL and you are not covered by the same rules governing a standard Residential Tenancy Agreement, because you are not a standard tenant. If you fail to pay your rent there will be a clause in the contract whereby the IL can ask you to leave and you will not get any of your initial deposit or rental credits returned. (See ‘Your Emergency is Not my Problem)
- Your KiwiSaver cannot form part of your initial deposit for the house because you aren’t taking ownership of it yet, but you can use it at settlement to purchase the property, subject to KiwiSaver rules of course. (In the meantime might as well max out those contributions then, eh?)
- Depending on how much the property has increased in value there is nothing to say that you can’t take ownership of the property then sell it straight away to someone else and pocket the profits as your own.
- This is just my personal thought - being trusted as a tenant buyer is actually a privilege that you really need to own as your challenge. There are many ways an IL could invest their money and so banking it on you is not something to be sneezed at. Try your dandiest not to let Hedonic Adaption creep in or take on any consumer debt during the term.
- Now this is really important. It’s unlikely the deal will be for a designer home on the North Shore, or even a relatively new home.You see, the deal only works up to an initial house purchase price of $450k. If you go higher than that at the start then the weekly rent including rental credits starts pushing over $1000 per week, which is unachievable and not really sustainable for most people.
- It works best if the TB can go house hunting for themselves. Ideally you want them to fall in love with the house and really take personal responsibility for it. They should have a vision for what they are prepared to take on and what renovation work would be within their comfort zone. For instance moving a TB into an old draughty villa, with no building experience, is not going to be a win-win; however, a good solid brick house might be just perfect for their skills, enthusiasm and expertise.
- The house needs to be an “investment grade” house so that should the TB go AWOL the IL isn’t left with a lemon and can at least re-tenant the home easily. So the basics still must be upheld – near public transport, schools, shopping, and easy access to the city/amenities etc…etc…
How is this investment facilitated?
There is a contract in place between the IL and the TB. There are all matter of clauses in here and it is required that both parties seek legal counsel before signing BUT the clauses that matter the most (in my opinion) are as follows:
- TB fails to pay within X number of days of monies being due – the IL can ask the TB to leave and keep the initial deposit and rent credits. (So you don’t want to stuff it up)
- Cosmetic changes are fine, but big renovations need the IL permission first. (That means putting in a German sauna and an outdoor smoke-house might not exactly add value to the property. But you are welcome to do this after you have taken ownership if you really want to)
- The IL will take care of the rates and insurance for the TB until they take ownership, as this is their responsibility as property owner.
- Additionally the contract should state what happens if the TB or IL want to get out of the contract early, or what should happen if they can’t settle come time to transfer the ownership over.
Everything I write about usually comes back to the money machine and this week is no exception. A money machine is something that spits money at you, which you can use to fund your lifestyle without the need to work (unless you wanted to). Does R2B property investment qualify? Yes and No is the answer. Yes – during the term of the contract the rental credits are yours to do with what you want to. No - in that they will run out at the end of the term so it’s not sustainable.
Having said that, being able to invest using your equity in a property (not having to put forward any cash of your own earning) is a relatively “easy” investment and the return can add some value to your portfolio if it is managed well. But it is a reasonable commitment, and one that shouldn’t be taken lightly, by either an Investor Landlord or a Tenant Buyer.
Investors in a substantial Auckland property syndicate associated with disgraced company directors Murray Rex Alcock and Allister Ronald Knight, appear to have lost all of the money they put into it.
The 656 Syndicate owned a substantial office building at 17 Sultan St in Ellerslie (pictured) and was one of several syndicates set up by Alcock and Knight's SPI group (previously Secure Property Investments) which have struck severe financial difficulties.
Alcock and Knight have each been fined $25,312 this week for breaches of the Financial Reporting Act during their time as directors of SPI Capital, after earlier giving the Financial Markets Authority enforceable undertakings to resign as directors of several SPI entities including the 656 syndicate, and to refrain from acting as a director, chief executive or chief financial officer of any company issuing securities to the public, for a period of five years.
But that may provide little comfort to investors in the 656 Syndicate, who have probably lost all of the money they put into the scheme.
The syndicate was set up by SPI in 2004 to acquire the Sultan Ave building, with mum and dad investors tipping in a minimum of $100,000 each.
The property was a substantial office building which had been redeveloped by prominent Auckland developers Mansons TCLM.
It was well located, adjacent to the Central Park office campus owned by Goodman Property Trust and had ANZ, which operated a call centre from the premises, as its anchor tenant.
But like several of the SPI syndicates, things did not go well and by 2013 the investors were facing the prospect of a forced sale of the property as they struggled to refinance its mortgage.
By that stage the building had lost some minor tenants and about 25% of its space was vacant.
Cash flow problems had led to maintenance being deferred which made it difficult to attract new, good quality tenants.
At that point Mansons came back into the picture and offered the syndicate a lifeline in the form of a mortgage provided by their property finance arm, New Zealand Mortgages & Securities (NZMS).
This was supposed to be sufficient to repay the existing mortgage (to NZ Guardian Trust which was exiting the mortgage market) and provide some additional cash to catch up on maintenance, which would make it easier to find tenants for the vacant space and lift the rental income.
But that did not happen.
As the financial situation of several SPI syndicates worsened and the FMA began investigating aspects of the group's operations, management of the Sultan Ave property was transferred from SPI Capital to Taurus Group, a Christchurch-based accounting firm with syndicate management experience.
Taurus director David Kitson said the company put forward a number of proposals to 656 investors to upgrade the property, including one which would have seen part of it redeveloped as a hotel.
But that would have required additional capital and the investors were unwilling to provide it and instead, voted to sell the property.
Although several conditional offers were received, none resulted in a sale.
Towards the end of last year the syndicate appears to have been facing severe cash flow problems once again.
Interest.co.nz understands that it owed Auckland Council around $220,000 in rates arrears and Watercare Services another $30,000 and NZMS had not been receiving interest payments on its loan, which was coming to the end of its term.
At that point Mansons made the syndicate an offer which may have been difficult to decline.
They offered to buy the property for $9.6 million, compared to its current rating valuation of $13.5 million, and the offer was accepted.
Kitson said the $9.6 million "was around the same amount" as the combined value of the mortgage on the property, the rates arrears, the unpaid water bill and the "very high penalty interest charges."
Which suggests the syndicate's mums and dads can kiss goodbye to the $100,000 minimum that each of them originally put into the scheme.
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An issue of $150 million of perpetual capital notes from Kiwibank with a speculative, or "junk", credit rating have been priced at the bottom of their indicative margin range.
The notes, being issued via Kiwibank funding vehicle Kiwi Capital Funding Limited (KCFL), will pay investors interest of 7.25% per annum for five years, which is a margin of 3.65% over the five-year swap rate. The indicative margin range was 3.65% to 3.95%.
The notes stand to be reset at the same 3.65% margin over the five-year swap rate on May 27, 2020. The notes have a first call date of May 27, 2022.
Kiwibank says the bookbuild is completed with the full $150 million sought reserved for clients of participants in the bookbuild process who have received firm allocations. The offer's joint lead managers are Deutsche Craigs, Forsyth Barr and Macquarie.
Interest on the notes is scheduled to be paid quarterly but, Kiwibank warns, won't be paid if conditions are not met and may change in certain other circumstances. Furthermore, if an interest payment is not paid for any reason, it will never be paid.
The offer opens on Monday, May 4, and closes on Friday May 22.
"Investors will be paid early bird interest on the perpetual capital notes at 4.5% per annum from the time their application money is banked. Investors are therefore encouraged to lodge their applications as soon as possible to take advantage of this," Kiwibank says.
The notes have a BB- credit rating from Standard & Poor’s, reflecting their ranking behind other obligations of KCFL, discretionary interest payments and loss absorption features. Kiwibank itself has an A+ rating. See credit ratings explained here.
The notes are perpetual, non-cumulative, unsecured, subordinated securities that aren't guaranteed by Kiwibank, the Government or anyone else. See more on this type of debt security here.
Proceeds of the offer will be used by KCFL to invest in regulatory capital instruments issued by Kiwibank, designed to help Kiwibank meet its regulatory capital requirements under the Reserve Bank’s Basel III capital adequacy requirements.
From Kiwibank's perspective there are clear benefits from the issuance of such notes. The two key ones are getting suitable regulatory capital classification from the Reserve Bank, and from an income tax perspective, obtaining deductibility for the coupons that are paid on them.
If Kiwibank encounters severe financial difficulty or doesn't have enough capital, the Kiwibank regulatory instruments may be converted into ordinary shares in Kiwibank or written off. If this happens, the returns on the notes may change or investors could lose their investment.
The Reserve Bank says it has completed the licensing of non-bank deposit takers (NBDTs), with licences issued to 31 entities.
NBDTs are finance companies, building societies and credit unions that borrow money from the public.
Under the Non-Bank Deposit Takers Act they were required to get licensed by today, May 1. Stricter oversight of such entities was put in place following the collapse of dozens of finance companies between 2006 and 2011. See full details in our Deep Freeze List here.
“Completion of licensing puts in place another measure to help maintain the stability of New Zealand’s financial system,” Toby Fiennes, the Reserve Bank's head of prudential supervision, said in a statement.
The Reserve Bank is tasked with monitoring NBDTs and intervening should an NBDT become distressed or fail.
“Licensing can’t prevent an NBDT from failing but it reduces the risk and aims to maintain minimum entry standards,” Fiennes said.
“Licensed NBDTs are required to meet prudential requirements that cover credit ratings, governance, risk management, capital, related party exposures, liquidity, and suitable directors and senior officers,” added Fiennes.
Licensed NBDTs include ANZ's UDC Finance and the Haier owned Fisher & Paykel Finance.
Here's the list of licensed NBDTs, and here are some questions and answers from the Reserve Bank on NBDTs.
By Elizabeth Kerr
Here’s the conundrum…You have money to invest in property, but the market rents are not enough to cover all the expenses, and your income is already stretched enough as it is, leaving nothing left over for topping up a rental property investment. So what do you do?
What if I said you could have capital gains AND positive cash flow in the one investment?
In this next two-part series I take a look under the hood of the modern, dressed-up version of the old rent-to-buy property investment method.
It’s not as straightforward as your typical property investment purchase but once you get your head around the nitty-gritty you will see it could be the equivalent of having your property cake and eating it too.
“Lights, Camera, and Action”….!
Enter Stage Left: Landlord Investor: This is the person who owns the house and has the intention of selling it to the tenant buyer. (Sometimes known as ‘Option Giver)
Introducing from stage right: Tenant buyer: This person lives in the house, pays rent and has the intention of buying the house from the landlord investor. (TB or ‘Option Taker’)
One upon a time, in a land just like this, Rent-to-Buy property investments (known as 'Wrap' investments) got a bad rap (no pun intended) because they were highly stacked in favor of the Landlord Investor and left the Tenant Buyer quite vulnerable to loosing a lot of money and being rendered homeless.
In a best-case property investment the process might go as follows:
- Investor buys house.
- Tenant moves in and pays enough rent to cover all of the expenses of the property and pay down the investor's mortgage.
- Over time the house increases in value.
- Landlord either lives off the passive income or sells the house for a capital gain.
The old style Wrap property investments went a bit like this:
- Investor buys house
- Tenant pays a deposit (not always) and weekly payments at a rate of the Investor Landlords choosing. For example if the Investor organizes bank finance at 6.00% then the payments might be 8% over the term of the loan – typically 25 – 30 years.
- The Tenant Buyer pays for all renovations and maintenance on the property.
- After 25 years the house would no longer be carrying a debt, via the investor with the bank, and would be transferred into the tenant’s name.
This is all good in theory but the biggest problem in this scenario is the time period. 25 years is a very long time. Who is to say the landlord doesn’t have a change of circumstance, a terrible gambling habit, or gets eaten by a shark? What happens when interest rate changes, or a natural disaster renders the house unlivable?
On the flip side, studies show that the average home buyer will stay in their home just 13 years before selling again. Who is to say they, the tenant buyer, won’t have a change of circumstances and need to find a new home? What if they lose their job? Beholden to 25 years is quite unrealistic. Lawyers especially hated these deals as more often than not an agreement that held so much promise at the beginning ended in tears and they were the ones left mopping it up.
But now some clever investors have used their experience and come together to offer a fandangled approach for rent-to-buy schemes that are evenly weighted between the Landlord Investor and the Tenant Buyer and, most importantly, last typically no more than five years.
SCENE 2: Lights dim. Spotlight on Katie sitting on a wet rock. Her shoulders are slumped.
KATIE: (sadly) “I’m never going to own a house… I can’t save quickly enough… Maybe I should just focus on marrying Prince Harry instead”?
This is how it works. Let’s take my favourite fictional friend Katie, who still has not been able to save enough for a 20% deposit, but has been keeping her expenses low, therefore has an excellent income, which would easily cover a monthly mortgage payment.
Katie is frustrated that she cannot get her foot into the property market because she doesn’t have a deposit. She is diligently saving but it appears the longer it takes for her to save, the further out of reach her purchase seems to get, due to the increase in asking prices for houses. She has $25,000 saved, but 20% of a $450,000 price is $90,000 so, clearly, she has a way to go.
She approaches a rent-to-buy company via a lucky lunchtime Google search.
Enter Stage Left: Rent to Buy Company: This company facilitates the transaction between the cash flow rich Tenant Buyers and the equity rich Landlord Investors. (Otherwise known as Rent 2 Buy, R2B or The Company)
RtoB Company notices Katie sitting on the rock and moves towards her.
RtoB Company: (comforting) “There is always another way to skin a cat me dear”.
KATIE: “Really? I don’t have to live with my parents forever? Tell me more….”
After very thorough reference testing and credit checks for Katie, she is taken through the R2B process and sent away to seek legal advice. After talking with her lawyer and thoroughly understanding what commitments are required of her and from the Investor Landlord, she is eager to get started.
SCENE 3: Sunday afternoon. Busy open home in a pleasant neighborhood. Katie enters house clutching a set of guidelines. (Supplied by the company to follow when choosing a home)
A few months pass and she eventually sets her heart on a three-bedroom, one-bathroom 1970s house, 30 minutes drive from her workplace. It needs a bit of work but she can see it has great potential.
It is on the market for $455,000.
She lets the company know she has found a house and they work hard with the real estate agent and the Landlord Investor to see if they can purchase it whilst satisfying all conditions needed for a rent-to-buy deal to be successful.
SCENE 4: Investor Landlord & Katie stand outside of 1970’s house. They are shaking hands jovially together.
The key to setting up a rent-to-buy deal for success is for the Landlord Investor to purchase the property at, or below the market value. The house is appraised at $455k in its current condition, and the RtoB Company secures it for the investor to purchase for $450k.
Remember that Katie had saved $25,000 so gives $20k to the Investor Landlord as her deposit and decides to keep $5000 behind for emergencies and some small renovations she wants to do to the house.
The Landlord Investor secures finance with a bank for $430k at 5.99%, interest only, locked in for five years.
After taking into account the costs of rates and insurance, the investor landlord is socked with a weekly cost of $576 per week for five years.
Katie pays to the Investor Landlord $835 per week. (Don’t spray your coffee on this… stick with me next week whilst I explain why that is cheaper than you might think).
Katie and the Investor Landlord agree that Katie will purchase the property from the landlord for $530,000 in five years time. There are factors that enable her to be able to do this:
- Market growth. If the value of her home increased by just 5% each year then in five years time it will be worth approximately $574k. However, she will be buying it below value at that time at an agreed price of just $530k. That is a $44k saving, or 7.2% below market value.
- Weekly rent credits. Katie pays $835 every week in rent and every week the investor landlord holds in reserve $200 of that which is then credited back towards the sale price of the house when it comes time for Katie to purchase in five years time.
- This money essentially becomes part of her deposit for the home along with the initial deposit she paid at the start of the deal. So, now her home purchase becomes a $574k house, which she is buying for just $530k - less her initial $20k deposit and less her rent credits of $52k.
- The amount that she has to hand over to the Investor Landlord at the end is just $458k on settlement.
- But wait there is more….. Kiwisaver first home deposit withdrawal. Over this time Katie has been paying her rent regularly AND paying the maximum into her Kiwisaver account. By the time she is ready to make her purchase she has an additional $22k, which means the loan she needs is just $436k for a house worth $574k. No bank in its right mind is going to say ‘no’ to giving Katie a mortgage for that deal.
Landlord Investor Numbers might look like this:
|Registered value for House||$455.000|
|Initial House Purchase||$450,000|
|Landlord Investor – Interest Only Mortgage at 5.99%||$430.000|
|Weekly Cost to landlord||$576|
|Weekly cost to Tenant Buyer||$835|
|Sale price to Katie||$530,000|
|Less Katie’s Deposit||-$20,000|
|Less amount held in credit towards TB purchase price||-52,000
($200 per week)
|Amount required to pay out Landlord Investor||$458.000|
|Amount required to pay off mortgage with the bank||$430,000|
|End Profit for Landlord Investor||$28,000|
|Total Profit for Landlord Investor over 5 years.||$95,315|
Tennant Buyer numbers might look like this:
|2020 House valuation||$575,000|
|2020 Purchase price||$530,000|
|Less Initial Deposit on House||- 20,000|
|Less Rent credits||-52,000|
|Less Kiwisaver contribution||-22,000|
SCENE 5: Katie carries boxes into her new house… she looks around with a satisfied smile and dusts her hands.
End of First Act.
As you can see there are a lot of numbers and a lot of variables to stitch a deal like this together. Tune in next week to learn more.
- Why would Katie want to enter into such an arrangement?
- Why would an investor want to do this?
- How this arrangement is facilitated – Contracts & Contacts.
- Tax – “yes you do have to pay it”!!!
- Can I do this with my current tenant?
- I’ve found a five-bedroom, four-bathrooms, and triple garage in Mission Bay – will that house work?
- And of course… how does this help my money machine?
If you have any questions or comments on Rent-to-Buy investing or on any column that I have written please email me at Elizabeth.Kerr@interest.co.nz.
Surging house prices in Auckland and Queenstown last month pushed home ownership even further beyond the reach of first home buyers in the two districts, according to the AMP360 Home Loan Affordability Report for March.
However the high houses prices in both places aren't just affecting first home buyers. They could also be preventing some existing home owners from moving up the property ladder, the report has found.
But housing remained affordable for first home buyers everywhere else in the country. And in Wellington, Otago and Hawkes Bay, affordability improved slightly in March compared with February.
The AMP360 Home Loan Affordability Report tracks the lower quartile selling prices of homes in each region of the country, along with the median after-tax income of typical first homes buyers (a working couple, both aged 25-29).
It then estimates what their mortgage repayments would be on a lower quartile priced property, with repayments totaling less than 40% of their net income considered affordable, and repayments of more than 40% of their net income considered unaffordable.
Last month a leap in Auckland's lower quartile house price to $587,200 from $554,600 in February, would have pushed the mortgage payments to $778.77 a week, or 50.6% of the couple's net income.
That would put a lower quartile-priced home in Auckland squarely into unaffordable territory for the first home buyers, especially once other home ownership expenses such as rates, insurance and maintenance are allowed for.
The report also shows that Auckland homes have only become unaffordable for first home buyers over the last two years.
The following table charts the changes to the key drivers of housing affordability in Auckland since March 2010.
|Weekly Income $||Deposit Saved $||LQ House Price $||Interest rate %||Weekly pymt $||Index %|
In March 2013, when the lower quartile house price was $455,600, mortgage payments would have been $583.34 a week, just within the affordable limit at 39.3% of net income at the time.
It also suggests a typical first home buying couple would struggle to save a 20% deposit to buy a lower quartile-priced home in Auckland.
Assuming they had been able to save 20% of their net income into an interest earning account, they would have saved $67,631 after four years, which is only 11.5% of the price of a lower quartile home in Auckland.
After Auckland, the most expensive region is Central Otago where the mortgage payments on a lower quartile priced home would take up 35.6% of a first home buying couple's after tax income. In Queenstown housing was almost as unaffordable as in Auckland, with the mortgage payments on a lower quartile priced home gobbling up 49.6% of a first home buying couple's net income.
That's followed by Canterbury 29%, Wellington 25.8%, Nelson/Marlborough 25.7%, Northland 22.5%, Waikato/Bay of Plenty 22%, Taranaki 21%, Otago 16.1%, Hawkes Bay 16%, Manawatu 14.3% and Southland 10%, all well under the 40% affordability limit.
Times tougher for upwardly mobiles too
The report also highlights the difficulties that might be faced by couples with young families, who may want to move up the housing ladder from their first home (at the lower quartile price) to a median-priced home, perhaps moving from an apartment or home unit to a house on its own section.
The model for the couple with a young family is based on the median income for a couple aged 30-34, with one child, where the male works full time and the female works part time, earning 50% of a full time wage.
It is assumed they would have a 20% deposit for a median-priced house, either because they have saved the money or accumulated sufficient equity in their first home.
Unfortunately the figures show that house prices in Auckland and Queenstown would be too high for them to be able to afford to step up into a median-priced home.
In both Auckland and Queenstown, the mortgage payments on a median priced home would eat up 62.1% of their take home pay, making such a move severely unaffordable.
However such a move should be affordable for a young family in all other parts of the country, where their mortgage payments would be under 40% of their net income.
Outside of Auckland and Queenstown, the mortgage payments on a median-priced home in Canterbury would take up 37.7% of the "young family" couple's net income, followed by Wellington 35.4%, Nelson/Marlborough 35%, Waikato/Bay of Plenty 31.3%, Northland 31%, Taranaki 31%, Hawkes Bay 27.2%, Otago 25.1%, Manawatu/Wanganui 21.8% and Southland 18%.
That means a young couple would be able to keep moving up the property ladder in most parts of the country, even if they have a reduced income during their early child rearing years.
But in Auckland and Queenstown, such couples are likely to face more difficult choices, which could include delaying having children until later in life, having children but remaining in their first home for longer, or making arrangements to enable both partners to continue working full time during their children's early years.
"It's particularly important that people looking for mortgage finance in high-priced areas like Auckland or Queenstown get appropriate professional advice about their mortgage options, because of the large amounts of money that may be involved," AMP360 national manager Paul Gardiner said."That is especially true for first home buyers, who may have to borrow large amounts of money relative to their incomes or the property's purchase price to get the home of their dreams."
By Gareth Vaughan
It's something most of us have seen. No sooner does someone dump the remains of a fish dinner in their rubbish bin than a cat or dog comes along smelling a treat on offer.
The pet probably knows it shouldn't but just can't resist going after the tasty morsel. The snack may, however, come with a sting in the tail in the form of getting a bone stuck in its throat if it's a cat, or a boot up the backside from its owner if it's a dog.
From a retail investor perspective some bank security issues remind me a little of this scenario. Offering interest rates above 6%, or even 7% in the current low interest rate environment, such investment opportunities from big, household name banks are an enticing proposition for yield hungry ma and pa investors.
But if something goes wrong naive retail investors could face a nasty surprise with their interest payment tap turned off or reduced to a trickle, or they could even see their debt securities converted into shares.
Thus I am glad to see the Financial Markets Authority (FMA) has issued a guide on bank capital notes.
From the banks' perspective there are clear benefits from the issuance of these capital notes, perpetual subordinated notes and hybrid securities. The two key ones are getting suitable regulatory capital classification from the Reserve Bank for either tier 1 or tier 2 capital under Basel III capital adequacy rules. And secondly, from an income tax perspective, obtaining deductibility for the coupons that are paid on them.
Thus the banks get strong regulatory capital recognition from the Reserve Bank under Basel III, and obtain deductibility for the interest.
British hard line
But back to the ma and pa investors. Does the FMA guide go far enough?
This type of bank security issue isn't unique to New Zealand. In Britain the Financial Conduct Authority (FCA) has taken a stronger line.
Last August the FCA put in place temporary rules restricting the retail distribution of what are known as contingent convertible securities, or CoCos, over there. These rules came into force on October 1 last year and are due to expire on October 1 this year. The FCA is now consulting on making the restrictions permanent.
"CoCos are risky, highly complex financial instruments. The FCA believes they are unlikely to be appropriate for ordinary retail investors, so has stepped in to restrict their retail distribution to investors who are sophisticated or high net worth. Distribution to professional and institutional investors remains unrestricted," the FCA said.
Closer to home the Australian Securities and Investments Commission (ASIC), has a page on its website warning investors about what are known as bank hybrid securities in Australia. It's headlined "big risk without a big return" and says "you take all the risk."
"Banks and insurers issue hybrids to raise money that can count as regulatory capital under the prudential standards that apply to banks and insurers," ASIC says.
"All new hybrids issued by banks and insurers are designed to be loss absorbing, which means you, not the bank, are at risk of suffering a loss. This protects the bank's depositors, at the expense of hybrid investors," adds ASIC.
In comparison the wording in the FMA guide is of similar strength to ASIC's.
Among other things the FMA points out common features of bank capital notes include; The bank may stop interest payments, or reduce the amount of interest they pay to investors, even if they’re still in business. The bank can convert the notes into shares in the bank, or its parent company, and the value of those shares at the time they are converted may be a lot less than the amount paid for the capital notes.
Additionally the notes may be cancelled so investors lose some or all of their investment, even if the bank is still in business. And, the FMA says, decisions on buy-backs are usually the bank’s call to make.
'Don't base investment decisions on advertised high interest rates'
In a press release announcing the issuing of its guide, the FMA’s director of primary markets and investor resources, Simone Robbers, says; “These types of products are not like a bank term deposit. We want to ensure consumers are not just basing their investment decisions on an advertised high interest rate and the fact that a household name is offering them."
She also says; "Bank capital notes are deliberately designed with features that give banks flexibility over payments. Although it can be difficult to predict when a bank might use these features, consumers should be aware that they can be used when it’s in the bank’s interests to do so."
"Consumers should also be aware that although bank capital notes are usually listed on the NZX, this doesn’t necessarily mean they will be able to sell their notes quickly, or at all," Robbers says.
Last year I asked the FMA whether they may do as the Brits were doing and block the distribution of these securities to New Zealand retail investors. At that time Robbers said; "It is not our intention to restrict retail investor access to these products as long as we are seeing responsible selling practices from providers and well informed investors."
An FMA spokesman confirmed yesterday this comment still stands.
The FMA points out that, aside from capital notes, its guide also relates to similar products such as perpetual subordinated notes and hybrid securities. Remember that the holders of these securities are near the back of the repayment queue if the proverbial hits the fan at the bank issuer.
ASB's 10-year subordinated, unsecured debt securities are paying investors annual interest of 6.65% for the first five years. And Kiwibank's 10-year unsecured subordinated capital notes, issued by sister company Kiwi Capital Funding Limited (KCFL), are paying 6.61% for the first five years.
In March this year ANZ NZ confirmed it was borrowing $500 million through an issue of mandatory convertible, non-cumulative, perpetual, subordinated, and unsecured notes that are scheduled to pay investors 7.20% per annum up until May 25, 2020.
And Kiwibank is seeking up to $150 million through an issue of perpetual capital notes, again via KCFL, that will pay punters an interest rate north of 7%. (Click here to see where the perpetual capital notes will rank in comparison to other Kiwibank securities).
Low credit ratings
A good measure of the risk these securities carry is their credit ratings. The new Kiwibank offer has a BB- speculative, or "junk," rating from Standard & Poor's (S&P). Last year's Kiwibank issue has a BB+ rating, also speculative or "junk." The ASB issue has a BBB+ S&P credit rating, and the ANZ one a BBB- rating, which is S&P's lowest investment grade rating.
In contrast ASB and ANZ themselves have AA- ratings from S&P, and Kiwibank an A+ rating. See credit ratings explained here.
The FMA notes high take up from retail investors for these securities and predicts more offers from the banks in the months ahead. This does indeed seem likely. ANZ NZ, ASB and BNZ have a combined NZ$3.05 billion worth of total outstanding Basel II securities that won't qualify as regulatory capital by 2018. Thus the banks will want to replace this with Basel III compliant capital, although it's unlikely all of it will be through the likes of capital notes issues.
RBNZ washes its hands of retail investors
As the banks' prudential regulator and overseer of their capital requirements, couldn't the Reserve Bank tweak the rules to make these debt securities that are marketed by the broking firms at retail investors, and bought by retail investors, less complex and more ma and pa friendly? Perhaps. But when I asked last year the Reserve Bank passed the buck to the FMA.
"As the Reserve Bank’s remit is to focus on promoting the maintenance of a sound and efficient financial system, its emphasis is on the financial strength of banks and the system at large. The FMA are responsible for promoting the confident and informed participation of market participants in financial markets," a Reserve Bank spokeswoman told interest.co.nz.
So what about the banks themselves? They could issue plain vanilla bonds instead, although these wouldn't carry such high interest rates and thus would hold less appeal for the yield chasing ma and pa. So what about an idea floated here at interest.co.nz by EY partner Brad Wheeler back in 2012?
Wheeler wrote that New Zealanders should be "demanding the opportunity" to buy shares directly in the Kiwi operations of our Australian owned banks without also having to invest in their parent banks.
"Given the Australian government’s reluctance to move on trans-Tasman tax reform, thus failing to allow New Zealand investors in Australian companies credit for tax paid in Australia, it’s not sufficient to tell these investors they should be satisfied with shareholdings in the Australian banking parents, as some commentators have done,' Wheeler wrote.
"Because New Zealanders can’t use Australian franking credits, it is not tax-efficient for them to invest in Australian-owned banks, even those which are dual-listed in Australia and New Zealand," he added.
"Put simply, it means Kiwi Mum and Dad investors have had to pay tax on the profits made by the bank in New Zealand when those profits have already had New Zealand tax of 28% paid on them. In tax-speak, that’s double taxation – one of the fundamental tenets our tax system seeks to prevent," wrote Wheeler.
A fair suck of the sav
Wheeler said he was revisiting this issue because of the introduction of Basel III.
"The answer may be as simple as raising the new capital required by the Basel III rules, or replacing existing non-compliant or inefficient capital by partially floating New Zealand banking shares," continued Wheeler.
He noted the Australian parents might have an assortment of issues with this, including regulatory, control, accounting and legal considerations. But, Wheeler suggested, the economics generated by the Basel III changes may make it "impossible to continue denying New Zealand investors their slice of the tax credit cake." And a slice of the chunky dividends produced by the Australian owned New Zealand banks.
"We probably don’t need the complex structures we’ve seen in the past. A getting-back-to-basics formula could be the answer to Australian and New Zealand banking capital requirements through an Australian sell-down in their New Zealand banking subsidiaries to meet their capital buffers, and a New Zealand capital-raising to fill the New Zealand regulatory capital coffers," Wheeler wrote.
That sounds suspiciously like common sense. And a fair suck of the sav.
However, for Kiwibank the partial sharemarket float option is politically unpalatable, even for the current government. Thus the suggestion by Michael Cullen, chairman of Kiwibank's parent NZ Post, makes sense. Cullen suggested the NZ Superannuation Fund could take a stake in Kiwibank.
Such a move might even enable further expansion by Kiwibank remembering it's not even active in the rural banking market yet. And for the Super Fund this might prove a better bet than lending money to a Portuguese bank.
*Concerned your KiwiSaver fund could be stocked up on CoCos? Have a read of this article by Victoria University's Martien Lubberink and send it to your fund manager.
This article was first published in our email for paying subscribers early last Friday morning. See here for more details and how to subscribe.
The median asking rent for homes advertised on Trade Me Property hit a record high in March.
The national median asking rent for rental properties advertised on the website was an all time high of $420 a week in March, up 7.7% compared to $390 a week in March last year.
However there were major regional differences with the biggest rent rise occurring in Christchurch which has now overtaken Auckland as the most expensive place to rent a home in the country.
The median asking rent for Christchurch homes was $495 a week in March, up 10% compared to March last year, even though the number of homes that were advertised for rent in March was up 50% on March last year.
That makes Christchurch even more expensive than Auckland, where the median asking rent hit a new record high of $480 a week in March, up 6.7% compared to March last year.
In Christchurch the median asking rent for a 3-4 bedroom house was $560 in March compared to $550 in Auckland.
Around the rest of the country, Northland was the only region to post a double digit increase (12.5%) in median asking rent for the year, followed by Taranaki on 8.8%, Bay of Plenty 7.9% and Otago 6.7%.
In Wellington the median asking rent was up 2.5% for the year, and in Waikato it was up 3.2%.
Two regions recorded declines in median asking rents for the year, Gisborne -6.7%, and Marlborough -10%.
To read Trade me Property's full report for March, click on the following link:
Instead, a new tax bill is set to introduce a couple of unwelcome twists to this notoriously complicated set of rules.
The FIF regime in its current iteration has been with us since 1 April 2007 and is therefore reasonably settled law.
However, the recently released Taxation (Annual Rates for 2015–16, Research and Development, and Remedial Matters) Bill includes an amendment which on closer inspection seems more of a policy shift than remedial.
The main part of the Bill contains some interesting proposals around research and development together with sensible changes to clarify the GST treatment of bodies corporate.
The rest of the Bill "proposes a suite of measures to ensure the tax system is well maintained and that the tax and social policy rules operate as intended".
This rather bland phrase includes topics such as Child Support, Working for Families, charities and tax administration.
In addition there are also some remedial revisions to the rules on foreign superannuation schemes.
Also included is a new provision effective from 1 April 2015, which I consider will unfairly impose a hefty tax charge on a large number of taxpayers.
The measure makes it mandatory to apply the "schedule method" to lump-sum withdrawals and transfers from a foreign superannuation interest where a taxpayer has less than $50,000 of FIF interests.
The problem I have with the proposal is that the schedule method takes no account of the actual performance of the superannuation scheme.
Instead the taxable amount is determined by how long a person has been resident in New Zealand.
This approach might have the advantage of simplicity but ignoring the actual investment performance of the superannuation scheme is unfair and likely to lead to over-taxation.
There is an alternative formula method available for defined contributions schemes, which, although complicated, does at least take into account the real investment returns.
The proposed legislation is likely to apply to those with sums scattered across several pension schemes who wish to take advantage of the new UK pension rules effective from 6th April.
Broadly speaking these new rules will make it easier to withdraw sums from UK pensions for those aged 55 and over. Many UK migrants and returning Kiwis have relatively small amounts of funds invested in pension schemes which have underperformed. Using the new rules to withdraw/transfer these funds seems a valid approach. However, the tax cost from applying the schedule method to any withdrawals and transfers could be costly and unfair.
I will be submitting on this point to the Finance and Expenditure Committee and I urge you to do so as well.
Submissions are due by 30th April and details about submissions can be found here.
But what really caught my eye was tucked away under the heading "CFC remedials".
This turned out to be legislation relating to the use of the "Fair Dividend Rate" (FDR) method for calculating FIF income which appears likely to increase the tax paid by managed funds.
Under the usual FDR method, FIF income is deemed to be 5% of the FIF’s opening value at the start of an income year. A variation, the "unit-valuing funds" method allows certain investment funds to make the FDR calculation on the value of the investment on each day of the year – that is, they must make 365 calculations rather than just one. This gives a more accurate result as it takes into account change in value throughout the year.
Investment funds using this methodology could make the choice between the ordinary FDR method or the unit-valuing funds approach after the end of an income year, thereby picking the method which produces the least income.
A perfectly reasonable approach you might think?
Not so according to Inland Revenue which proposes limiting the ability in future to switch between methodologies. This is on the basis, "This was not an intended feature of the rules as it was expected that taxpayers would choose one or the other method and use that consistently. The change proposed in this bill is intended to restore the original policy intention."
It’s common for new legislation to require remedial amendments usually to correct unexpected results from inadvertent drafting errors. Such amendments form part of every tax bill. Any problems are usually ironed out within one or two years of the initial legislation. However, the current FIF regime legislation was passed in December 2006.
A hidden policy shift
In my view a legislative change suggested more than eight years after the original legislation is a hidden policy shift not a remediation.
This seems particularly so given the likely effect of the change will be to increase the tax paid by managed funds.
As is often the way the "remedial" legislation tackles the symptom not the causes.
When the original FIF legislation was proposed many critics said the FDR rate of 5% was too high and would lead to over-taxation.
Taxpayers using all available options to minimise their taxable income is therefore a rational response to perceived over-taxation.
A better policy response would have been to consider whether the current fair dividend rate of 5% is too high.
It’s also worth remembering the words of then opposition MP Dr the Hon Lockwood Smith. In December 2006 he concluded his speech opposing the new FIF legislation as follows:
"... this legislation will distort investment. It will provide a serious disincentive to invest offshore in a diversified portfolio. This legislation will provide an even greater incentive for New Zealanders to bring back their money from overseas and invest in residential property here in New Zealand.
People get the capital gains tax free and the returns are far better, so why would they not?
This is bad legislation because of all those complexities and distortions."
The Government has changed since 2006 but the issues identified remain. (They are also especially ironic in the wake of recent comments from the Reserve Bank Deputy Governor Grant Spencer).
In that context instead of sliding through an effective tax increase through "remedial" legislation wouldn’t it have been better to address the issue of potential over taxation by reviewing the basis of the FDR calculation?
Incidentally, the original FIF legislation was changed after over 2,000 submissions were made. So if you want to make a difference make a submission to the Finance and Expenditure Select Committee on the Bill by 30th April.
By Elizabeth Kerr
Every time someone tells me about someone they know who has had a great job earning a small fortune each year two things happen.
Predictably I say the customary “good for them”… but in my head I wonder – “why the hell are they still working then…. on that wicket they should have been able to retire ages ago”.
I suspect the answer may be that they really like their job, the idea of early retirement hasn’t entered their brain, a combination of the two, or more likely they haven’t yet cottoned onto what is “enough” for them.
So with that conversation in mind, today I’m looking to help you identify what “enough” means to you and discuss the biggest obstacle on the way to getting there.
How much money is “enough” money?
I know that YOU understand deep down inside that money alone does not make you happy.
But how much money do you think you would need to keep yourself away from being ‘unhappy’? The short answer is that no one really knows, and the long answer could be any of the below:
- USD $75,000 (approx $97,000 NZD). A team at Princeton University have discovered after analysing 450,000 responses to a Gallup survey that any additional income over $75k per year doesn’t tend to have any additional impact on ones happiness. So with that in mind you could rule a line at $97,000NZD and be done with it knowing you would be happy with that as your retirement income.
- From another angle the NZ Living Wage is set at $18.80 per hour which has been identified as the amount necessary to “survive and participate in society”. So with that in mind one could argue anything above that is more than “enough”.
- The NZ super scheme affords you just $288 if you’re married and $374 net if you’re single (living alone) per week. Is that amount “enough”?
- Some experts say you need 75-85% of your final pay to maintain your current standard of living. That seems too much to me. When I stopped working there was less petrol, cheaper groceries (due to time for food preparation), no pantyhose, no parking charges, no expensive suits and more free time for free exercise, packed lunches, cheaper leisure and cheaper travel due mostly to the absence of structure. In summary everything seems cheaper not by 25% but by closer to 50% just by using some elbow grease and being smart with my time. So no, I don’t think that calculation is entirely correct, but may be the closest indicator so far, and is very much dependent on your standard of living.
If you’ve been living a life at $250,000 per year, coming down to just $97,000 is probably going to cause you some pain as you adjust your lifestyle to fit that income, let alone $18.80 per hour or just $288 per week.
Why can’t highly paid and respected finance professionals all just agree and tell us what we need? The answer is they just can’t. No one can predict how long you are going to live for and secondly, no one knows for certain what the return on your investments is going to be.
The answer is...
To know if you have enough to retire, you just have to
grow a pair and decide your number all by yourself. That’s it. That’s the holy grail of retirement planning right there. Just decide and then make your lifestyle fit. The especially great news is you can do that at any age – not just at 65.
To start with you could look at your list of non-negotiable expenses and work to get those covered by your money machine. Once you have done that you have a bit of freedom to decide how you go about affording life’s extras. There are only two options for this - either you a) work and spend what you earn, or b) keep investing into your money machine so it can produce a larger passive income.
Which option you take I think depends on how much you enjoy your job and what you would rather be doing (if anything) with your time.
Option A is great if you know that you won’t be giving up paid employment all together but instead are just making an employment shift, for example: taking a not-for-profit job, changing careers, maternity leave, re-training in another field or maybe just going part-time.
Option B is best if you are done with paid employment and don’t think you will ever want to make a buck with your time ever again. Think volunteering, taking an internship, perpetual study, travelling, parenthood or just dedicating yourself to the art of growing old with grace and humour.
The fly in your soup is…
The biggest problem you face while you’re deciding on your number is that the goal posts are continually moving due in most part to some very clever marketers trying to get you to part with your money in exchange for their products.
While you might be sitting here today thinking there is nothing that you really need anymore, they already know that and are in the throws of making sure they can convince you of otherwise. They play a long game so unless you are sharp they will eventually win you over.
One of the ways you can get on top of this is by smarting up to the concept of Hedonic Adaption.
“Hedonic what”? ...you say.
Hedonic adaption refers to the idea that everyone has a base level of happiness and will return to that base level given time, regardless of what has happened to them. I simply refer to it as ‘loose lust’ - you want it but it’s not going to change you in any fundamental way.
In the context of today’s column, Hedonic Adaption refers to the notion that nothing you buy will make you eternally happy because after a little time you will return right back to where you are at now. Advertisers work hard to convince us otherwise, to convince us that without their products our lives will be miserable.
Take the classic new car advertisements spamming our TVs at the moment emphasising how well rounded your life will become with that particular vehicle. One minute skiing, the next you’re carving it up in the city on your way home from closing a great business deal – hold on, swing by to pick up drop-dead-gorgeous girlfriend from groovy bar – wave to all your very fashionable friends - and drive up to the country via a picturesque windy road. Perfection isn’t it?
‘Oh no you really thought by buying that car your life would be like that….. ohhh hate to break it to you’. Hedonic Adaption means that after a few weeks of driving the car you’ve been lusting after, it will undoubtedly become “just a car” and feel just like your old one did. (Two hours in Auckland traffic at Easter weekend and you are well on your way back to your base level of happiness).
How does it relate to having “enough”?
People who build a money machine for themselves and retire early, understand how hedonic adaption plays a part in their lives and how to control it.
They are quite clear about what lifestyle design factors make them most happy and that half of the battle is in the brain before it ever is in reality.
They know that the dash of envy they may feel over their mate's new purchase does not inspire them to run out and buy one as well.
Those that don’t cotton on to it early will be forced to feel some discontentment and depression as they are forced to make sacrifices due to insufficient funds for their lifestyle.
The responsibility for deciding what “enough” is rests on your own two shoulders and is illustrated in the way in which you design your lifestyle.
Those that do achieve a money machine are usually very clear about the difference between having enough money to afford what one needs, and being happy & content.
They know their number and that’s what they zone in on every time that they make a purchase, an investment or a saving.
And just a thought...
I bet there are a lot of people who built their money machines in Auckland property and who are sitting on “enough” right now.
Is it your turn to make a life change yet, or has Hedonic Adaption fiddled with your number again?