Joseph Darby says rising costs have widened the gap between what a tenant pays and what their house costs to provide with the owner paying the difference. Why does the shortfall exist, and what's the return landlords need to justify it?

By Joseph Darby*

Few New Zealand financial beliefs are as persistent as the idea that rent is dead money. As an investment claim, current numbers tell a different story: the tenant pays for only part of what the house costs to provide, and the owner pays the rest.

Take the median Auckland house, for example, which sold for $950,000 in August. Rent one and you pay about $650 a week on MBIE's bond data.

Now examine what the owner pays each year. Council rates, insurance and upkeep have all inflated rapidly in recent years. The pressure on them remains upward: local authority rates rose 8.8 percent nationwide in the year to June. Home insurance premiums have risen 40 percent in the last two years and grown at three times the rate of general inflation since 2011, according to Treasury analysis. For the purposes of illustration, rates are taken as $3,800, a little under Auckland Council's average residential bill of $4,378 because the median house sits below the average value. Allow another $2,700 for insurance and $4,750 for maintenance, 0.5 percent of the property's value. Together they come to about $215 a week.

The larger cost is capital. Readers of this site are aware interest rates are rising again and sit closer to long-run averages than to the record lows many had come to treat as normal. Owning $950,000 of property means either borrowing the money and paying interest, or tying up savings which could be earning a return elsewhere, or a mix of the two. Paying cash for the house removes the mortgage and leaves the cost of capital in place as forgone investment return. Either way the capital has a price, and current mortgage rates are the market's price for it. One-year fixed rates at most of the major banks sit just under five percent, so at five percent the $950,000 costs $910 a week, regardless of how it is supplied. Every figure from here is before tax, for ease of illustration.

A house at these figures therefore costs about $1,130 a week to provide. The tenant pays $650. The owner carries the remaining $480 while keeping the property and potential gains or losses. In economic terms the owner subsidises the tenant's housing by $480 a week. The position is negative carry: the property's income sits below its ownership and capital costs. For ease of example, we will stick with Auckland figures, but the pattern holds nationally. At the nationwide medians of $750,000 and $590 a week, the same calculation gives a subsidy of about $310.

Owners accept negative carry because they expect future price growth and rent increases to compensate for today's shortfall. Before examining that expectation, I should declare an interest: I rent the apartment I live in and still own several houses, including one in Auckland, and I am in the process of selling two.

Investment returns are routinely assessed above the risk-free rate, the return on the safest government bonds. Ten-year US Treasuries, the conventional global benchmark because they are deep, highly liquid and backed by the US government, currently yield about five percent in US dollars. For a New Zealand investor the currency adds risk, though over the past two decades it has added return as the New Zealand dollar weakened. Given the risks facing a single New Zealand house, and its illiquidity, a rational investor would want the expected return from housing to sit well above a liquid government bond. The Auckland house produces a net rental yield of about 2.4 percent before interest and tax. The investment case therefore depends on capital growth, rental growth, the owner's ability to add value, or a combination of those factors.

Growth assets are best judged against other growth assets, so briefly compare the house with a global share portfolio. The government's new house price index for Auckland is built from council sales records. It shows Auckland house prices rose 1.6 percent a year over the 10 years to May 2026 and 4.7 percent a year over 20, before rental income. Over the same periods the MSCI World index, the most widely followed measure of global shares, returned 15.1 percent and 9.6 percent a year in New Zealand dollars, including dividends. Investor returns would be lower after fees and tax, though the gap with housing would remain wide. The 20-year window includes the global financial crisis and a pandemic, both of which weighed on shares, and the whole of Auckland's last property boom. Property versus shares is a larger argument than this paragraph can settle, though it is worth adding that KiwiSaver, diversified funds and low-cost platforms have made investing outside residential property familiar and easy for New Zealanders.

Past returns come with no promise, so a buyer today must decide what return to require from here: the hurdle rate. Over 125 years, shares have returned about 3.5 percentage points a year more than government bonds, and investment-grade corporate bonds about one point more. A single house carries risks government bonds do not: one asset, one location, one set of rules, tenants, weather, months to sell and, usually, debt. With government bonds yielding five percent, a reasonable investor might require nine percent before tax to justify those additional risks.

Nine percent is a total return on the owner's equity, so the property-value growth needed depends on how the purchase is financed. The net rental yield is 2.4 percent before tax, so a mortgage-free owner needs 6.6 percent a year in value growth to reach the hurdle.

At a 50 percent loan-to-value ratio, rent falls about $1,200 a year short of interest and running costs. Because the return is measured against $475,000 of equity, covering that shortfall and earning nine percent requires value growth of about 4.6 percent a year. Growth of 4.6 percent is roughly Auckland's 20-year historical rate and nearly three times its rate over the past decade. The leveraged owner reaches the hurdle only if Auckland houses grow as they did over the past 20 years. The same nine percent flatters them, since debt raises both the risk on their equity and the losses if growth disappoints. At a four percent bond yield the hurdle would be eight, and the growth required would still be more than double what Auckland delivered over the past decade.

The calculation assumes passive ownership of a representative property. Skilled investors can do better by renovating, subdividing or developing.

Closing the $480 gap would take median rent near $1,130 a week, 74 percent above today's. Alternatively it would take a cost of capital near the all-time lows of about 2.5 percent, or a purchase price near $450,000 with running costs unchanged, or some combination of the three. Further rises in borrowing costs widen it unless higher rents or lower prices offset them.

Whether the $480 subsidy persists depends mainly on borrowing costs and on property supply and demand. The Reserve Bank has raised the Official Cash Rate twice since July and signalled it may need to increase it further this year, putting upward pressure on mortgage interest rates. Net migration has fallen from more than 100,000 a year in 2023 to 20,300 in the year to July on Statistics NZ's provisional estimate, removing one source of exceptional demand growth. Both sides of politics have loosened planning rules over the past decade, which should increase supply. With the election weeks away, Labour is campaigning on a capital gains tax covering investment property, and Opportunity proposes a land tax.

A passive property at these figures needs substantial rental growth, growth in value or active improvement to justify a $480 weekly subsidy to the tenant and a nine percent hurdle. Short of that, the tenant takes the immediate benefit, the owner carries the risk, and the property deserves a hard look at what it is doing in the portfolio. For an Auckland tenant in this position, renting is currently the smart money, provided the household keeps the subsidy by investing the deposit they never paid and the weekly cashflow difference.

*Joseph Darby is a financial adviser and CEO of Become Wealth, a licensed provider of financial advice and Discretionary Investment Management Services (DIMS). Become Wealth advises on investments including direct property, share funds and bonds. This article is the author's opinion and does not necessarily reflect the views of Become Wealth. Nothing in this article is, or should be taken as, an offer, invitation or recommendation to buy, sell or retain a regulated financial product or residential property.