Greg Ninness details how and why investors could turn to commercial property as their term deposits start to mature, pushing prices up and yields down

Greg Ninness details how and why investors could turn to commercial property as their term deposits start to mature, pushing prices up and yields down

By Greg Ninness

The commercial property sector is likely to be one of the main beneficiaries of the current low interest rate regime as investors cast about for assets capable of providing a reliable income stream.

According to Reserve Bank figures, New Zealanders had $172.6 billion sitting in bank term deposits at the end of August (slightly more than the market capitalisation of the NZX at $159.5 billion) and much of that money would have been invested by older New Zealanders who are reliant on it for a significant portion of their income.

For these people the decline in interest rates could have a severe impact on lifestyles.

For example, five years ago the average five year term deposit rate offered by the major banks was 5.5% but that has since dropped to 2.65%.

That means someone who invested $250,000 in a term deposit five years ago that is now maturing, is facing a 51.8% drop in the interest income it provides, from $13,750 a year to $6625 a year if they reinvest it.

Ouch.

So it will not be surprising if people start looking at alternatives, and commercial property will be to the fore for many because of the still relatively attractive returns it can provide and the ease with which money can be invested in the sector.

For example, there are a variety of property-based vehicles listed on the NZX, with most currently providing gross dividend yields in the 3.5% to 5.5% range.

And property syndicators are already falling over themselves to get new offerings to market, with cash returns that are generally at least as good or better than the yields provided by listed vehicles, although investors generally take a capital hit up front when investing in syndicates because of their high set up costs.

Then of course there's the option of investing directly in commercial property.

Although large commercial properties are mainly the preserve of wealthy or corporate investors, smaller commercial premises are often within reach of mum and dad investors, even in Auckland where smaller retail or industrial units can often be had for less than the average cost of a residential property in the city. And while their net rental yields can vary widely depending on the type of property and its location, they are generally above 4.5% and sometimes significantly so (details of commercial property sales including the prices and yields achieved can be viewed on our Commercial Property Sales page).

This groundswell in demand combined with lower financing costs, will percolate through the entire commercial property sector, with everyone from developers to property-based fund managers, commercial real estate agencies, valuers, property managers, accountants, lawyers and let's not forget the banks, benefiting from the more buoyant conditions as they all take a nibble from the deals they are involved in.

One result of the influx of capital into the sector is likely to be rising prices, however the same is not necessarily true for commercial rents.

While prices can be pushed higher by positive capital flows, rents are more likely to be driven by general economic conditions and these still face prevailing headwinds, mostly blowing in from offshore.

So its probably unlikely that the rise in prices will be matched by the rise in rents, with the result that yields, which are essentially the sector's income earning potential, will fall.

If that's the case, it may pay investors considering a commercial property option to make their move sooner rather than later.

However it also presents a conundrum for investors with existing commercial properties.

They will benefit from rising prices, which will push up their asset values at the same time as falling interest rates bring down their finance costs, putting them in a pretty sweet spot.

Some may decide it's a good time to sell but as with most things, timing could be everything and the trick for them will be to pick the peak of the market, something that's not easy to do. But if that's the biggest problem they face, it's a not bad place to be.

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investors with good memories might not get caught in the net with the school fish heading for property syndicates,waltus,st laurence and dominion come to mind.

Lastlegs, so where are you investing then?
In reaction to Martin Hawes article the other day, you called (seemingly with some urgency) for KiwiSavers to withdraw their funds while they still could due to the imminent crash.
When prompted then, you didn't provide any alternatives or suggestions.

Sounds like some-one who doesn't invest in shares or commercial property, prob leaves it in TD undiversified.

yes,you are dead right TDs all the way.and houses,pay cash,live in them,do them up and then sell them.

Doing them up? That sounds awfully productive and hard work for a lot of people on here.

you are not wrong,got this place in january and done a fair bit inside,had to get a plumber to finish renewing the plastic pipework under the house as it was failing and so was I.done the deck and concreting,cut some trees down but had to get the arborist to top the big ones as my tree climbing days are over.just a bit of electrical work left and we will put it back on the market.

Hi,again.my advice was prompted by the scenario painted by martin hawes,if he was reading the tealeaves correctly all investment funds would lose value so if being over 65 you could withdraw your funds from kiwisaver and put it in a safer investment that was capital guaranteed.if you have been enjoying a good return on your kiwisaver you will not want to do that.if the kiwisaver is all you got then you have to decide what your appetite for risk is and act accordingly,do nothing,switch or ditch.there are no safe investments I know paying more than term deposits with major banks.

Hi lastlegs
So you belong to the Retired Poppy School of term deposit investment. Strangely he has gone missing in action as term deposit rates head south.
Given this imminent and significant crash you are assuming, you don’t seem to be factoring in negative interest rates nor haircuts to term deposits in the event of this crash you see looming.
Unfortunately term deposits after tax are currently just about returning less than the (currently very low) inflation rate and in the short and longer terms are expected to fall further. So those in term deposits are already effectively losing on the value of their money.

LStlegs
You may seem to think I am getting at you, but one who posts alarmist unqualified comments that one should pull all their savings out of KiwiSaver clearly don’t even understand that shifting to a more conservative fund is probably a better option and one that would be recommended by most reputable financial advisors. Your advice the other day is not consistent with any reputable financial advisor and is simply alarmist scaremongering. While there is always risk of crashes, a significant crash could be some time off.

reputable financial advisors will always steer you into investments that earn him commission and trail fees,as the song says"you dont need to be a weatherman to know which way the wind is blowing"and read the small print disclaimer in your investment fund glossy reports.past performance is no indicator of future returns.

Negative interest rates.

Screws everything. Most of the calculations and equations used to manage, price and describe financial asset portfolios will fail with -ve %. (Provide no answer). - how does that help?

Why let central bankers put AC current through a DC system.
There are other ways, eg1. just give people cash, rather than QE into instoe investors hands...

Q: is it our (nz voters) job to pull Oz banks out of the bog?

Remember last crisis, eg2. the borrowers were bailed out, not the bank. Rural bank
People had their servicing held and principal amount was reduced.
That worked, why try something we have not seen work now?

The negative interest rates will only reach banks. It's just a method to bail out under capitalised or illiquid banks. It is a demonstration of extreme weakness in the financial system. If negative interest rates ever reach the population then households are illiquid. It's helicopter money.

Think you might find negative interest rates will reach the masses.

In the banksters, we are dealing with monsters in all sense of the word. They will try everything to keep their party going; at least until they have designed another system of wealth transfer for the masses.

Commercial property investment is not for the faint hearted. Sometimes it can take years to find tenants, and commercial rents are alot more volatile than residential rents. The reason for this is when premises do become vacant, the size and design may not necessarily be suitable for everyone.

As for investing now, I would suggest people pay down debt before anything, as we are due for a rainy day. In residential property, I believe Auckland is already experiencing rain, with a few mortgagee sales presenting themselves. Not sure if its that heavy yet however.

This rain will eventually transfer through to commercial property, and from where I'm sitting most purchasing now is being undertaken by new entrants or syndicates. This is a worrying sign, as history has shown they pay they highest prices.

Does anyone plot the number of mortgagee sales in NZ, I checked a week ago on Tradme and there were 34 and this week there are 36, two points are hardly a trend, but someone probably knows if these numbers are suddenly rising

Most arent reported for obvious reasons.

Do some research on properties that have sold high in the past 2=3 years, and you'll see what I mean

Here you go. Only to September 2018. CoreLogic Property Guru might give you access to that data if you feel like paying $230/month.

https://www.oneroof.co.nz/news/mortgagee-sales-at-lowest-level-in-more-t...

I think now is a time for caution. Yes, it’s difficult to find investments with good yield and asset prices seem high. Holding cash has a very low return and getting lower, and some shares have dividends higher than TDs, but it’s interesting that none other than Warren Buffett is holding a great deal of cash ($120B), being patient for the next big set of obvious opportunities with a sensible margin of safety. This is not a “new normal”, and it’s not a great time to dive in to buy either shares or investment property. Patience is needed.

Buffett is not the only one holding cash for the next big opportunity, Todd Corp are plating the same game https://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=122...

Yes, quite a few value investors are. Over the past few years, bargains have become fewer and fewer. A time to sell overpriced assets (only if desired), not to buy. Markets can stay irrational longer than expected, but there are a lot of near end-of-cycle signs around.

They're probably just giving up on developing in Auckland.

Dealing with Auckland Council on an on-going basis would be grounds for ending it all I reckon.

), being patient for the next big set of obvious opportunities with a sensible margin of safety.

"Next big opportunity" might be out of Buffet's orbit. Furthermore, markets could be trending down for the next 20-30 years like the Nikkei has.

Yep, sure, one of the top investors in the world for many decades won’t be able to navigate that.

"Commercial property investment is not for the faint hearted. Sometimes it can take years to find tenants, and commercial rents are alot more volatile than residential rents. The reason for this is when premises do become vacant, the size and design may not necessarily be suitable for everyone."

Above is akin to saying "dont get married just yet, cause divorce rates a too high right now". if you got the moolah or capable to raise it, go for it, never been a better time. dont listen to self proclaimed gurus. a lot of them came out after gfc in 2007 and scared people from investing, while the composed and wise carried on....

I didnt say dont buy into it, rather its not for the faint hearted.

Picking your a real estate agent or very average investment advisor, with a vested interest. Cashflow returns havent gone up, only that cost of funds has gone down causing a misallocation of capital. With the banksters game nearly up, there'll be better investments than property. Replaced by something that creates real value, rather than being jacked up by the banksters control of the money supply.

Marriage is hardly a great measure to use. Most fall apart, while some continue by documentation only. Ask the majority of your honest friends and they'll tell you.

And by the way, I'm a happily marriaged seasoned commercial property investor.

Yes indeed. I would add, most commercial properties have deferred maintenance issues when you buy them. New or old, they usually leak when it rains. Many commercial property managers are barely able to collect the rent each month, see previous point. Plus, when a tenancy has sat empty for a year a two it will need $$$ spent by the owner to bring the structure up to the standard of the present century in order to attract a tenant willing to put his or her $$$ into their fitout. This is great, but you do need the $$$ in yer back pocket. So years of trouble followed by years of bliss, followed by....

Commercial property is great if you own the right type of property that is easily rented.
We have one commercial property that returns us a 15% return on purchase price, not bad considering where interest rates are currently.
Recent tenant has signed up for very long term lease and we had a tenant prior to the last tenant moving out, that we had for over a decade.
Yes there are some commercial property that aren’t worth the risk but providing you are diligent, there are opportunities out there.

15 percent return on purchase price? What would be the yield based on the market price for that

Houseworks you are on the money. There are such things as inflation and loss of opportunity if you had sold the asset and bought a better performing one. I have a large parcel of shares bought for a dollar that return dividends of 35c per year plus imputation credits. I certainly don’t think they return 35 per cent per annum as the share price has risen. Plus I should have sold some of them and bought more A2 Milk and Xero shares than I currently hold.

"Then of course there's the option of investing directly in commercial property."
Yes it's an option, only if you have a good lawyer and property manager. Should the tenants struggle with their business they blame the landlord and they stop paying rent. It's not a great investment when it has no cashflow

Return on current market value would only be around 5% due to the high building costs now due to quakes, and it is quite large building
We don’t intend to ever sell and why would we, as it is a goldmine really, and haven’t needed to spend very much on it, but we did buy it very well at the time .
We don’t use a property manager for our residential or commercial as I firmly believe that we can manage every bit as good as any paid property manager.

Commercial property heading for a sweet spot as interest rates tumble and investors chase income returns

Your assertion is in need of qualification.

Thus, the decline of interest rates to zero corresponds with a monetary imbalance in favor of deflation, if at least an abundance of deflationary pressures. This is something that Milton Friedman also talked about, particularly in 1998 with regard to Japan. He called it the interest rate fallacy, meaning that low nominal interest rates signify "tight" money conditions, or what would be consistent with significant deflationary pressure. It is and remains a fallacy because economists like those at every central bank around the world have decided instead that low rates are only "stimulus."

To correct this view, Friedman pointed out the basic, non-trivial distinction between a liquidity effect and an income effect. Low rates can be stimulative in the short run (the liquidity effect), but over the long run their persistence means something far different. A yield curve is supposed to be upward sloping given the core time value of money and investing. That arises from opportunity cost, meaning the more plentiful the opportunities the greater the time value and the steeper the curve (the income effect). Yield and/or money curves (the eurodollar curve and even the history of the OIS curve) that collapse and remain that way unambiguously demonstrate that "stimulus" deserves only the quotation marks.

Note the repo liquidity dilemma the FRBNY is enveloped by without obvious remedial success, at modestly low interest rates, ours are decidedly lower. Only recently, the RBNZ 's overnight cash rate (OCR) was nearly matched by the New Zealand Government Stock 10 year note yield.

Indeed. Falling interest rates in the marketplace mean lack of opportunity. The central banks pretend to be in charge of something, but in fact are forced to follow the market. They can make things worse and frequently do, usually by not responding in a timely manner to what the market is telling them. Probably better than clueless politicians being directly in charge of interest rates, though.

Probably better than clueless politicians being directly in charge of interest rates, though.

Probably not. An independent central bank divorced from an empirical reality is not something citizens, with a productive 40 year working lifespan, can endure without severe remorse if sovereign monetary policy matters progress as they have for another decade or more.

Rewind here. Rates at all time lows means predictions for inflation and economic growth are very poor.

Sure you can argue using a discounted cf model commercial property will rise but this neglects the rising amount of vacant retail and commercial property and the government's inability to reduce business rates in times of stress.

For these reasons commercial property is far more price volatile than residential. It's not the place for mom and pop to be investing unless they are very high net worth and its prob less than 20% of their portfolio.

But also you need to be financially literate to do so. What's the point in buying a shop or an office if comparable property funds are trading at a discount to NAV and you have immediate liquidity ?

Your regular mom n pop shouldn't be in this space.

If unsure then start with something small and learn more through practical experience.

I must admit driving around parts of Christchurch, I have noticed quite a few for lease signs up in certain areas.
Residential is what most investors buy because they are cheaper to buy, but Commercial is easier due to the fact that tenants stay longer, pay all the outgoings and tend to care for the building better in general.

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