The Next Ten Years:
Shaky foundations
Olly Newland's Column, 17 May 2009
Against the backdrop of a deepening global recession no-one can say how long it will be before 'normality' returns to the market. We are told this is shaping up to be the deepest recession since the 1930s Great Depression. If that is the case, we are also told (and I agree with this) we should expect flow-on effects to the world economy -- possibly for a generation or more.
But let's leave the high-level prognostications to the economists. In our own backyard, property investors and home owners alike must ask the question: Will the property market as we know it survive, or must it too undergo a fundamental shift?
From where I sit, the next ten years will likely see a far tougher financial and credit environment. The reworking of the laissez-faire capitalist system which brought us to this point cannot be avoided. The refrain "let the free market decide" has lost its potency and appeal -- at least for now. The massive and unprecedented bailouts by world governments and the collapse (or forced mergers) of household names and companies both demand and drive eye watering changes.
As well as a re-ordering of credit rules, I predict there'll be a major shift in how we assess a potential property investment, particularly commercial property. Over the coming decade (and perhaps beyond) I foresee a permanent change in the investment environment and in different classes of property investment as we all respond to the emergence of the new, tougher financial order. Some types of real estate investment that were considered "hot" yesterday will become the disfavoured white elephants of tomorrow.
Taxes:
One of the most likely changes to the property investment scene will be the imposition of new taxes. Because of the recession the government is fast running out of income from general taxation and GST receipts. The pressure is on to find new ways of raising money to maintain services. There already exists the means to introduce some taxes at the stroke of a pen, by government regulation, without the need of new legislation. One of these is Stamp Duty, common overseas (notably Australia) as a means to impose taxes on big ticket items. Property is just such a big ticket item. Transfer taxes such as Stamp Duty (currently set at zero percent but not actually abolished) are effectively a capital gains or wealth tax.
In NZ, Stamp Duty was charged on all real estate transactions, including leases, for many years. Housing was exempted as part of tax reform but commercial property sales carried Stamp Duty as recently as 1999. I predict this form of tax will be high on the agenda for the politicians and their boffins trying to fill the Treasury vaults.
Investors should be alert to the distortions that may arise should Stamp Duty (or similar tax on property) be introduced. It will ultimately be passed on as upward pressure on rents and costs.
Some examples of property investments that could feel the long term effects of the recession and its aftermath are:
Petrol stations: For decades gas stations have been one of the most stable blue chip investments. Long-term leases, bullet proof tenants, guaranteed customers and often brilliant locations. Their weakness was always that they are a highly specialised and relatively high-tech development. Gas stations are costly to run with high maintenance and labour costs, and the profits on petrol sales are marginal at best.
The new economic order will likely force the giant petrol companies to divest themselves of their remaining company-owned outlets in favour of the more profitable business of bulk supply only. The gas station chains will be sold off to become privately owned, operating much like a family-run corner diary. For an investor, they will still provide an adequate return for the risk but like many other classes of property, they will lose their blue chip status. My advice for investors is to either ease themselves out of this type of investment or make allowances for the inevitable down grading in the quality of the tenant and standard of the premises.
Banks: Here is another class of blue chip investment which is due for a shake-up. The recession, coupled with lightning fast improvements in technology will increasingly make many traditional bank premises redundant -- especially those with lots of floor space. The evidence is here already. I have personally been involved in several instances of banks seeking to reduce their longer leases to shorter ones -- thus giving them the option to quit expensive rentals more easily in the future. 'Nothing personal, just business.' Most trading banks see internet banking as their future and the need for impressive premises is fading to be slowly replaced with simple outlets. One bank even calls their branches 'stores'.
For an investor, my advice regarding banks is the same as for gas stations: Ease out or only buy a bank premise that can be easily converted to alternative, usually retail, use.
Secure Homes/Gated Communities: I see the rise of security as paramount for by reason of the stresses arising from the recession. The most popular homes of the future are likely to revolve around spacious apartment living, gated streets and lock-up communities -- all driven by the rise in demand for security before convenience.
The notion of a free-standing home, open on all sides made of paper-thin materials, will fall more and more into disfavour. The days of the isolated lifestyle home or far-flung beach house are also numbered -- except of course for the wealthy, who can afford the luxury of high walls and even greater security to protect them.
Investors should always look ahead and try to anticipate. Timing is always the key to successful property investment.
Property Syndicates: The collapse of interest rates has had a profound effect on those who rely on income from interest on invested capital. As the pain of that savage cut in income is felt, investors will look for alternative income streams. The new rash of property syndicates promoting shares in commercial property is a completely predictable response. But beware: they are shark-infested waters.
There is nothing new about syndicates. They have been around for years. Sometimes ownership was though units, other times through shares or 'proportionate ownership' where scores of co-owners' names can be on the title. I have no doubt syndicates will become very popular in the years to come, as they promise high returns with minimum risk. But investors in syndicates should be careful. Many, many syndicates will fail to live up to expectations.
Investors must realise a few facts about syndicates: (a) selling your share of the syndicate is very difficult, (b) the managers will be earning hefty fees for running the syndicate (c) the promoters will likely be making a capital profit on the selling price into the syndicate (d) no matter who the tenants are, vacancies will occur and expenses arise -- which can greatly diminish the promised returns.
Despite their traps, a properly structured property syndicate built around a suitable building can provide a good and steady passive income for those who want to avoid the hassles of every day property management. Investors interested in syndicates must carefully weigh the pros and cons before rushing in. Get some impartial advice and don't rely on the promotional material offered to try to sell you the 'investment'.
The days when any property investment would automatically make money are over. We are in a new age where the old rules are changing and no-one is yet sure of the new rules. The coming ten years will bring challenges and opportunities indeed.
Olly Newland
17 May 2008
www.ollynewland.co.nz
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