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Back to the future Olly Newland's Column, November 2009 I was privileged to be invited again to be part of Empower Education's annual MARKET UPDATE for investors held earlier this month. I always enjoy these evenings as a good chance to catch up with friends and clients and also to get the valuable perspective of the other speakers. At this event I was joined by Westpac's chief economist Brendan O'Donavan and Mark Withers' switched on business partner and chartered accountant Stephen Tsang. We don't always agree about everything, indeed we often clash (respectfully) with our views. It's always very interesting to hear other perspectives, to trade stories, and compare strategies and what we see as market indicators. The organiser of the event, Peter Aranyi gives us all a free hand to discuss what we like, so that the audience can soak in all the views and opinions knowing that what they hear is the truth as each of us sees it. (You can read Peter's review of the evening here.) The global financial picture, NZ's own recession and its out-workings, and the idea of tax reform -- as you can imagine -- were all topics which loomed large in our discussions, as I'm sure they do in board rooms and kitchens throughout the country. Double-dip or single dip? -- Are we heading for another asset bubble? With governments all around the world pumping funny-money onto the system, things could get out of control in a sudden way. (Just as the credit crisis took everyone by surprise.) I have lived through inflation in the 1980s with 18% inflation per annum, 22% interest rates -- and 1,000% p.a. for overnight money. Those were not pleasant times, just as now is not a pleasant time for many people. I surveyed the audience and asked how many people had been affected by the current recession directly -- or knew someone close to them who had been affected. Almost every hand went up. In my view (not totally disagreed with by the other speakers) there is a strong chance that, instead of the steady recovery we are told to expect, we may have yet another major bubble building up. Personally, I think the chances are better than 1 in 4, so keep your eyes and ears open at all times. In particular watch out for: - Big surges in the stock market - Large rises in gold and precious metals - New record prices for art and antiques - Stories abut how hard it is to find reasonable rents - More 'how to get rich' schemes offered by loud spruikers promising untold wealth in 5 easy lessons or the like They are all signs that inflation is coming -- and let me tell you from experience, it can be big and ugly, and hungry. The only disturbing note with this last boom was its huge difference from the others I have lived through. That difference can be summed up in one word: INFLATION. The massive spike in property prices was accompanied with little wage or price (consumer) inflation to hold these prices up. The booms of the 1960s, '70s and '80s were all accompanied with massive inflation. As I have noted elsewhere, the cry back then was "Buy property as a hedge against inflation". But not this time. Today it seems to me that we only have two choices: Either property prices fall back or wages/incomes rise to catch up. It's now widely recognised (as I spelt out in The Day the Bubble Bursts) the boom just past was not driven by inflation. It was driven by an excess of loose money -- easy credit -- and those chickens are still coming home to roost. The trillions of dollars artificially pumped into economies around the world as stimulus' or bailout money in the aftermath of the sub-prime crisis is, in a word, fictitious. There is no such thing as a trillion dollars (let alone many trillions!) Such a figure is merely a lot of zeros on a computer screen. However, while the global 'market' pretends these zeros can buy things, they create demand. I believe within two years we could have too much money chasing too few goods. In other words, inflation. A tragedy with a silver lining I can foresee that in in the years to come from the average house price will be $2 million or more. You think that's impossible? I can look back 10, 20 or even 30 years and prove it. In the 1960s and '70s I was buying houses for $10,000 to $15,000 a time (and boy, do I wish had kept them all!) I believe that within a few years we will have such a shortage of property, mainly residential, that we will have the making of another boom, this time led by the shortage of stock. So those who have at least a 10 to 20 year horizon (or even more) to invest -- you could be in for a bonanza. Property is all all about timing. Get the right and you will make a killing. Get it wrong and it will be disaster -- just ask the likes of Bridgecorp, Hanover, BlueChip and the plethora of finance company debenture holders staring into space, wondering what they'll see for their money. Falling home ownership -- the consequences Home ownership is falling. There are more renters then ever who may never own a home. Yet somebody has to own the rental homes. Over time rents will rise and make renting profitable again. But it will take a long time, in my view: five years or more. That's the reality. The move by banks requiring higher deposits (down payments) will push more and more people into long term renting, in some cases, forever. This could well be the saving of the residential property investor in the long term. Not tomorrow or the next day, but perhaps in a year or two. Finance is harder -- for borrowers and lenders A big clutch of finance companies have collapsed. Most of the rest are in lock down or hibernation. Big flow-on effects will come from these events -- they will result in continual difficulties for some and bonuses for others. (Look at Hanover's broken promises.) Banks have tightened up lending on property and existing roll overs may be strained -- take precautions. Mortgages may not be rolled over => loans called up => problems for investors and most especially any surviving developers. The optimistic noise coming from some development companies rings a little hollow. We need finance companies -- they're vital for investors. But most have gone. As a consequence I see the rise of a new breed of finance companies filling the void because the demand is there. Any new ones willing to give it a go should be encouraged so long as they are run sensibly. Discretionary spending has fallen -- retailers are already complaining or grateful for any small encouraging signs/upticks in retail spending, car sales, home sales and prices ... but I am sure we are not out of the woods just yet. The worst may be over but a full blown recovery could be as far off as ever. Taxes on Property -- changes are a-coming Let's not mince around this. Here's some straight talking on the subject. I am no accountant but I have lived through the effects of taxes in one form or another that have been imposed on property and can say this without the slightest hesitation: All such taxes inevitably lead to increase in property prices in the long run. Let's take a look at the various types of suggested taxes from the ordinary punter's point of view: Capital Gains tax Widely practiced overseas it is not official policy in NZ (yet). Overseas the tax works to different formulae depending on the country. The general thrust in most cases is to exempt your own home (or allow substantial concessions) but to tax gains on investment real estate. Again, there are myriad exemptions and allowances in the fine print which soften the blow but -- as we have seen -- property booms occurred in all countries whether they had this tax or not. Sometimes CGT can be very unfair. A relative of mine in Australia inherited the home of her late mother and father who had owned it for 40 years. My relative left it empty most of the time or rented it out casually over the subsequent 11 years while she sorted out her own affairs. Then, to her horror, found that she had a $250,000 tax bill to pay on the sale! Somehow the family home of 40 years had morphed into a full time investment property, according to the Australian Tax Office. It also makes you wonder how this tax can be applied to properties that have been in the same ownership for 5, 10 or 20 years? Do you start counting the profit from the day it was purchased, or some other date? And how do you allow for renovations and upgrades during ownership that improve the value? Is inflation taken into account? And what happens if an owner needs all the money urgently to go to a rest home? Will capital losses be permitted? (Especially in times like these.) As we already have a rigorous income tax policy on property trading (and tough new 'Associated Persons' rules to boot) I am not convinced that a capital gains tax would work. The main worry is that such a tax will discourage people from selling (as has happened before) reducing turnover and driving up prices. Stamp Duty This is one of the earliest forms of tax. 200 years ago you literally put a stamp on a document to acknowledge that duty (viz. tax) had been paid. Up until quite recently, Stamp Duty was paid on commercial property transactions and commercial leases also attracted Stamp Duty. I can recall Stamp Duty being charged on ALL property deals and many other transactions as well. Stamp Duty is set at zero at present and this is one tax that could be brought back at a drop of a hat. Land tax 'Simplicity' is the catch-cry for this form of tax. What's being suggested is a 1% land tax on all land values paid annually. It would, in effect, become like another rates demand. This tax would be easy to control, would have steady return and would be almost impossible to avoid. Some economic analysis (emanating from Treasury, apparently) suggests that such a tax would immediately collapse house values by 17% to 20%. I find that difficult to believe. I doubt if the owner of a $500k property with $200K land value would throw away $100k for the sake of $2,000 pa -- irrespective of the 'Net Present Value' tables! This tax would probably not be applied to family homes or maybe would have a threshold limit before being applied. Most commercial owners would be able to pass the tax onto the tenants. Either way any such tax will be passed on and drive up rents and prices in the short- and medium-term. Death Duties Estate duties were another tax that was highly popular with the masses as it slowed down the accumulation of wealth being passed from one family generation to the next. In other countries it caused devastation to historical buildings and art collections by means of an effective means of covert Socialism. Many saw it as a "revenge tax" on the wealthy . But it's still there on the law books. When it comes to politicians who always pander to the working classes (i.e. the votes) one can never be sure whether or not the tall poppy syndrome will prevail once again. LAQCs This unique-to-NZ 'tax dodge' (for that IS how it has been used a lot of the time) is well past its use-by date. Originally the Loss Attributing Qualifying Company regime was designed for things like forestry partnerships where tax deductible losses were inevitable until the forest was harvested (in year 27 or whatever). But the explosion of LAQCs was driven by over zealous financial advisors. Losses on property transactions can be claimed by individual investors whether they have a LAQC or not. All this tax dodge has done is encourage people into crazy "tax-effective" deals -- with no idea what the actual deal is. Buying property for tax dodges was never a good idea. You should be buying to make profits, not losses, and be happy to pay tax as it means you are making profits. I expect some action on this front. Pressure is your worst enemy Many investors and property owners are feeling financial pressure. The trouble is, it can occupy too much of your brain. By relieving any pressure in your own circumstances, you can mull over deals and wear vendors down. Good deals are almost always done by people under no pressure. You get the best deal when you're not under pressure. Bargain hard -- again it's all about pressure. You can play with vendors or buyers if YOU are not under pressure. Sometimes a deal can take months. So add to my advice about "timing" the word "patience" as the other vital ingredient for successful property investing. Without patience you will never make it to the top. Summary If the subprime/derivatives/stock options/financial crisis shows us anything, in the end it is that owning bricks and mortar has a lot going for it. Property doesn't (usually) disappear overnight. It lasts a life-time and longer. It will produce income. You can touch and feel it whenever you want to, and you retain total control. Just ask the poor bond holders who invested in Hanover Finance for instance. Ask them if they were given a second chance now whether they would they have preferred to have invested their money into direct ownership of a property in their own name or still continue to trust their money to what's effectively someone else's gigantic slush fund. I think we know the answer. And now these same poor souls have been asked to swap their bonds for shares- 900 million of them!! If even 10% of the bond holders try to sell the shares they have swapped, the share price could well fall to being a penny dreadful -- and faster than greased lightening. Ouch! Olly Newland November 2009 www.ollynewland.co.nz © 2009 Olly Newland. All rights reserved. Get the benefit of Olly's experience: Visit Olly's website www.ollynewland.co.nz for details of his Personal Mentoring Programme and consulting services. FEEDBACK: Do you agree or disagree with Olly? Send your comments, criticisms, counter-arguments or any feedback to him by clicking here. Read more of Olly's columns here. Order Olly's book: The Rascal's Guide to Real Estate (updated second edition) or browse our website for a wide range of investment-related resources including Olly's best-selling books: Climbing the Property Ladder, The Day the Bubble Bursts and Lost Property and audio programmes -- essential information for investors.

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