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Have your say: if house prices fall, would you still buy an investment property in 2022?

Reportedly, all five of New Zealand’s major banks now expect house prices to fall in 2022. After the Reserve Bank of New Zealand first forecast a price decline in its August Monetary Policy Statement, economists at the five major banks gradually revised their forecasts, one after another, from mostly expecting prices to remain flat next year to mostly predicting modest falls.

Five major banks predict house prices will fall next year

Reportedly, all five of New Zealand’s major banks now expect house prices to fall in 2022. After the Reserve Bank of New Zealand first forecast a price decline in its August Monetary Policy Statement, economists at the five major banks gradually revised their forecasts, one after another, from mostly expecting prices to remain flat next year to mostly predicting modest falls. So far, BNZ’s economists appear to be forecasting the largest decline, with the annual rate of decline expected to peak at around 6% or 7% in 2023. The last domino to fall was ANZ’s economists, who have now changed their earlier forecast of broadly flat prices next year to a decline of 4%.

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Inflation intensifies as rental yields continue to fall

According to Trade Me’s latest Rental Price Index, Auckland’s median weekly rent exceeded NZ$600 for the first time in October 2021, up 5% compared with October last year. The North Shore was Auckland’s most expensive rental area, with a median weekly rent of NZ$650. Rodney, to the north, followed closely at NZ$640, while Papakura’s median rent also reached NZ$625 last month. Auckland City and West Auckland were the only two Auckland areas with median weekly rents below NZ$600, both at NZ$595. Meanwhile, New Zealand’s national median weekly rent also reached a record high of NZ$560 in October, up 8% year on year.

Does seeing rents rise lead you to assume that landlords’ rental yields will rise too? You may be mistaken. According to interest.co.nz’s latest indicative rental yield data, house prices continue to rise faster than rents, reducing residential properties’ potential income returns and their potential appeal to investors. Moreover, the published yields are only rough gross yields. After deducting expenses and the future tax costs arising from the government’s removal of interest deductibility, rental yields in some expensive major cities, such as Auckland, could fall to a level that fails to keep pace with general inflation.

So here is the question: with the outlook for next year’s house prices widely viewed as unfavourable and rental yields failing to outpace inflation, would you still invest in rental property in 2022? This raises another question: if Auckland property prices fall in 2022, which type of property investment do you think would be most resilient?

Some may ask: if both are high-risk investments, should we invest in shares or property next year? The New Zealand Herald recently published an article answering questions like these from investors:

Question: We have been fortunate enough to pay off all our mortgages and are debt-free. I am wondering whether we should borrow to buy an investment property to rent out, hoping to make capital gains. With shares, we can earn returns only on the money we invest, whereas with property we could earn capital gains on its full value. If the rent covers most of the mortgage interest and we keep repaying the loan at our current rate, we could pay off an NZ$800,000 house in around 15 years, by which time it could be worth even more! Although we enjoy being debt-free, would taking on debt again to invest be the right decision? On the other hand, I worry that the housing market is overinflated and could face major changes ahead... So should we invest in shares or property?

Answer: That depends entirely on how you manage investment risk and the choices you make. Assuming your money is invested mainly in shares, returns from rental property and shares are very similar over the long term. However, as you say, you would be borrowing to invest, making property investment riskier. Of course, if the investment succeeds, your gains would also be greater. As you note, house prices could fall, but so could share prices. Both markets have performed very well in recent years, so a decline would be no surprise. As house prices fall, you could find yourself in negative equity a few years from now, with your property worth less than the mortgage. One point to bear in mind, though, is that mortgages generally have repayment terms of 15 years or longer. Provided you do not sell cheaply during a property market crash a few years from now, it is simply impossible for house prices to remain low for more than 15 years. Instead, your eventual gains would be substantial.

Of course, we also need to consider the worst-case scenarios:

  • House prices, insurance and home maintenance costs could be higher than expected. For example, a new roof or other major repairs might be needed.
  • The rental market could change, making good tenants difficult to find, or leaving the property vacant with no tenants at all for a period.
  • An imbalance between supply and demand in the rental market could result in too many rental properties, pushing rents down.
  • Your tenants might be overly fond of parties, damage the house or persistently fail to pay rent.

Conclusion:

If you have a very long investment horizon, investing in rental property may produce better results. Whatever you decide, however, consider your financial circumstances and ability to repay the mortgage, and invest within your means.

Borrowing to invest

Question: My property is worth NZ$1,500,000, I have a mortgage of NZ$230,000, and I also have a share portfolio worth NZ$250,000. I pay interest on the mortgage and earn dividends from the shares. I cannot offset any interest expenses against my dividend income to reduce my income tax. Could I sell NZ$230,000 worth of shares, use the money to repay the loan, then apply to the bank for a loan of NZ$230,000, secured against my home, and buy the same value of shares again? As the loan would now be for investing in shares, could I claim the interest as an expense in my tax return?

Answer: Alliott NZ tax specialist Greg Millar says: “In theory, the plan to sell shares, repay the mortgage and then raise fresh funds to invest in the same shares is feasible.” The borrowing would be for investment and income generation. “However, the plan could be caught by tax avoidance provisions. IRD could ask what the purpose of the restructuring is. Under the plan outlined, there appears to be no reason other than obtaining a tax deduction for interest costs.” Miller adds that there would be financial risk. The share market could rise between selling the shares and buying them back. Then again, you might be lucky and the market could fall.

Another question is whether you could obtain a mortgage to buy shares. LoanMarket mortgage adviser Bruce Patten says: “Broadly speaking, from a lending perspective, this is feasible. There is no problem with borrowing to invest in shares.” However, he adds: “Investors need to be mindful of the recent changes to the CCCFA, the Credit Contracts and Consumer Finance Act, and whether they still meet the bank’s criteria to borrow this amount.” Overall, it is a clever idea that could work—but only “could”.

Disclaimer: the views above do not represent YIJU’s position. YIJU accepts no related liability.