No guarantee high returns from property will continue

Weighing up the pros and cons of residental property investment.

Wednesday, December 1st 1999, 12:00AM

Pick a typical New Zealand household and chances are they live in their only investment asset: the family home. If they do have other investments, they quite possibly include an investment property across town.

While a mortgage free property is important to the peace of mind of many retired New Zealanders, retirement planning demands more consideration of a diversified investment portfolio.

A similar survey in the United States would find a much larger proportion of household savings invested in managed funds, particularly in equities. The statistics suggest that New Zealanders have about two-thirds of their wealth invested in residential property, compared with less than one-third of America’s wealth.

So, why is this? Do kiwis suffer from some peculiar cultural preference for owning land with a house on it? Or is it solely a result of the New Zealand taxation regime, which tends to favour residential investment?

The answer is probably a bit of both. There is certainly at least one important tax advantage to investing in rental property: investors don’t have to pay tax on capital gains on housing, whereas they often do with financial investments. In addition, it is also easy to leverage a property investment by offsetting rental income against mortgage interest expenses.

Taking these points into consideration, a housing investment can often perform just as well as other investment classes. A comparison between housing returns and managed funds returns, over the last decade, shows they have been very similar. Consequently, New Zealanders have not tended to suffer as a result of their poorly diversified investment portfolios.

As high as the returns to housing have been, there is no guarantee this will continue. This is because inflation rates are now lower and more stable, and the outlook for the housing market is much weaker than in the mid-1990s due to lower population growth and stronger supply of new houses/apartments.

However, even if housing returns remain high, historical performance shows us that it is a risky strategy to carry all your eggs in one basket. By diversifying investment into other asset classes and across other countries, New Zealanders should be able to achieve similar (if not higher) returns with a lower level of risk.

Finally, many investors may be unaware that while residential property investment provides tax free capital gains, tax-free capital gains are also available through investing in passive equity funds. For example, investors in AMP’s world index New Zealand (WINZ) fund have their money invested in 300 companies across 6 countries. A tax-ruling from the IRD ensures no tax is payable on the capital gains.

Overall then, it is certainly true that in the past New Zealanders have had quite a love affair with residential property. But times are changing. Because diversified tax-efficient products are new to the New Zealand market, many New Zealand households are probably still not aware of the alternatives. Looking to the future, and noting these products’ similar tax-status, and vastly superior diversification, it would be difficult not to recommend tax-efficient well-diversified investments over residential property.

Anne-Marie Brook is the economist at AMP Asset Management

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