Unproductive assets
- Caglan Bagci, NZIJ Mortgages
Obviously I am a fan of property as an asset class. I help people grow their wealth through investment in property on a daily basis. Most of my personal wealth has also been created through property investment. So it pains me somewhat when property is referred to as an unproductive asset. Unfortunately it is true in the sense that aside from offering shelter or a space for a business to operate from, it does not create any other outputs or employment. Obviously there is the initial effort and resource used to create a structure of some sort but beyond that it just sits there.
Now a business by contrast, sometimes has growth potential that is way beyond its current form. Growth often creates further employment along with goods and services that can benefit many sectors of society. So a business or shares in a business are often referred to as productive assets.
I often hear very general statements being made by financial advisors that ‘shares will out perform property’. And certainly there are many pretty charts showing index figures available that reinforce this notion. Also there are a number of specific examples of individuals that invested at the start of a new venture becoming overnight millionaires e.g. Trade me.
This scale of outrageous return is not available with property. It is by contrast relatively predictable in performance with expectations usually being fairly closely met. My father puts it plainly ‘you don’t make much but you don’t lose much either.’
Most people will start with buying a house to live in. After a few years they will notice that they have some equity in their home and want to make use of this by investing in their first investment property. By using their existing home as additional security I can normally arrange 100% finance to purchase an investment property. A quality, positively geared property is ideal. They are unfortunately as rare as hens teeth so most people will use a negatively geared approach.
A typical example is of a three bedroom residential investment property in the Wellington area. Rental will vary greatly but most of the investors that I work with are looking for a reasonable yield. 6% is a typical yield that investors accept these days on a negatively geared approach. Obviously a higher yield can be found but quality tends to suffer and the 6% level tends to produce a property that one is not ashamed to own. Interest rates are low in the short term but we should calculate on higher rates than currently available as we expect that higher rates are on the horizon. Working with 8.5% as an average interest rate means that the investment will require a cash contribution of 2.5% of its value per annum.
If we take the value of the property as $400,000 then at 2.5% it requires $10,000 per annum from us. Over a ten year period we have contributed $100,000. We know that quality property roughly doubles in value over 10 years (I have every confidence of this continuing indefinitely) so we now have an $800,000 asset. $400,000 of equity has been created from $100,000 of contribution over a ten year time frame. I have deliberately avoided potential tax advantages in this example as they will vary between individuals.
The wealth created here is not just for the lucky ones and in fact this example is quite conservative. I have worked with many investors who have done much better than this. Although we are not looking at overnight multimillionaires we are looking at significant wealth creation for all investors.
Not bad for an unproductive asset!
I am happy to respond to any questions on this article. Please send your questions to mortgages@nzij.co.nz
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