Research: Making sense of property investments
David Beattie asks: are Kiwis irrational in sinking their savings into a single and undiversified asset class?
Sunday, November 7th 1999, 12:00AM
But, is this the same as saying Kiwis are irrational in sinking their savings into a single and undiversified asset class? Our research suggests not.
In previously published research, we looked at the relative performance of some of the key assets that are included in the household net worth measures. We showed that during 1998, households with an emphasis on housing had indeed significantly under performed other households which either had a more balanced mix of assets or an emphasis on managed funds.
However, we did at the time recognise the extreme limitations of drawing conclusions from only 12 months of data. In this feature, we have analysed performance over the past nine years, to see if New Zealand households have been right in traditionally holding high proportions of their savings in housing investments (other than owner-occupied dwellings).
The chart below shows the growth in wealth (after taxes, fees and expenses) for each of four "test" households over the 9 year period ended June 1999.
There are a number of interesting observations that can be made about the varying fortunes of our four household types:
- households with an emphasis on term deposits would have accumulated less wealth than the other three,
- the end wealth of households which emphasise assets other than term deposits is very similar,
- the wealth of households with an emphasis on managed fund assets has only moved ahead of other households over the last nine months, on the back of strong international equity market returns,
- households with a housing emphasis have experienced less volatility in wealth than those with a managed fund emphasis, but not, importantly, at the expense of significantly less wealth.
It is indeed this last point which, in our view, goes a long way towards explaining why New Zealand households do not appear to be in any great hurry to modify their long held love affair with housing. And, according to the results of the last nine years, nor should they be.
In addition, it could be reasonably argued that the above figures for housing growth do not fully capture the potential value that may have been added by the many housing investors who take a hands-on approach to the management of their beloved assets.
The above results seem to vindicate the often questioned rationality of New Zealand households in historically holding higher exposures to housing assets than their global household counterparts. Importantly, this is despite the fact that over most historical time periods, the asset classes upon which managed funds rely, have actually significantly outperformed housing assets in gross terms (i.e.: before tax). This often reported finding tends to be used as the justification for encouraging households to hold a better balance between housing assets and managed funds.
However, there are two very important dynamics at work with housing assets, which at least seem to compensate for the gross performance handicap. Firstly, capital gains on housing are tax-free. Secondly, by taking out mortgages on house purchases, housing investors are subjecting themselves to the powerful long term phenomenon of leverage - this is something which is not normally considered by households when investing in managed funds (leveraged equity products are now more readily available however) .
Combine all of the above with the fact that New Zealanders understand more about how property investments work and it seems clear that the rationality of New Zealand households has to date been intact.
If historical returns and structures persist, rational New Zealand households will not (and probably should not) significantly alter their savings behaviors. For those who believe that changing the mix would be beneficial to New Zealand's' longer term economic prospects, there are a number of challenges ahead.
Policy makers looking for change will need, amongst other things, to focus on the apparent unevenness of the capital gains tax playing field.
The onus also remain on the managed funds industry to prove to New Zealanders that their products have a clearer value added role to play in their wealth creation plans than our analysis suggests.
David Beattie is the chief investment officer at WestpacTrust Investments.
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