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Why Invest?
Before looking at the hard principles of commercial property investment in New Zealand and Australia, we want to spend a minute looking at the philosophy of investment. However, proceed directly to principles of property investment if you wish.
An Investment Philosphy
As professional people you need to know your financial and investment objectives. Without a clear understanding of the goals you wish to achieve, effective planning is very difficult.
Effective planning allows you to minimise risk, and maximise returns. Failure to plan and to understand the financial benefits of planning can lead to investment in a minefield of unrelated and ad hoc projects, each of which individually may have some perceived merit, but which overall fail to achieve the results desired.
You do not need to become an expert overnight. But at least embarking on a plan that meets your objectives; talking to friends, experts and advisers; by at least starting to learn the rules and the mechanics of sound property investment; you will be well placed to achieve the results that you wish to achieve.
People Have Different Resources & Different Objectives
While each individual sets their own objectives, our clients tend usually to share common goals when determining an investment strategy.
Some may wish to retire at age 75 in Iceland on a retirement benefit, but most people look for the following;
a. to create an automatic inflation adjusted income from non-work related sources available after one's professional working life.
b. to achieve an automatic and sustainable real increase in equity, which can be used to provide lifestyle and consumption objectives.
Most investors also wish to exercise control over the irinvestment decisions, while developing expertise over the nature and quality of the investment portfolio.
People invest now so as to have the capacity to spend more later.
In this sense, investment is often defined as 'deferred consumption', and the results in real terms (ie. after inflation) must be readily apparent and realisable. Successful investment causes an increase in wealth.
Wealth Accumulation and Income Can be Achieved
Through Labour or Capital
An 'income' or 'return' usually arises from one of two sources - labour or capital - or from a combination of both.
In employment, income is achieved through the provision of labour. When the labour is no longer offered or required, the income stops. This is the usual result of retirement.
A new source of income is required.
When you invest capital however, for example cash or some other asset, you create a return which will continue for as long as the capital is invested, and where there is, or can be, little or no personal involvement required.
Looking at the investment of capital side of things, are turn from invested capital is achieved through a combination of two components:
a. Capital Gain
For example, where $10000 investment asset becomes worth $15000 in three years but where there is no income over the period. Ownership of bare land is a common example.
b. Income
Where the $10000 earns $100 per month over the three year term, but the asset is still worth $10000 at the end of year three. This is the usual bank and financial deposit situation.
Investments offer a variety of combinations of these components with varying degrees of risk.
The higher the risk, the higher the return required, because clearly investors requiring a particular level of return will choose the lowest risk to achieve it, and investors happy with a particular level of risk will take that investment offering the highest return for that chosen level of risk. Any other combination is sub-optimal.
Bank and Financial Deposits
Subject to a close analysis of the strength of the financial institution concerned, deposits with banks almost invariably offer a secure income from capital, but without capital gain.
Without limiting the value of gilt edged bank deposits where appropriate, with even small levels of inflation, the real value of the investment is declining and this must be taken into account when considering the interest earned.
For example, $10000 invested with the bank a year ago, after 3% inflation in real terms is worth $9700 today, $9409 next year, and down to $7374 in real terms after ten years.
This loss is of course partly offset by the interest rate except that the Bank controls the rate payable.
In New Zealand, for example, rates paid by banks reached around 17% in the late 1980's, compared with around 5-9% today. Deposit rates of return have been higher over the mid 1990's, but the level of interest vs the rate of inflation requires monitoring. The recent history to the New Zealand economy is shown in current news.
To New Zealand tax residents, the interest income is also subject to a withholding tax deducted at source by the institution of 24% of gross interest.
In most other countries, the interest payments are usually considered income for tax purposes and assessable at year end - taxablein any event, subject to the tax regime in each particular country.
In Hong Kong interest income is tax free. New Zealand interest income is also effectively tax free (subject only to a 2% withholding levy) to non-tax residents.
A final comment, and one that is of critical importance, is that a bank deposit represents 100% equity - that is, the investor puts every dollar into the deposit. There is no room for even moderate 'gearing' or borrowing to increase returns on capital.
Gold, Silver, Antiques and Non-Income Producing
Appreciating Assets
Over the very long term, rare assets are likely to appreciate, but they do not produce an income.
Risk expects an appropriate return. Investment in such assets, while producing the potential for gain long term, produce little certainty of good rates of growth when compounded annually.
For example, a gold antique or original painting purchased for $20,000 in 1981 may be saleable now for $40,000, but this would representa return of only 7.2% p.a., compounded per annum and with high risk. And the asset produces no useful income, so the investor must supply every dollar of the investment.
There is therefore no benefit from borrowing or gearing and there is also the inherent danger of the asset value not increasing even to the minimum extent shown in the example, if at all.
The asset's value is determined solely by the demand in the market at the required time of sale, and the owner has achieved no income benefit to compensate for slower or non-existent capital growth. Some experts can certainly benefit from ownership of such assets.
Predominantly, the successful ones are investors who require no income from the asset; who never have to sell; who have a wide spread of items in such categories so as to be able to 'portfolio manage' their investment; and who are expert in their field - the risk for the non-expertinvestor is high.
Sharemarket Investments
Investments in the sharemarket theoretically start to offer a more controlled balance between the production of income and the capital appreciation of investment capital.
The income arises from the receipt of dividends, and the capital gain arises (hopefully) from the increasing value of the sharesheld. But dividend income is, as a rule, minimal.
Public company directors prefer to re-invest profits back into the company rather than return them to shareholders.
And there are risks associated with this market, as many investors over the last few years have learned to their cost. In early 1994, for example, the NZSE40 stood at 2400; by early 1995 - around 2000- a loss of 20%.
Capital gain in share value is very dependent on market perception of the share's value. Certainly over the long term, a company with consistently increasing net assets and/or profits is likely to have an increasing share value.
However, almost overnight a share value can be quickly reduced through changes which relate to the market and not the intrinsic value of the share, such as changing interest rates or government policies, the performance of a competitor or similar industry type company, and other market influences.
There is also an absence of any real control of the investment by the investor.
The directors and employees of the company will make the business decisions. The investor has to live with them, good or bad.
So you can see, there are many ways that investment aspirations can be satisfied. But we believe to start, that only by clearly defining the financial goals that you wish to achieve, can you successfully optimise the results.
Secondly, that you need to study the principles of property investment, and become fully conversant with the actual way that property works.
Like all investment analysis, the fundamentals lie in cashflow/income and capital value analysis techniques - but there are several simple rules to learn and which, if followed, provide a failsafe way of avoiding property investment risk and maximising gain.
The more conversant you are with the basic rules and arithmetic of property investment, the more successful your strategy will be. Our property investment analysis package will help in this regard.
And don't forget to drop us an email with your questions and requests, or telephone us on 64-9-4861761, or fax us on 64-9-4896674. |
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