|by Gordon Edginton|
|As we have been saying for some months, it is taking time for market sentiment and momentum to slow. The trend in turnover of homes is clearly downward but not at an alarming rate. Current predictions of a “soft landing” appear correct and there do not seem to be any serious economic risks present which would put this gradual easing in the cycle at jeopardy.|
|Sales activity for the first quarter of 2006 was down 16% from a year ago following declines in each of the first four months. There were 2450 sales in April compared with 3,200 sales in the same month 2005 and total first quarter sales were 10,470 compared to 12,400 sales in the first quarter of 2005. The April sales figure was the first larger drop in volume this year, down 23%.The May sales figures have shown a surprising jump in activity to 2,981 sales, back essentially to the average 3,000 per month enjoyed over the past three years. This has bucked the trend of the first four months slowing sales, showing a significant rebound. This sales data can be somewhat volatile and there are certainly conflicting signals being shown. The number of days to sell has now risen to 37 but the median price has also jumped up to an all time high of $400,000.|
The gradual easing in activity has not translated into any correction in house prices – yet! The median price for Auckland has now plateaued at around $390,000 although has hit $400,000 for May. It has been in a relatively tight band from $380,000 to $395,000 for some months now – since September 2005. Prices have plateaued in most areas and we expect them to remain flat and possibly soften over the next few months. South Auckland low cost areas are still performing well with increasing prices.
Number of days to sell has risen to 37 in May from a consistent 28-30 days in 2005 and 30-31 days in 2004, symptomatic of a slow down but still below the market norm of 40 days to sell. This may mean further weakness is on the way.
|Consumer Confidence Downward|
|Consumer confidence has continued its downward slide, mirroring (or leading) the activity in real estate. The index is still positive (i.e. optimists outweigh pessimists) but is at its lowest level in nearly six years, since September 2000.|
|The downward slide in the economy and spending will continue to translate towards an underlying tone of weaker consumer confidence over the coming months. This will undoubtedly impact on the housing market with further weakness as market sentiment has turned.Consumer confidence would have been much weaker were it not held up only by the public’s perception that now is a good time to buy a major household item ? influenced obviously by the lower New Zealand dollar, making imported goods more expensive to purchase and putting pressure on importers to raise their prices in the future. This perception will evaporate once the expected increase in prices occurs and consumers quickly lose the desire for these major items. A further slide in consumer confidence seems inevitable.|
A continued slowdown in domestic spending coupled with a softer housing market and weaker economy are forecast. Inflationary pressures are therefore likely to ease and may by 2007, result in a relaxing of the tighter monetary conditions and thus lower interest rates.
|Market Shifting to New Phase|
|It is clear the market is now shifting to the next phase of the property cycle. We have had strong capital gains for four years, since the current upward leg of the cycle started in 2002. This long period of growth has outlived all market commentator’s expectations ? ours included. We were picking a slowdown to start in mid 2005 but noted in our newsletter then our expectations had been pushed out by approximately 12 months due to the long and strong performance of the residential sector, it was taking some time for the easing to occur through changing sentiment.|
|Our expectation of a slowdown occurring in mid 2006 seems to have been proved right. The downturn was well overdue when looking at past cycles. Why it has lasted so long and performed so strongly this time around is due to a number of well documented reasons including strong population growth, relatively low and stable interest rates, a strongly performing economy and low unemployment.Also, the impact of demand from investors buying rental property to secure their retirement and savings has been significant. This has been influenced, in no small measure, by the “baby boom” generation of the 1950’s and 1960’s and Kiwi’s love affair with residential property as a form of investment. The baby boomers are either near retirement age or moving rapidly towards it and have created this large wedge of investment demand which has been poured into housing with obvious effects.|
Investor returns are now at very low levels, with no rental growth coupled with a flattening out in property prices and little prospect of any capital gain. This together with higher interest rates and changes to tax depreciation announced by IRD will dampen investment property as the preferred investment vehicle ? for the time being at least.
|Residential Depreciation Changes|
|Recent IRD announcements have finally given some clarity on the issue of claiming depreciation on residential housing.For a number of years investors with residential rental property have been claiming depreciation on residential buildings using the “building fitout” asset category. This has resulted in standard chattels (carpet, blinds, drapes, stove etc) and complete building fitout being separately itemised by the taxpayer to break up the residential property into smaller components in order to obtain higher depreciation rates.|
In particular, “building fitout” items such as internal walls/partitions, wiring, plumbing, doors, bathroom and kitchen cupboards have been split out and depreciated at higher rates than the main structure. This was the prime area of concern for the IRD and position of greatest uncertainty to rental investors and their advisors.
The IRD have now advised their approach in future is to not allow the practice of “breaking up” rental property into smaller components in order to obtain higher depreciation rates under the “building fitout (when in the books separately from building cost)” asset category. The better view from the IRD is to apply the depreciation to the combined asset (i.e. the entire structure). Some limited assets within the building fitout category are still allowed but not those that are permanently affixed to the structure.
Taxpayers who have been using the component approach will be required to add the value of the various “components” they have been depreciating individually into the rest of the building and also combine the depreciation claimed for those individual assets. The building depreciation rate (of 3%) is then used against that combined asset.
The good news from an investors/taxpayers point is that taxpayers will not be required to adjust previous income years. There will be no penalties imposed or reassessment for prior years on investors that have been claiming the higher rate of depreciation on “Building Fitout”.
For cases still under review by IRD or proceeding through the disputes process, IRD will consider allowing the taxpayer to take up their new approach to settle the matter. This now gives rental investors certainty on their depreciation and investment position and greater confidence.
The other welcome change announced earlier was the change to the depreciation rates. These are now being calculated on a “double declining” basis and all of the depreciation on chattels have increased. For example, various chattel assets depreciation rates (excluding the 20% loading on new items) are now as follows:
|he increase in these chattel depreciation levels partially helps to offset the reduced cashflow due to the new rules. Although the changes to depreciation asset acceptability will mean a reduced depreciation claim, this reduced depreciation simply means it will take longer to get the full depreciation allowance.To an investor with a long term view, it should make little difference other than an initial reduced cashflow benefit in the early years of ownership. The investor will be claiming depreciation either way ? but simply at a lower and somewhat slower rate.|
From a cashflow point of view it is still beneficial to maximise depreciation and apportion the chattel asset.
|This sector of the property market has continued to outperform. Average yields have fallen to an all time low of 8.0% for industrial and suburban commercial as investor demand remains strong. Despite rising interest rates and a slowing economy which has dented the residential market, the commercial market has as yet been unscathed.|
|The falling New Zealand dollar has in fact improved the attractiveness of commercial real estate to overseas investors and will help to stimulate demand for industrial space from manufacturers as their products become more competitively priced overseas, resulting in increased orders.The Auckland industrial market has seen rapidly escalating land values throughout all regions. The more desirable central Mt Wellington/Penrose area now has land values over $400 per square metre while other main industrial locations of East Tamaki and North Harbour are in excess of $350 per square metre.|
These high land values coupled with rapidly escalating building costs have pushed rental levels to in excess of $100 per square metre for warehouse space and approaching $200 per square metre for office in prime buildings.
Vacancy rates in nearly all classes of commercial property remain at very low levels with demand for space still strong, this will push rents higher and continued rental growth is expected.
Auckland Property Market July 2006
December 16, 2013