As risky as houses

by Linda Sanders / 20 June, 2013
If you’re thinking of buying an investment property, consider the what-ifs.
Investing in property
Photo/Thinkstock


QUESTION:

The sharemarket seems volatile and risky. Shouldn’t we just invest in housing instead?

ANSWER:

This came from a budding investor toying with the idea of starting a share portfolio. A generation – or maybe two – of New Zealanders have grown up with the idea that shares are too risky. The 1987 crash and its aftermath affected New Zealand’s economy and investors more severely than most other countries’ and a huge number swore off investing in shares.

In addition, something about the Kiwi psyche seems uncomfortable with entrepreneurism. Many think small businesses are okay, but once you get a bit bigger, either it’s dodgy or the people running the show are greedy and out to rip off everyone – customers and investors alike. We have very low levels of share investment – although KiwiSaver is helping change that – and high levels of property ownership.

So in response to the first part of the question, yes, shares are volatile and do have a higher risk than, say, bank deposits – which is why people should invest in shares as part of a portfolio, to spread that risk. But housing investment is not without risk. And ironically, the longer interest rates stay low, the more likely we’ll face a boom-and-bust scenario.

The shortage of housing – especially in Canterbury and Auckland – is driving up prices. It’s being exacerbated by very low interest rates. That’s persuading people they can borrow more money. But what many will not be fully considering is what happens if interest rates go from less than 5% to 7%-plus, or more.

If you’re considering buying an investment property, you need to think about the what-ifs. Assuming you’re borrowing most of the money, and expecting the mortgage to be paid by the rent, you need to know how your finances will cope if the property is empty for more than a few weeks or if values fall. Although there’s a shortage of housing in some areas, this is not the case everywhere, and there’s no guarantee prices will stay buoyant.

The shortage may be temporary – judging by the 20% increase in construction activity in Canterbury in the last quarter and 11% for New Zealand as a whole. We’ve seen gluts here before, and the market is already overheated and overpriced in some places.

We’ve a way to go, but markets have a tendency to over-correct – a shortage can quickly turn into a surplus if interest rates or the economic outlook change. So housing is not without risk.

Our investor also wanted to know about the risks of buying low-priced shares.

I’m a director of a company with “penny dreadful” shares. The logic behind them as an investment opportunity is if you have a share worth 10c and it rises 5c, that’s a 50% increase, whereas if you have a share worth $1 and it rises 5c, that’s only a 5% rise. So companies with a low share price can be more volatile, and therefore potentially good trading, assuming a share is more likely to go from 10 to 15c than $1 to $1.50. With a low price, you can make money trading on 1c or 2c movements.

In our company’s case, a low share price is a deliberate policy, but other companies’ prices are low because their capital may have been mostly depleted, such as mining companies that spend on exploring for resources. Before you think about investing in a company whose share price is low, you need to look at its prospects and decide whether it has a future.

The last question our budding investor had was what happens if the company goes bankrupt?

Well, you lose much of – or even all – your money. Investing in shares involves risk capital. Shareholders are at the end of the queue, being repaid only after banks, wages, Inland Revenue and other creditors have taken their cut of the company’s finances.

Disclosure: Linda Sanders is a director of two NZX-listed companies.

Send questions to: money@listener.co.nz
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