Newsletter March 2010
March 1, 2010
Economics
I attended a Wairarapa Chamber of Commerce presentation earlier this month, where Cameron Bagrie, the ANZ National Bank chief economist, spoke. He painted a fairly gloomy picture of the year ahead, and I think what he had to say is very pertinent for those invested in property, and maybe even shares. His underlying message was that asset prices need to come back to a value that recognises their ability to produce income. He spoke of the excesses that caused the global financial crisis (the easy access to credit), and how this has distorted asset prices. U.S banks were lending money on property under the premise that values could not and would not fall. At the height of the boom it seemed anyone could gain a loan to buy property – even those who could ill afford to make the repayments. The term “NINJA” loan was coined – no income, no job, and no ability to make repayments. Never mind, the loan is secured over property and we know that can’t go down in value!
He had some sobering statistics for New Zealand. Average household debt has increased from 60% of net income to 160% of net income between 1990 and 2008. New Zealand is now one of the most indebted nations in the world, up there with Hungary, Iceland, Greece and Portugal. It’s fine using debt to fund assets that grow in value, however price corrections coupled with job losses can send the deck of cards crashing down. Our younger generation are going to have to learn to live within their means, and recognise the relationships between job security, working hard, saving a proportion of their income, and their desired standard of living.
The next couple of years are predicted to be fairly lean in the investment world, as Governments around the globe unwind the stimulus packages that have been put in place, and companies and individuals unwind their high debt positions. Cameron Bagrie suggests property (housing, farmland) will come down to a value that reflects its earning ability, rather than its ability to grow in value. The message I received for share investors is that we shouldn’t be surprised to see markets subdued for quite some time as the stimulus packages put in place around the world are gradually withdrawn.
Taxation
The Victoria University Tax Working Group issued its report earlier this month, and it is clear there will be changes to our current tax system. The group suggests the current tax laws, while introduced with good intentions, have undermined the coherence and integrity of the tax system and created a system that is unfair and inequitable. What they are after is a system that “minimises impediments to people working, saving, investing and innovating; minimises distortions to investment allocation decisions; and maximises the integrity and fairness of the taxation system so that there is widespread trust in it, and that taxes paid reflect the ability to pay and not the opportunity to avoid.” If this is the aim of the Government we may see measures that are more pervasive than simply tinkering with changes to tax rates. The benefit system in New Zealand is full of loopholes that allow wealthy individuals to take advantage of Government benefits that were never intended to be available to such people. Don’t be surprised to see laws around trusts on the Government’s agenda before too long.
Whatever the Government does is probably going to have to be fairly neutral overall. They need as much tax revenue as they can get at present, so they can’t afford to offer tax cuts without picking up the lost revenue elsewhere. They also want to win the next election, so they can’t afford to irritate a large sector of society. The Tax Working Group made a number of suggestions around aligning personal, corporate and trustee tax rates, and around broadening the tax base. What might we see in the next Budget?
- We may see the trustee, top PIE and top personal tax rates aligned
- The corporate tax rate might be lowered in line with Australia
How is the shortfall funded if some of these tax rates are reduced? Recommendations include:
- Raising GST to 15%
- Imposing more tax on the property sector
- Removing the depreciation allowance on some buildings
- Capital gains tax
- Land tax
- Taxing residential property investment (other than the family home)
There are screeds of statistics touted in the media regarding who is shouldering the tax burden in New Zealand. A survey of one hundred of New Zealand’s wealthiest people showed only half of them pays the top tax rate. In contrast, Cameron Bagrie told me 46,000 New Zealanders pay the same amount of tax as 58% of the population (1.915 million people). The Government has an unenviable task trying to overhaul the tax system and stay in power. We all have our own opinion on what the best course of action is. I’m a firm believer in encouraging individuals to become wealthy, and I don’t think they should be penalised by paying proportionately higher rates of tax. I’m a fan of a flat tax rate that encourages individuals to work harder and better themselves, and I would personally be happy to be the highest tax-payer in the country. Because of our historically high top marginal tax rate (66% in the 1980’s) many wealthy individuals used trusts and companies (legitimately) as a means to avoid tax. I believe if the Government is going to further lower the top personal tax rate it will tighten the rules around trusts and the eligibility for welfare benefits.
I think the major changes we will see will be around property, as many leading economists have commented for years on how unproductive (for the country as a whole) some of New Zealand’s property investment is. Many residential property investors have their affairs structured as LAQCs (Loss Attributing Qualifying Companies). The LAQC allows them to offset losses from their property investment against other income they have. Between 2003 and 2007 (the height of the property boom) losses declared through LAQCs doubled to just under $2 billion per year. If the Government wants to extract a fair amount of tax from this sector of society it will need to implement some of the recommendations from the Tax Working Group.
If you are a direct property investor any changes the Government makes are going to affect you. Sharemarket investors will be affected also depending on the companies you hold. We saw all the listed property trusts lose value as soon as the Tax Working Group report was released and they have remained weak since. Our researchers produced some figures on the effect of removing the deductibility of depreciation on commercial buildings. By their reckoning the main property trusts would suffer decreases in dividends of between 6% and 10%. Hardest hit would be those with most of their assets in buildings (AMP Office, ING and Property for Industry). Goodman and Kiwi Income are less affected due to their higher weighting in land and chattels. Other companies that may be affected would include Auckland Airport, Ryman Healthcare and Sky City Entertainment. We will need to wait for the Budget in May to see which of the recommendations the Government implements.
Fonterra
As expected Fonterra issued their new bond via the institutions, so retail investors were not able to participate. The only way we can access it for clients now is through a secondary market purchase, which incurs brokerage of 1.00%. The new bond is a six-year bond paying 6.83%. This compares favourably with their March 2015 bond (7.75%) which is trading in the secondary market at around 6.70%.
Auckland City Council
Auckland City Council has issued an investment statement for an issue of $350 million in secured, fixed-rate, five-year bonds. The main features of the offer:
- Maturity date – 24th March 2015
- Indicative minimum interest rate between 6.20% and 6.60%
- Interest will be paid semi-annually
- Minimum investment of $5,000 – thereafter in multiples of $1,000
- Standard & Poors credit rating – AA-
- Closing date – March 19th
Council bonds such as this offer good diversification for those holding most of their fixed interest in bank deposits. The security is excellent (the council’s ability to levy its ratepayers) and the rate offered is similar to the five-year money currently offered by the major trading banks.
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