Mary Holm: Rich by rental? Don't bank on it

Mary Holm

Q: I am concerned about the unfortunate investor in retirement or approaching retirement who chances to have his/her life savings invested in the markets at the time a slump occurs.

It seems to me this is a risk we all face, even yourself, for what if we have a recovery in the intermediate term, but the world enters another slump in or about 2020, when you want to start drawing on your own retirement funds?

I have a close friend who has been saving diligently over the past 40 years through a pension fund that has now reached maturity. In August 2007 the redemption value of the policy was $60,000, but in the ensuing 18 months almost 50 per cent has been wiped off the value of the savings. If cashed in today she will receive only $30,000, a harsh penalty for not getting her timing right.

There is risk associated with everything we do in life and this especially applies to our retirement savings, be they in shares, property, fixed-interest securities or cash. Over an adult lifetime the cash and fixed-interest securities tend to be eaten away by the ravages of inflation. And the value of shares, commercial and industrial property tend to demonstrate high volatility reflecting the economic conditions of the day.

What I like about residential property (freehold house and land) is that people need to be housed no matter what the state of the economy, and the volatility in the housing market tends to be less marked. Even in the current downturn the apparent loss in value in the housing market (I do not include flat and apartment complexes) has been considerably less than the corresponding losses in fixed-interest and sharemarkets.

I accept what you say in that gearing to buy property has its risk, but it also offers the opportunity to significantly increase one's personal wealth. People do this all the time when buying a home to live in, and extending this idea to buy another property or two over a period of time does not strike me as being high risk.

Cash flow is all-important, and an individual can control that risk by not overextending his/her resources.

A: There's no disputing that people need to be housed. But if you think that means rental property is automatically a good investment, let me offer you my home for a mere $100 million.

People also need to be fed and clothed, but that doesn't mean we should all rush out and buy shares in companies that provide food and clothing. Whether any investment is good or bad depends largely on what you pay for it. And in recent years New Zealand house prices have got a bit silly.

Business Herald columnist Brian Gaynor points out that the median New Zealand house price rose 113 per cent between June 1998 and November 2007, while inflation was just 24 per cent.

That difference between house prices and inflation can't be sustained. As a recent OECD report on New Zealand says, "... a deep and protracted recession, involving a housing market correction, is unlikely to be avoided".

I'm not saying house prices are certain to fall further. But I certainly don't share your apparent confidence that they won't.

Of course a price fall might not matter much to someone who owns a mortgage-free property. The tricky part is getting to that point.

Very few people can buy a property without a large loan. And usually for the next decade or so the mortgage remains substantial. That's fine if the tenants behave themselves and pay regularly; the house doesn't turn out to be a leaky home, and the owner has enough income to cover any shortfall between the rent and all the property expenses - mortgage, insurance, rates and maintenance. Oh - and if prices rise.

But things can turn ugly if the owner can't keep up the payments and is forced to sell when prices are down. More than a few people have recently found themselves selling their rentals for less than their mortgages, ending up with debt and nothing to show for it. That's a lot worse than seeing your savings halve.

You acknowledge the importance of cash flow, and say investors shouldn't overextend. But unless they have several hundred thousand dollars sitting around, they can't get into rental property without taking on a fair bit of risk.

Turning to your story of your friend and others approaching retirement, they shouldn't try to time markets. Nobody, not even the experts, gets that right often enough.

I've said so many times that I feel like a broken record: If you are within 10 years or so of spending your savings, move it out of shares, property and other risky assets into high-quality bonds and cash.

One more point: You say people buy houses to live in all the time, so extending this to rentals is not high risk. The very fact that they already have lots of their wealth in property makes further exposure to that market riskier.

Okay, now I'm going to have a flood of complaints that I'm anti-property. Time for another of my broken record sayings: Property can be a great investment. I - and many of my friends - have done well with it over the years. It's just that it's riskier than many people realise.

Q: Is there anywhere online where I can find out which finance companies, banks etc are covered by the government guarantee if they collapse? The companies are very slow to give reassurances.

A: Go to the Treasury's website, www.treasury.govt.nz. Information about the deposit guarantee scheme and who is covered by it features prominently on the home page.

Q: I have been told by my KiwiSaver provider that mortgage diversion is still held up in legislation. Is this true or are they just dragging their feet, as I am quite looking forward to setting it up to pay my mortgage off faster.

A: You wrote to me before the Budget announcement that killed off KiwiSaver mortgage diversion for everyone but the 600-odd who had already signed up for it. So it's quite likely you are unhappy about that news.

Don't be. It was a mercy killing. Mortgage diversion had become pretty useless. Rather than having it sitting around confusing everyone, it's better to have it off the books.

Under mortgage diversion, anyone who had been in KiwiSaver for at least a year could divert up to half their own KiwiSaver contributions - but not employer or government contributions - towards mortgage payments on their own home.

Mortgage diversion didn't affect employer contributions. And, if you left at least $1043 of your contributions in KiwiSaver each year after diversion, you got the full KiwiSaver member tax credit. If you ended up leaving less than $1043, the tax credit would match the amount you left.

To use mortgage diversion, your KiwiSaver provider and lender had to agree to it. And some feet were certainly dragging, as you have suggested. But that's all a bit academic now.

Was diversion a good idea? Never for the self-employed or non-employees. They can put as much or as little as they like into KiwiSaver and put the rest into their mortgage, without bothering with diversion.

For employees, it depends on your pay level, as follows:

* If you earn more than $104,300 and contribute 2 per cent to KiwiSaver, you would still leave more than $1043 in your KiwiSaver account after diverting half the money, so you would get the full tax credit.

For you, the question used to be whether repaying your mortgage with diverted money was a better "investment" than saving that money in KiwiSaver.

Generally, mortgage repayment would win. Repaying a 6 per cent mortgage is the equivalent of earning a 6 per cent return, after fees and taxes, in an investment. To do better than that in KiwiSaver is quite a tall order - although those in higher risk funds might achieve it.

* If you earn less than $104,300 and you diverted 1 per cent, you would be left with less than $1043 in KiwiSaver, so your tax credit would be smaller. The lower your income, the more impact that tax credit reduction has.

For example:

On $90,000, your tax credit would fall from $1043 to $900.

On $60,000, your tax credit would fall from $1043 to $600.

On any income less than $52,150, your tax credit would be halved.

For most people, especially those on lower incomes, the reduction in the tax credit made mortgage diversion not worthwhile.

This is especially true when you consider the hassle of setting up mortgage diversion. Even for someone earning $150,000, diverting 1 per cent of pay amounts to only $1500 a year. The difference in "return" on using that money to repay the mortgage versus leaving it in KiwiSaver might well be peanuts.

So why was mortgage diversion ever there in the first place? Well, it made more sense before the minimum employee contribution was dropped from 4 per cent to 2 per cent on April 1 this year.

At 4 per cent, everyone who earned more than $52,150 - as opposed to $104,300 - could benefit from mortgage diversion. What's more, the old higher mortgage interest rates made it more attractive.

But with the new 2 per cent minimum, those who would previously have contributed 4 per cent of their pay and then diverted 2 per cent to their mortgage could just switch to putting 2 per cent into KiwiSaver and 2 per cent into their mortgage - without bothering with mortgage diversion formalities.

That's the point, really. It no longer made sense for anyone much to bother with mortgage diversion. Nobody should mourn its passing.

While we're at it, let's clear up a misunderstanding in some media about the end to mortgage diversion.

At least one writer said a person who couldn't afford to put 2 per cent of pay into KiwiSaver could have used mortgage diversion to effectively contribute 1 per cent and put the other 1 per cent towards mortgage payments.

Sounds reasonable. The only trouble is that almost all mortgage lenders wouldn't let KiwiSavers divert money towards their regular required mortgage payments. It had to be extra mortgage payments off the principle.

That means diversion would not have offered relief to someone struggling to meet regular mortgage payments.

Sure, it would be good in the long run if they made extra payments. But in most cases it wouldn't be as good as putting that money into KiwiSaver where it would be matched by the tax credit.

Mary Holm is a seminar presenter, part-time university lecturer and bestselling author on personal finance. Her website is www.maryholm.com. Her advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to mary@maryholm.com or Money Column, Business Herald, PO Box 32, Auckland. Letters should not exceed 200 words. We won't publish your name.

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