Bob Jones: Property fund promoter should think again

Auckland house prices soared because of the imbalance between supply and demand induced by a surge in immigration. Photo / Dean Purcell

It's certainly a sign of the times when something called the Dunn Housing Fund is being flogged to the public to "invest" in Auckland houses. The promoter is a real estate agent specialising in apartment sales, and seeks $7.5 million to buy 10 Auckland houses, hold them for 11 years then cash up. He promises a scarcely thrilling 1.2 per cent initial dividend but with a totally guessed at annual value growth plus rising rents, a return over 11 years averaging 8.4 per cent a year. This is so glaringly a bad deal it should be renamed Dumb Funds Ltd.

First it's essentially speculation, assuming that as Auckland house prices have risen sharply in recent years, they will continue to do so over the next decade. That's highly unlikely. If the past few years' growth rate continues, then wages and salaries must rise dramatically to meet such ever-rising price levels. This seems unlikely.

Auckland house prices soared because of the imbalance between supply and demand induced by a surge in immigration, including from within New Zealand, and particularly Christchurch. But the empirical evidence and logic tell us that in a self-correcting market economy, that imbalance will not last and also, that the correction process will overshoot, resulting in an oversupply; ergo, price levels drop. That always happens and is characteristic of functioning market economies.

The second factor behind the Auckland housing boom is low interest rates, a huge spur for private investors. When inevitably they rise, investor demand will dwindle. This boom was compounded by irresponsible 100 per cent bank lending which the Reserve Bank has wisely put a stop to. The governor was criticised for preventing young people putting their foot on the property ladder with this action. That wasn't his motive, rather it was to stop banks' irresponsible lending, for they're too important to the economy to be allowed to get into trouble. And as for first home buyers, they can do as their parents and previous generations did and save for a deposit.

Mr Dunn intends commencing this speculative house purchasing in a red-hot market, a sure recipe for failure. Furthermore, he's competing with an army of operators knowledgeable in the field (the house market is very different from his apartment speciality) who are also buying on the same assumption of continuing price growth. The prices are now so high by all normal criteria, returns are at minuscule levels once the usual outgoings are deducted, plus presumably Mr Dunn is not undertaking this foolishness for love. At the end of 11 years any profit will be subject to tax, even without a capital gains tax, simply because the expressed intention is to sell. I'd be interested to know what advice Mr Dunn has received on this.

Another important reason Dunn Funds Ltd should be renamed Dumb Funds Ltd is the intention to have a gearing factor no greater than 10 per cent. That is unbelievably naive. Debt can make or break you, depending on its quantum and the nature of the investment. But given that this fund is aimed at a decade-long speculation, any value growth becomes significantly compounded by debt gearing, or, as Americans accurately call it, leverage.

This term derives from physics whereby an unmovable object can be shifted by using a lever. With investing, debt is that multiplying effect lever. Conversely, if the asset declines in value then it correspondingly compounds the losses which is why investing is not for amateurs. Even billionaire investors always lever their investments as gearing is absolutely fundamental to investment success and frankly, with 10 per cent leverage, then why bother?

Despite all the hype, where are the rich residential property investors? They don't exist. Some folk have done well in a small way from the recent years' boom, and often provided a useful service "doing up" run-down properties, but residential investment is essentially mum and dad stuff. People suspicious of the sharemarket and putting their money in others' hands feel comfortable doing something they understand and I certainly don't knock them; to the contrary I admire anyone who has a go at self-help, and that includes Mr Dunn. But with this scheme he should think again.

Recently I ran across the best known Auckland operator in this field. Tellingly, he told me he had now sold everything as he considers current price levels to be absurd.

Finally, this fund is too small to be listed thus the only exit is to find someone to sell to, which could prove very difficult. Mr Dunn is advertising his proposal as "unprecedented". He's absolutely right about that and potential investors should ask the obvious question, why? The answer ought be clear to the meanest intelligence.