Long term property investing reduces volatility

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The headline may be a case of deliberately stating the obvious, after all, economists will always tell you that investments of any shape or form; whether shares or property perform well in the long term, their advice is be patient, stick with it.

No; my interest was not in a catchy headline. I wanted to examine the data behind the claim that longer term investing in property from a rental business perspective is less volatile, especially when compared to shorter term investing. To be clear I judge short term to be 3 to 5 years with long term being 10 years. 

The ability to undertake a detailed analysis of the investment returns of rental property has been greatly assisted by the Ministry of Business, Innovation and Employment who have released online the full data set of rents by Territorial Local Authority (TLA) by month going back to 1993. The data set identifies the mean rents and the lower quartile rents.

I have used this data set and mashed it together with the REINZ median house price data going back to 1992 and the Reserve Bank of New Zealand data on mortgage interest rates for the same period. This collection of data has allowed me to build a model that shows the real rate of return based on the median house purchased and rented with a notional 100% mortgage paying the monthly variable rate of interest on the mortgage. The rate of return is based on the selling price at the end of an investment period being the median price at that month, plus the monthly rental income, less the mortgage payments, less the original purchase price at the start of the investment period based on the median price at that month. Note that mortgage payments are only the interest component.

Before detailing the presentation of this data I thought a couple of preliminary charts might be of interest. The first is the indexed growth of property prices and rents over the period since 1993. 

House prices have far outstripped rents.png

Not surprising here. Property prices have soared ahead of rents. Given the often quoted economists view that property prices need to reflect fundamentals of the comparable cost of renting, the message clearly have not got through. The massive divergence of the indicies from 2003 onwards is so clearly seen in the chart. There was some adjustment as property prices eased back in 2008 but the recent resurgent property market now sees property prices at an index of 350% of where they were in 1993 with rents at 232%.

Looking at the financial performance of rental investment, a simple judgement of the investment is to see how much of the monthly mortgage repayments is covered by monthly rents. The chart below details this as a trend line by month from 1993 to date.  


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As can be seen the fact is that at only two occasions over the past 20 years has the the mean rent actually come close to covered the monthly mortgage. Towards the end of the 90's when property prices stagnated and interest rates fell as a function of the Asian Crisis and then again in 2002 jus before the massive surge in property prices again at a time of low interest rates. However in today's world when interest rates have never been lower for longer the rental income barely covers 80% of the mortgage repayments as property prices continue to grow. 

So having provided some contextual data for the mean rents, property prices and mortgage rates here are the charts which show the actual financial return in dollar terms for rental property invested over a 3 year / 5 year / 10 year period for each month right up to June 2013.


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Over the 3 year horizon the significant returns achieved by buying in the early 2000's are not even close to being achieved again at this time and clearly the worst outcome would have come from the net losses attained in the period of 2009 to 2011.

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The 5 year horizon resembles very much the 3 year investing picture, with slightly higher returns for those exiting in the perfect position of the peak of the market in 2007 - again recent returns based on a 5 year investment come nowhere close to those levels.

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The 10 year investment horizon demonstrates the value of long term investment which is always around $70,000 for the 10 year period. What is interesting is despite the recent low interest rates and rising prices the recent level of return is declining and is likely to continue to show lower returns on a 10 year horizon as the purchase period slips into that period that saw the greatest rise in property prices. So the guidance would be - hang on in their for the long term.

The short term investment of 3 or 5 years can achieve excellent returns but as ever you have to time the market perfectly and this is only ever really seen in hindsight. The current return on all 3 periods shows a level lower than the peak and the average.