In many ways, property is no different than any other business. Ultimately, it is a service business - you provide somebody with a place to live in exchange for a weekly fee.

Because of this, an investment in property should be treated in the same manner, and with the same valuation metrics, as one would apply to any other business they would consider investing in. And like most investments, it can be a good investment at one price and a poor one at another.

People often site the low-risk of property, and the fact that there is always some inherent value there. This is, to a large extent true, given that the ongoing costs (exc. interest) are usually pretty low and fixed, and that the rental market is a large one that will always exist, such that one can attract a buyer (renter) at some price. And given the low cost structure, almost always the rent will be high enough to cover operating costs. To this extent, it is true that there is always "value" there.

[It is also true, that with 100% ownership, you are not exposed to risks associated with others running the business in a manner to which you would not approve. This is a risk you run when you invest in stocks.]

However, doing a Leveraged Buyout of a house (which is effectively what you do when you buy a property partly financed by a mortgage) can change this.

Many people are negatively gearing today. They may be picking up a 5.0% gross yield after costs, but paying 8.0% to service the mortgage. This is a loss-making business, full-stop.

On a $300,000 property, with 20% down:

Rent after costs (but before tax) = $15,000
Interest = $240k x 8.0% = $19,200

Loss before tax = $4,200

Now, some will say "but you will get a capital gain". Perhaps, but this should only occur if the value of the underlying property also goes up, and this can only happen if the "rent after costs" increases. If it increases at 3.0%pa, then yes, you should get a capital gain of 3.0%.

Capitalise 450$pa @ 5% = $9,000 capital gain. One is ahead, just, by, $4,800. ROE = 8.0%

But this is a risky game to play. Rent may not increase by 3.0%. The drivers are:
-increased population
-inflation
-supply of housing stock
-concentration of population (can you build out or only up?)
-movement among suburbs to preferred/less preferred areas (driven by economic performance).

These factors must be assessed carefully. Buying in good areas in Auckland, one could expect annual rent increases of, say, 2% inflation + 2% comprised of population growth and economic growth driving people into more attractive areas.

[Less attractive areas might experience a mere 2.5%pa]

So that's 4%pa growth.

The prospective return offered by a a property is therefore equal to its gross yield (after costs) + 4%. So a property yielding 4%pa + 4%pa growth = 8.0% yield before tax. The tax relief on capital gains, and deferrals due to depreciation allowances etc is probably enough to offset maintenance requirements and actual depreciation etc, and add 1% pa to value; therefore, the total "comparable" return is about 9.0%.

That's probably about fair value. You can't make much money borrowing at 8.0% to invest it at 9.0% with considerable costs involved. But 9.0% gross is probably reasonably fair given (1) current interest rates, and (2) the levels of risk associated with property.

However, changes in interest rates will measurably impact the returns realised. Rises in interest rates will force yields on properties up, devaluing them, and vice versa.

For many New Zealanders, 9.0% is a pretty good return and a mortgage enforces some saving discipline on holders. I think that this is good. As such, the rent or buy decisions is fairly neutral, but geared towards "buy" for those with otherwise poor saving discipline.

However, owners should be wary of overgearing themselves. If interest rates rise, will they be able to take the pain? They will realise substantial losses if such rate increases are permanent. A "low-risk" property investment can become high-r