NZ Herald 27 March 2010

AYou’re not the only one who took exception to my comment last week, that too many landlords “have been too arrogant in the past about their burgeoning wealth for non-landlords to feel much sympathy for them.”

“Ouch Mary!,” wrote one reader. “Landlords too arrogant! That hurt! Can you name five?”

Yes, quite easily. I would just dig out letters from readers over the years. They usually label me as anti-property, even though I’m not.

My message has consistently been that you can sometimes do very well with property, but it can be riskier than investors realise. Some people haven’t wanted to hear that, though. Hence the, “we’re right and you’re wrong” letters — which, strangely enough, have died out in the last couple of years as mortgagee sales have mounted.

Beyond that, I suppose some anti-landlord sentiment arises from the fact that most people are tenants for at least part of their lives. It can be hard not to resent a person who has some control over the place you live in — and who can raise your rent and kick you out of home at any time, albeit after giving notice.

That resentment may not be logical. Tenants should perhaps be grateful their landlords have provided accommodation when they can’t afford to buy their own. But I suspect it’s part of the answer to your first question.

It might also partly answer your second question. While some people simply can’t afford rental property, others may find the idea of having power over other people’s lives unappealing.

I must say, though, that some of my best friends are landlords or landladies. Years ago, I was one myself. And most of the landlords who have written to me this week seem far from arrogant. So perhaps — when we consider all landlords as a group — I should eat my words. It’s a wholesome diet, as Winston Churchill once said.

AIt’s funny how things change. For years I’ve been writing that landlords don’t actually have any tax advantages, only to be told by some landlords and property promoters that that is silly — “Just look at our tax returns!”

The truth is that there is nothing in tax law that says, “We are going to give rental property a break here.” But what does happen is:

• Landlords claim depreciation on buildings as an expense, as you say, when usually the building value increases. Sure, that depreciation is clawed back when the property is sold, but there is no interest charged. The landlord effectively gets an interest-free loan — which can be worth big bucks over the years.

• Investors in rental property nearly always borrow to invest. And the mortgage interest they pay is tax deductible. That’s fair — it’s a genuine expense. But often these days the total deductions for interest plus insurance, rates, maintenance and depreciation are bigger than the rental income.

While that’s not the case for you, it is for many landlords. It means they can deduct their rental property loss against other income — which is nice, up to a point. If a salaried person deducts a $10,000 property loss, they get out of paying tax on $10,000 of salary. That reduces their tax by $3800 or less, depending on their tax bracket.

They’ve lost $10,000 and gained $3800. Nobody got rich that way. It all makes sense only if they make a capital gain on selling the property that’s big enough to more than outweigh all their losses over the years. Which leads us to our third bullet point:

• Under the law, landlords should pay tax on their capital gains on property if they bought it with the intention of selling at a profit. And I can’t see how landlords who bought knowing they would suffer losses for years could argue that wasn’t their intention. But — despite Inland Revenue’s saying it is enforcing this more — it seems many landlords don’t pay tax on their capital gains.

Where does all this leave you? You are not suffering losses so you are not deducting them. And it sounds as if your main intention on buying might have been to get rental income in retirement rather than to sell at a profit.

However, assuming the value of your buildings rises — as most do — you are getting the “interest-free loan” from depreciation. If the government takes that away, most landlords couldn’t really complain — although it will be interesting to see how those whose buildings do depreciate will be accommodated.

It would probably be fairer still, though, to more tightly enforce the tax on capital gains on rentals. The trouble is proving people’s intentions. I’ve said for years that New Zealand’s law is plain weird on this. But for all kinds of reasons, change seems unlikely soon.

AYours was the only response to my challenge to accountants, last week, to explain why they are talking clients out of joining KiwiSaver. At least we now have a reason — although it’s not a good one.

Before KiwiSaver, it was usually best for everyone except risk takers to put any spare money into paying off their mortgage before investing.

Repaying a 6 per cent mortgage faster than necessary improves your wealth as much as an investment earning returns of 6 per cent — after fees and taxes. To do better than that. you would have to go into a risky investment, whereas mortgage repayment is riskless.

However, with KiwiSaver the incentives make it easy to earn a return that beats mortgage repayment, even while investing in a low-risk fund.

In the first year in KiwiSaver, in particular, the returns are amazing, as follows:

• Employees put in 2 per cent of their pay, their boss matches that, the tax credit also matches it up to $1043, and the kick-start boosts it all by $1000.

  The contribution of an employee earning less than $50,000 is quadrupled. Wow! And even someone earning $100,000 will see their contribution more than tripled — $2000 from them, $2000 from the boss, a $1043 tax credit and a $1000 kick-start. And that’s not counting returns on the money.

• Everyone else — the self-employed and non-earners — gets the $1000 kick-start even if they put in nothing. But if they do contribute, every dollar is matched by the tax credit, up to $1043. Their money is almost tripled, or better.

How can mortgage repayment come anywhere near that, accountants?

After the first year, you no longer get the kick-start. So, if you wish, you can stop contributing and just leave the first year money to grow.

But it’s still worthwhile for just about anyone with a mortgage to stick with KiwiSaver. Employees should contribute 2 per cent of pay and non-employees $1043 as a non-employee — to get the full incentives. Any further savings above that should go into the mortgage.

I say “just about anyone”, because there is one group — younger non-employees — who might do better with mortgage repayment.

Let me explain. When we look at money that older people put into KiwiSaver — which stays there for not many years — the total return on that money is boosted greatly by the incentives.

However, a young person’s contributions — whilst equally boosted by the incentives — sit in the account for decades before retirement. And during that time the money grows “only” at the return earned on the KiwiSaver fund, which may well be lower than the return on repaying a mortgage. Many years of lower growth can cancel out the effect of the incentives.

The cut-off age depends on mortgage interest rates and KiwiSaver returns, but let’s say it’s around 30 or 35. Non-employees under that age might be wise to stop KiwiSaver contributions after the first year and concentrate on their mortgage until they reach 35. After that, though, KiwiSaver wins.

For employees, KiwiSaver beats mortgage repayment at all ages, because of the employer contributions.

There’s another reason some people might stop KiwiSaver contributions after a year — because they really dislike tying up their savings. Fair enough. But 2 per cent of pay is not huge, and you do miss out on thousands of dollars from others.