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Does buying a business beat property?

Kiwis are wedded to investment property, but they’re missing out on the superior returns they could get by owning a business, says ABC Business Sales’ Chris Small.

8 March 2022

Kiwis love property investing, but are they missing out on better returns and wealth creation opportunities in the business sector?

I’d say they are. Perhaps the most straightforward way to understand the differences and why business investment or ownership has a massive advantage over property is to look at this simple table (below).

The numbers make it obvious.

The average house price in New Zealand is currently NZ$826,000, according to the latest statistics from REINZ as at July 2021.

Based on a 5 per cent yield rate for an investment residential property, that equates to a gross return before tax of NZ$41,300.

The average business price is currently NZ$733,460, and based on a market average multiplier of 3.5x (29 per cent yield) equates to a pre-tax cash return of NZ$212,703.

Clearly, there’s a big difference in the annual yields, with business ownership returns six times higher than residential property’s.

This analysis excludes capital gains for either asset class. The pre-tax profit for business ownership is based on the company being fully managed, with limited input from the investor.

Yes, maybe business ownership does have a higher risk profile than residential property, but at ABC Business Sales, we believe the risk premium for investing in a business is nowhere near six times higher than investing in residential property.

Based on this data, we expect business values to continue growing and for more investors to realise this asset class can be lucrative – and rewarding.

We need education

I think there’s a big need to educate the new generation of New Zealanders.

The old adage that buying your first property should be your first goal in life is outdated. We should be encouraging young people into businesses as their first investment.

Business ownership offers an income for life and gives you more career choices.

Too many Kiwis get caught in the trap of saving for their first home, using all their savings on the deposit and then spend the next 20 years of their life trying to repay the mortgage.

They often sacrifice travel, starting a family, career opportunities, and many other life experiences.

The current government and many economic commentators accept that having most Kiwis’ net worth tied to property is not good for our economy, nor is it good for the country’s growth prospects.

Property as an asset class doesn’t provide jobs, doesn’t improve our nation’s productivity, and it doesn’t help with our export dollars.

Property’s up against it

We’ve recently seen new tax rules put in place to slash the benefits of property investment.

With interest costs no longer tax deductible on investment properties, but business lending allowed as a tax-deductible expense, it gives you an inkling of where the government’s thinking is right now.

Currently around 72,000 residential houses are sold a year, versus business sales of between 1,000 and 1,500.

Clearly, there’s a big mismatch when we think of the contribution each asset class makes to our economy.

Recent surveys are starting to show a tide turning away from investment property.

Tony Alexander’s most recent survey of property investors said only a net 15 per cent are likely to invest in property going forward, versus a net 58 per cent who would look at investing in business assets in the future.

The price-to-income gap

For New Zealand to see a major move in investment patterns away from property and into business segments, we’ll need the support of the education sector. It could well take a generation before we see significant changes.

I really believe, in 20 years, if everyone under the age of 30 has a goal to own a business rather than a house as their first asset, it would hugely benefit New Zealand’s culture, community and economy.

The new generation really needs to start thinking about the price-to-income gap created as the housing market gets harder to enter. They need start looking for alternative ways to bridge this gap.

If housing prices aren’t going down, buyers will need to lift their income. The best way to do this is to buy a business.

It’ll give them a big lift in income, something that can be used later to help fund a home loan or a property investment.

Relying on your salary, hoping you’ll get a pay rise each year, and then waiting to save a deposit isn’t the fastest way to bridge the income gap.

New Zealand’s obsession with property investing stems from our culture and what our parents and family tell us.

I believe, for us to make a move away from this obsession, one of two things needs to happen:

A property crash scares a whole generation away from the property investment class, in the same way as the 1987 share market crash made a generation scared and sceptical of investing in the share market.

The government provides fiscal stimulus and subsidies to encourage investment dollars away from property and into the business sector.

We’ll need this to be supported by our educational sector, creating a new generation of young entrepreneurs.

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