Alan Bollard: Kiwis like buying houses more than buying businesses
Talk by Dr Alan Bollard, Governor of the Reserve Bank of New Zealand, to PricewaterhouseCoopers
Annual Tax Conference, Auckland, 9 November 2006.
* * *
Introduction
This talk looks at a very Kiwi phenomenon: householder investors who prefer to put their savings into
houses rather than a broad range of financial investments, especially equities. Apart from having all
their eggs in one basket, this also has implications for the level of gearing taken on by the household
sector and the manner in which New Zealand's debt is funded. It has also meant that not much local
equity is available for New Zealand business. The gap has been filled by foreign equity, which brings
many development advantages for large businesses, but which is less conducive to supporting
startups and other small businesses. It has also left the economy more vulnerable.
The Reserve Bank has the dual roles of promoting stability in prices and promoting stability in the
financial system, to enhance economic performance. Both these concerns drive this talk.1 The bigger
picture around financial stability will be updated when we release our latest Financial Stability Report
on 15 November 2006.
Household balance sheets
In comparison with other comparable OECD countries, New Zealand households hold a very large
part of their assets in housing. The rates of owner-occupied housing are not particularly high in New
Zealand. Rather what marks us out are a number of features:
We hold relatively large holdings of second homes (and associated durables like cars and boats),
usually under-utilised, and delivering low returns. In addition, over the last few years we have spent
heavily on investor housing (houses and apartments), investments stimulated by expectations of
exciting capital gains rather than exciting rental yields.
This exposure to housing is being financed by increased mortgage debt from the banking system. The
average New Zealand household's debt has risen from around 100 percent of disposable income to
around 170 percent over the last five years. This imposes a heavier mortgage-servicing burden, which
has been justified by the big increases in house values. The typical household now commits about 13
percent of its disposable income to service debt. This makes these households much more vulnerable
than they used to be to adverse events, such as increases in unemployment and rising interest rates.
These debt servicing rates are significantly higher than in other OECD countries.
Despite this vulnerability, the increases in house values have stimulated a strong wealth effect.
Households feel richer (and provided house values hold up, they are richer), and have been spending
with confidence. Their confidence is such that they have been prepared to dissave at an
unprecedented rate.
The preoccupation with housing assets has been at the expense of other assets that one might
normally expect to find in balanced household portfolios, namely financial assets, such as equities.
This speech highlights the unusually small holdings of equities by New Zealanders and some of its
financial and economic implications.
Most of our housing stock is owner-occupied, and our behaviour here is not unusual by OECD
standards. In this talk I focus on those households with sufficient resources to consider investments
beyond their own occupied houses. Many New Zealand households are not sufficiently well off to
consider much in the way of equity investment. For those that are, a financial advisor would look at a
particular set of household circumstances and, depending on these, advise an appropriate balance of
holdings split between:
•
Land and buildings in both residential and commercial sectors.
•
Cash and financial debt instruments that might vary by duration and risk.
• Equity holdings, both direct and portfolio ownership, in private and public firms.
These holdings would differ largely depending on variations in income, wealth, household size,
composition, and age. The situation is further complicated by the ability to hold assets directly or via
managed funds; by quite different tax treatments; by decisions to invest in New Zealand or overseas;
by commitments in directly held family firms, farms and forests; and by decisions by the Government
to hold certain assets jointly on behalf of New Zealanders.
Sources of equity in New Zealand
It appears that holdings of equity by New Zealand households are particularly low by OECD
standards, with direct holdings of both domestic and foreign equities making up no more than about 4
percent of total assets. A frequent reason cited is the severity of the October 1987 stock market
collapse, an event that passed by 20 years ago. In the US, despite similar pressures in 1987, troughs
in the 1990s, the "dotcom bubble", and the "tech wreck", direct equity holdings are now around 17
percent of assets. New Zealanders' indirect holdings of equities via superannuation funds, unit trusts
and other long-term investment products managed professionally by large funds also appear to be low
by international comparison.
Data on our holdings of equity is not conclusive. As at December 2005, the household sector held
around $14 billion of domestic equities and around $6 billion of overseas equities. Indirect holdings of
domestic equities on behalf of households via superannuation schemes, managed funds and unit
trusts accounted for another $8 billion. The overseas equity holdings of such funds are likely to
account for perhaps another $15 billion given their overall exposure to international assets.
How much equity do individual households typically own? The picture built up by the Reserve Bank of
household balance sheets from various surveys confirms that equity holdings rise sharply with income,
implying that the distribution of holdings is highly skewed. Based on the 2001 Household Savings
Survey we estimate that the median value of direct equity holdings for those households that own
shares is around $6,000. However, the same survey showed that a very significant proportion of
households (around 70 percent) had no direct holdings of shares at all.
The listed public company investment opportunities available through the NZX are limited, given the
slow growth of large New Zealand corporates, and the advantages some have seen in listing offshore.
Some of the better-known names have delivered poorly to shareholders, or disappeared off the
exchange. Despite this, the index returns have not been poor over the medium-term, and over certain
periods have even out-performed housing investment in pre-tax terms.
New Zealanders invest about twice as much in equities directly compared with managed funds. This
may reflect our DIY investment culture, also a disdain for advisers, fund managers and their fees.
Many see equities as a shorter term, more speculative investment rather than a longer term hold. New
Zealanders in general do not have a high level of financial literacy about such investments and how to
manage them. Aversion to equity may also reflect some psychological traits, particularly the desire to
hold and control a physical asset over a financial one, or one where the investor can contain costs by
utilising their own skills in construction, house maintenance or tenant management.
Tax treatment will often prove a deciding factor in decisions about housing versus equities, direct
versus portfolio approaches, and onshore versus offshore investments. From this individual point of
view, housing-heavy investors may look to be acting rationally. In particular, capital gains on housing
assets are usually tax exempt, while those on financial assets are often not. In addition, households
can negatively gear investment properties so a loss is created, which can be deducted from income for
tax purposes.
But it is not the purpose of this speech to examine the implications of tax policy for household
decision-making. I focus here on the wider concerns - the implications of holding too many eggs in one
basket, the exposures generated by gearing decisions, and the lack of ready access to local equity by
New Zealand firms.
There are specific difficulties interpreting the data on equities. In particular, New Zealand is a country
of small firms and farms, almost all privately owned, most of them through families. An important form
of debt is mortgage financing on the owners' house(s). This raises the statistical complication that the
household sector holds more equity than is initially apparent. An additional complication comes from
the inconsistent treatment of family trusts, and the assets held by them. We estimate that about 15
percent of households now hold assets through family trusts.
Furthermore, globalisation is complicating things considerably. Our official data on offshore equity
holdings by New Zealanders probably under-estimates the real situation. Statistics New Zealand
surveys New Zealand resident institutions as to their offshore holdings and bases their measure of
direct holdings on IRD returns. As a result, offshore holdings of private equity and equity paying low
dividends are unlikely to be fully captured. Migrants into New Zealand pose particular measurement
challenges, especially when they retain ownership interests in offshore operations where they continue
to have family or corporate ties.
Of course the Government itself has significant holdings of equity and it would be rational for
householders to take these into account in their savings decisions. Through various Crown Financial
Institutions, and in particular the New Zealand Super Fund, the Government indirectly holds about
$600 million of New Zealand equities onshore and about $1,800 million offshore. Through its State
Owned Enterprises and holdings in Air New Zealand, it holds another $10 billion directly. Local
Government also holds significant equity positions.
There are three particular types of corporate in New Zealand that have been untouched by foreign
ownership because their form and modus operandi prevents this. They include State Owned
Enterprises, and other Government companies and holdings. In particular, there are some very big
infrastructure players among the State Owned Enterprises, with each of the top four firms having total
assets in excess of $2 billion. The second corporate form of interest is the iwi or trust-owned Maori
corporation, often with fragmented ownership. These are estimated to total about $4 billion. Finally,
there are some large and powerful producer co-ops (especially in primary production) and retail co-ops
with member ownership. These now constitute a high proportion of the New Zealand-owned corporate
sector.
Equity for the corporate sector
Let us turn attention to the corporate sector in New Zealand, their organisational forms, where they
invest, how they are financed, and ultimately how they are owned.
The corporate sector, in contrast to the household sector in New Zealand, has over recent years been
saving strongly; savings that ultimately are reinvested, returned to shareholders, or used for equity
investment in other operations. The very low levels of household savings need to be viewed against
this stronger corporate savings performance.
Where do New Zealand corporates get their financing from? As noted above, the family-owned firms,
farms and forests turn to the household sector. New Zealand corporates raise most debt finance
directly from banks, either from the New Zealand subsidiary or, if they are big enough, directly from the
offshore parent bank. These debt markets appear to work well, although borrowing locally means
paying rates that have traditionally been higher than in other OECD countries, even Australia. The
New Zealand rates contain a premium that reflects exchange risk and the liquidity risk that is inherent
in a small remote market such as New Zealand.
Compared with other comparable countries, the corporate bond market is a very thin one in New
Zealand. (There are, of course, a very large number of global bonds denominated in $NZ, but most of
these are Eurokiwis or Uridashis, whereby foreigners effectively provide finance for lending into the
New Zealand household market.) The corporate bond market is thin because it is effectively restricted
to those corporates large enough to be recognised internationally. In addition, there is a significant
compliance cost to issuing bonds/notes domestically, and direct bank debt often looks an easier
option. (The lack of a corporate bond market in turn means a less mature yield curve and lower quality
pricing information.) For most small to medium sized businesses, the banking system is a more cost
effective conduit for accessing offshore investors funds. The effect of this is to limit the onshore
funding options available, and to limit the onshore financial instruments New Zealanders can easily
invest in.
Turning to the stock market, it appears that domestic corporates and New Zealand individuals have an
ownership stake in publicly listed companies of around 53 percent. The remainder (47 percent) of the
stock market is owned mainly by interests from the US, Australia, and the UK. This differs slightly from
the international investment position, which suggests foreign interests own only around 28 percent of
New Zealand assets. The lower proportion suggested by the international investment statistics reflects
the fact that ownership of non-listed and unincorporated businesses tends to be rather lower than in
publicly listed companies. (Australia is the largest inward investor with around 30 percent of total
foreign investment.)
This is shown in the figure: due to small scale firms and private equity, the size of the stock market in
New Zealand is very small, both absolutely and as a proportion of GDP. Of course some New Zealand
firms list singly or jointly on the Australian exchange. Despite enjoying some good returns, the small
size of this exchange limits options for both New Zealand firms and New Zealand investors.
We are currently seeing a phenomenon where considerable private equity is roving the world looking
for investment opportunities. Close to home, one source of this is the Australian pension schemes,
which are filling limited investment opportunities onshore and are increasingly looking at markets like
New Zealand. Some of this involves publicly listed New Zealand companies, while a less transparent
part has been private offshore funds buying private New Zealand companies.
Offshore some of these funds have helped develop more sophisticated segments of capital markets,
such as venture capital. But in New Zealand the relatively small scale and low risk appetite of
institutional funds means that this market has had to rely on a small number of high wealth individuals
and has developed much less as a result. This limits high growth, high risk firms' access to growth
capital, particularly important in a market where home bias is strong due to the inevitable uncertainties
in assessing start-up / growth firms.
Some consequences of our equity short-fall
What are the consequences of New Zealand's households' preference for investment in housing over
investment in businesses?
At the micro level it appears that small-medium firms have been less able to access New
Zealandbased specialised capital market instruments, for example, in the area of private equity, and venture
capital. It is hard to judge how much of a disadvantage this has been, but if it drives New Zealand
corporates towards foreign financial markets and eventually towards foreign relocation, then that could
be activity lost to New Zealand.
New Zealanders' unwillingness to provide equity capital has been an incentive for increased direct
foreign ownership. In many cases this has been desirable, even inevitable, for expanding companies.
One can see a natural progression whereby some New Zealand companies gradually outgrow the
technical and market limitations of this country, and as they expand into bigger markets, take on more
of the ownership attributes of international firms. But if that happens "prematurely", there is an
opportunity benefit foregone for New Zealand.
New Zealand's liberal attitude to foreign ownership has brought us many important advantages. We
have enjoyed access to the world's capital, to best practice international technologies, to specialised
business skills, and to marketing networks. These have brought higher productivity, employment
opportunities, and have contributed to our higher growth rates.
This also has to do with the much discussed cultural tendency of some New Zealand entrepreneurs to
grow their business to sales levels of some tens of millions, then exit for the "bach, boat and BMW"
semi-retirement subculture, leaving overseas investors to expand the business further and develop its
full value internationally.
GDP is a measure of what is produced in New Zealand, while National Income (which used to be
called GNP) measures the fruits of production that actually accrue to New Zealand residents. In 2005,
National Income was around $10 billion lower than GDP, as a significant part of GDP accrued to the
overseas owners of New Zealand-based companies. Ultimately, it is National Income that matters for
the overall economic wellbeing of New Zealanders. The wedge between GDP and National Income
has some quite complex welfare implications for government, which has to balance how much its
policies aim to promote activity in New Zealand, or activity owned by New Zealanders, whoever or
wherever they may be.
One particular consequence is seen in our current account deficit, a measure of the external financing
required by the country's investment-savings imbalance. In recent years about half the deficit has
been represented by the trade imbalance. The other half has mainly been the imbalance of income
earned by foreigners in New Zealand compared with that earned by New Zealanders abroad.
Measurement problems apart, this appears to have been growing as a result of recent investment
trends. A further decline in the ownership share of New Zealand business will worsen this deficit and
put the balance of payments under continued pressure.
Interestingly, our net international investment position as a percentage of GDP has not worsened
substantially in recent years. However it will be difficult for New Zealand to substantially improve the
investment income component of the current account deficit in the short to medium-term because the
stock of foreign ownership is already so large. If the $NZ were to weaken in the medium-term in line
with many economists' predictions, then we would expect to see a further pick-up in foreign investment
attracted by cheaper New Zealand assets.
Such a large debtor position, arising out of New Zealand's poor savings performance, makes the
country more vulnerable to adverse shocks. We are inevitably more exposed to changes in global
interest rates or sudden shifts in the investment preferences of overseas investors. At times, this can
make it more challenging to maintain price stability and avoid unwanted swings in economic activity.
This pattern of household investment also impacts economic performance. If New Zealanders fail to
identify and invest in higher yielding equity then we condemn ourselves and the country to lower
returns, and economic growth will be lower.