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Capital Comment Newsletter: March 2011

It's a crime
Share it fairly
But don't take a slice of my pie
So they say
Is the root of all evil today

To see the Pink Floyd video click here

In my January (Global View) newsletter I talked about how it’s impossible to view the New Zealand economy in isolation to what’s happening in the rest of the world - and how inflation fears are starting to appear. The summary of where I saw our country heading included the following observations.

  • The U.S. and European economies will take some time to get over the banking and financial crisis they have gone through – far greater than that experienced in Australia and New Zealand. This will mean interest rates will remain low as their governments attempt to stimulate the economy and reduce unemployment (amongst other things).
  • The Official Cash Rate here will not rise in the near future and when it does it is likely to remain at a lower average than it has in the past. (In fact it’s been lowered).
  • The 4% CPI increase for the year to the December quarter was an anomaly due to the GST increase but inflation is on the rise worldwide (being the easiest way governments can get out of the debt they have incurred to stimulate their economies).
  • Banks have to lend money because that’s their business. Their lending criteria will now be primarily debt serving ability.
  • Businesses have been hurting due to the lending practices banks have been taking – to some extent forced upon them by regulation – and by the demise of other lenders like the finance companies. There will be many opportunities for cashed up buyers – or those that have access to finance – to buy or invest in successful businesses that are carrying too much debt.
  • Commercial property will be judged by its ability to generate cash flow. Quality of tenants and terms of lease will be the key factors. There will be good buys for those who can attract tenants for properties not fully leased – whether it be by refurbishment, clever marketing, or the ability to postpone immediate rental cash flow.
  • Bare land may prove to be a long term hedge against inflation – but how long will you have to wait? Location where the land can be used is the key, not just scarcity (see what’s happened to the price of most coastal property over the last 2 years).

Since then the earthquakes here and in Japan, and the unrest in North Africa, have placed more uncertainty in all our minds.

What We Need To Do

It’s therefore appropriate that BNZ economist Tony Alexander’s web site contains a page entitled “What we Lack”. This is the first in a series examining what is holding back New Zealand’s growth. It contains a long list of international studies which compare various countries on largely economic criteria.

The most recent article on the web page focuses on the World Economic Forum’s Global Competitiveness report and where New Zealand appears to be seriously uncompetitive. It’s worth repeating here Tony’s view of what the poor rankings mean, and I quote:

  • We are a nation of extremely poor savers. This means interest rates are relatively high, the hurdle for profitable investment is high, and availability of finance for riskier activities (non-housing) is constrained.
  • We face a continuing loss of skilled people overseas. The return to businesses from training staff is reduced because of high risk of loss offshore, those with the least to lose in terms of career and savings and therefore presumably most likely to take risks based on thinking outside the square leave the country.
  • The labour market is generally viewed as deregulated, except when it comes to being able to freely hire and lay-off people. This means businesses will tend to be reluctant to hire because of perceived exiting difficulties for under-performers. Cutting losses in other words is difficult.
  • The small size of the NZ economy means buyers feel they cannot perhaps find the best bargain and most suitable inputs for their businesses.
  • The country’s competitiveness advantage is based upon growing grass very well – an activity which tends not to produce high returns on capital on a consistent basis or which is amenable to up-scaling and innovation of and widespread adding value to outputs.
  • The country lacks scientists and engineers needed to develop and make applicable to the market new technologies.
  • Businesses perceive there is a lack of domestic competition – an oft-cited example (elsewhere, anecdotally) being building materials.
  • The country’s infrastructure in terms of roading, railways, broadband and electricity is viewed as inadequate. This adds to the cost of doing business not just in terms of direct transport costs but reliability of supply.

He sums up by saying “The areas of high competitiveness disadvantage for New Zealand are poor savings, poor infrastructure, poor domestic competition, poor finance availability and cost, lack of scientists and engineers, and over-dependence upon a primary sector export base.” To read Tony’s article click here.

It's interesting to see that when asked which of 15 factors they rate as most problematic for doing business in New Zealand, the respondents to the WEF’s Executive Opinion Survey placed infrastructure as the most substantial impediment, followed closely by access to financing, then tax rates, then an inadequately educated workforce.

It’s appropriate in this newsletter to look more closely at what is seen as the second greatest impediment – access to finance.

Financing Business

A continuing theme in my newsletters over the last 3 – 4 years has been the lack of finance for property and business which commenced with the demise of the finance companies here in 2007 followed shortly after by the Global Financial Crisis triggered by the sub-prime mortgage debacle in the U.S.

The business sector most severely hit by the lack of access to finance is privately held companies, including SMEs, and in my last CAPITAL COMMENT, I did promise to discuss this. So here we go.

Bank finance secured over collateral property, usually the proprietor’s residence, has been the traditional method of financing private businesses. Plant and debtor finance have also been a common method of obtaining funds.

But it's not just money

Many people starting businesses think money is the first thing they need. Often it’s the last.

Two of the keys to a successful business are capital and distribution – and not necessarily in that order. Too many people enter into a business without a proper business plan. They think that raising the money is the most important thing, whereas it’s distribution - or the ability to market the product or service - that is.

In most cases it’s not until a proper business plan and presentation to raise the funds have been finalised that the source and type of finance required becomes apparent. This is when the third ingredient in a successful fund raising comes in to play - what is the (debt) repayment strategy and/or the (equity) exit strategy?

In a small country like New Zealand capital is a scarce resource. And as a general observation the valuation of properties and businesses, and therefore the ability to raise finance, is now far more reliant on sustainable cash flows than has been the case in recent years.

We formed TBK Capital to help people raise money. If you’re in that space, make sure you come and see us early in the process so we can help you structure and present the proposal and identify the best source of funds for you.

Filling the gap

But there are ways of funding business (and property) other than borrowing money. As I said in the January newsletter, in my view is inflation is not dead – simply hibernating – and investors cannot afford to have all their funds locked into low yielding bank deposits or bonds forever (also bearing in mind the capital value of bonds, or rather their early redemption value, decreases as market interest rates rise – which they must surely do).

The good news is this brings up opportunities for private investors to fill the gap and receive far better returns on their funds than could normally be expected in this low interest environment. And they gain protection against inflation.

Let’s look at some of them.

  • Growing businesses strapped by lack of working capital. This can be resolved through bank and non-bank lenders – and by equity participation. There are plenty of people out there looking to invest in good businesses. We can structure “joint venture” or other equity participation deals where the incoming investor is protected from previous liabilities incurred by the incumbents or takes a position in preference to them.
  • Commercial property investment opportunities where owners with excellent revenue generating properties are looking for equity investment partners to reduce bank debt and improve dividend streams. These provide proven longer term investment opportunities with an excellent hedge against inflation.
  • Buyers or owners of properties looking to add value by re-furbishing and/or re-tenanting. Banks are often reluctant to lend on these as loans fall into “development” territory - but they are happy to re-finance when completed. This provides a great opportunity for an equity or quasi equity joint venture partner in the meantime.
  • Almost completed developments requiring short term funds to finish at which stage there is a bank takeout.

Other opportunities include straight loans. These include second mortgages - almost impossible to get - and loans just outside bank criteria. For example I have one private investor who is looking to lend $2 - $5 million on commercial property. The general criteria is loans the banks are reluctant, or unable, to do - often as a result of policy decisions. For example a particular proposal may fulfil the bank's criteria but any further loans may exceed their comfort zone for total lending to that borrower.

TBK Capital we will be offering private investment opportunities like those mentioned above. And it looks like we’re not the only ones recognising these opportunities. The number of deals "angel investors" participated in rose sharply in 2010 from a year earlier. Affluent investors who invest in start-up firms, invested a record $53.8 million in 2010. There were 103 deals completed in that year, up from 76 in 2009. See the Sharechat article here.

So if you’re looking for funds - or if this type of investment is of interest to you - please give me a call or reply to this newsletter accordingly.

Housing market leads the economy

As readers of my previous Global View newsletter will know, I am a firm believer in the residential housing market being a leader of the New Zealand economy. To see some excellent articles on this from an economist’s point of view see Rodney Dickens articles in Rodney’s Ravings archives here.

I don’t think there’s any question the residential housing market has stabilised with February sales well up on January. The Real Estate Institute sees this as a modest recovery in terms of both prices and volumes.

They say “reports from members indicate that although rents are rising in key urban areas and there is a continuing shortage of housing stock, particularly in Auckland, buyers are still being cautious. This is evident in the increased days to sell, which measures the time between the property being listed and an unconditional sale being completed. Equally, vendors are not under pressure to sell and landlords are successfully increasing rents, albeit by small increments.

There are a number of factors affecting the market yet to be played out, These include the tax changes affecting depreciation from 1 April this year which will mean many small investors will leave the market, improvement in home affordability, the drop in interest rates as a result of the Official Cash Rate being lowered following the Christchurch earthquake, people leaving Christchurch, slight loosening of bank lending standards, increased rents in urban areas, and of course a drop in residential construction.

For an excellent commentary on the demand for housing in Auckland and why rents are rising, see editor Bernard Hickey’s interview with Auckland Property Investors Association President David Whitburn here.

Watch the Auckland residential market as this will lead the way. The changes residential agents I know are experiencing include increases in open day numbers, buyers making decisions (as distinct from low offers) and stock that has been sitting is now selling as vendors have held in and buyers are being more realistic.



John Paine
TBK Capital Limited


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