This week, a bouquet for the Napier City Council (NCC). It has decided to sell it's industrial leasehold land. It is doing so because of its concerns the leasehold land is holding back development. Those concerns are not unique to Napier. They apply to most provincial cities, including Whangarei.
Most of the ground leases around the country are legacy properties created by local councils or state owned organisation in days long ago, usually through land reclamation.
The NCC owns 74 leasehold properties, worth about $34 million. That portfolio generates about $1.6m a year in rental income a year.
In March 2016 the Council commissioned real estate services company CBRE to prepare a review the impact leasehold tenure was having on reinvestment in Napier. It then commissioned consultants Boffa Miskell to review each of the ground lease properties with a recommendation to either retain the land for now and do further design and planning investigations; or dispose of the land but establish some specific public benefit outcomes before doing so; or dispose of the land as is. About 40% of the properties fell within the hold-for-now group, with the remaining 60% to be sold.
The Council's decision to sell the leasehold land will be greeted by many as good news - including leasehold land expert Nigel Dean who in an article in Stuff described leasehold land as "a blighting factor" that had "frustrated development".
He added the leasehold land system was so biased towards the lessor, the land owner, that the leasehold market had become "dysfunctional".
He said the numbers do not work for lessees because lessors were asking rents of 7% for what was a safe, low-risk investment and many lessees were "struggling to keep their heads above water". In his opinion, 4% to 5% was a fairer ground rent. Certainly it's important to question why in a low-interest rate environment one would lease land at 7%, when it would be cheaper to source bank finance and purchase land, that's assuming suitable land is available which in most cases it is. Not only would their cash flow be improved but they would benefit from the land value increase! It's a no brainer.
Lessees will also be mindful of the cost to take a lessor’s rental assessment to arbitration. Arbitrations often take the form of a judicial hearing before a panel of arbitrators, involving lawyers, valuers, and other expert witnesses who all charge like wounded bulls. On top of that there's the venue hire, stenographers, caterers, and so on; and the risk that after spending a bucket load of money to have your day in court, a majority of the panel may side with the lessor’s experts, and you get clobbered with costs!
An arbitration can cost hundreds of thousands of dollars so going down that path does not make commercial sense unless the annual ground rental is very large or the rent review period is for a very long term (like 21 years). As a result, many lessees feel "captured" into accepting the ground rental offered by the lessor on review.
The CBRE report is particularly interesting because it provides a rare insight into the returns councils are receiving from its ground lease investments. Those reports are usually not available to the public for "confidentiality reasons".
They say that over the last 15 years the Council's ground lease portfolio returned an average annual compound rate of return of 14.4% (which includes the annual rental income and the annual gain in land value). This is on a par with the returns from owning industrial and commercial land in Auckland, is higher than the sharemarket NZSE50 index at 9.3% and higher than (risk free) 10-year government stock at 6%. CBRE qualify their numbers by saying the long-term rate has been influenced by a one-off spike in land values in 2004. The shorter-term returns are more volatile and less attractive.
In my view the 14.4% return is extraordinary given land ownership is an extremely low risk investment, not much more than government stock. Clearly though, council investment in leasehold land comes at a cost to the community and they need to weigh that cost up against the returns. In my view, the Napier City Council have made the right choice. They have recognised their ground leases are holding back economic development and recognised that they can make similar returns by investing their money elsewhere.
Last week I mentioned the case of the couple who wanted to build a minor block wall, only to find the council fees were going to cost substantially more than the wall itself. I suggested this was more common that the government and councils would like to admit. A number of readers have contacted me about this. One says, "Your example is unsurprising. I put in a second kitchen. Cost of builder electrician and plumber $2,200. Cost of fridge, stove, sink etc $2,500. Cost of paperwork and council $24,000. Yes that is 3 zeros! And that is not all: Time to do the work 10 days. Time for paperwork over 5 months."
If you have a similar story to tell, please contact me on email@example.com.
Frank Newman, an investment analyst and former councillor on the Whangarei District Council, writes a weekly article for Property Plus.