Housing Costs Shut-out Coincides With Boomers Bailing From Businesses

Why now more than ever, young New Zealanders should be saving for their first business instead of their first house.

A perfect storm of reasons is brewing, supporting the merit of investing in a business rather than residential property right now.

At the same time as a new housing affordability survey shows that 90% of first home buyers feel locked out of the market, a supply of quality Baby Boomer owned business are being listed for sale for the first time in decades.

ABC Business Sales managing director Chris Small says an unexpected post-Covid equity increase for mature business owners’ portfolios is a key motivator for them looking to move on.

“Many of these owners have established their proven businesses over 30 years and having just enjoyed a dramatic increase in the value of their property holdings - not to mention missing out on two and a half years of overseas travel – they’re thinking we’re not getting any younger, we’ve got a good level of equity earlier than expected plus an attractive business to sell right now. We’re ready to move on.”

Small says the dollar returns on investments in business compared with property at moment also stacks up from both a short-term yield and even long-term capital gain perspective.

“The average house price in New Zealand is currently $1,053,315. Based on a 4% yield rate for an investment in residential property that equates to a gross return before tax of $42,132.

“In comparison, the average business price is currently $749,729 and based on a market average multiplier of 3.5 times its profit, this investment equates to a 29% yield or a gross return before tax of $214,208.”

(Please refer Footnote A & B for further details/figures)

Small says the message is that there has never been a better time for young New Zealanders to consider investing in their first business instead of their first house – especially given the current financial restrictions and supply chain challenges of the property market.

“There’s even the very topical big-picture consideration for the benefit of the country’s economy of why business investment is also a much more productive asset class contributing to our GDP and export dollars versus investment in non-productive property assets. But that’s another story.”

Footnote A:

Business Yield v Property yield

• The average house price in New Zealand is currently $1,053,315 according to the latest statistics from REINZ as at Jan ‘22. Based on a 4% yield rate for an investment in residential property that equates to a gross return before tax of $42,132. The average business price is currently $749,729 and based on a market average multiplier of 3.5x (29% yield) equates to a pre-tax cash return of $214,208.
• Clearly, there is a material difference in the annual yields, with business ownership returns being six times higher than residential property. (This analysis excludes any capital gains for each asset class. The pre-tax profit for business ownership is based on the company been fully managed with limited input from the investor.)
• It needs to be acknowledged that business ownership has a higher risk profile than residential property, but it can be argued that the risk premium for investing in a business is not anywhere close to six times higher than residential property. Especially when buying a business with a proven trading history and following a thorough due diligence process.

Footnote B:

Capital Gains

Capital gains are made on business sales when the owner has increased profitability and achieves the same or higher multiple. Below is a simple example over a five-year period:

• April-2017 You buy a business for $1,050,000 based on 3.5x net profit $300,000
• April-2022 You sell a business for $2,100,000 based on 3.5x net profit $600,000

This represents a 100% capital gain. Capital gain is dependent on increasing the profitability of the business.

Leverage & Business Equity

Banks lend to businesses based on its profitability and total market value. A rule of thumb is a bank will lend 50% of the total value or 2 x profit. Hence, in the above example by increasing the value of business from $1.05m to $2.1m it allows leverage and borrowing an extra $500K of debt to either buy a new business or reinvest in your own business or pay yourself a special dividend.

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