Looking to buy a rental property in 2018? 8 Key Tips
24 January 2018
Looking to buy a rental property in 2018? 8 Key Tips.
Is your next rental property purchase just a gamble on capital gains? Here are some tips to help you get ahead with rental properties!
1. Buy a property where you can add value.
Too many investors just buy a standard property, in a standard area, at fair value, with no opportunity to add value in the future.
- The easiest opportunity is where the property is under-rented. For commercial properties, the higher the rent, the higher the value. So, if you can find property that is partially empty or rented below market value, then it can be quite easy to increase your equity and cash flow. For residential, higher rent doesn't necessarily mean higher value, but it will improve cash flow.
- Simple renovations and improvements are my second favourite - Use a good property manager and discuss options with them:
- If you add a heat pump, how much extra rent will you get?
- If you add new carpet, how much extra rent will you get?
- What else could you do to make the property better for tenants? How much extra rent will you get for these improvements?
It is normally pretty easy to get a 10% return on your investment for simple renovations. But, realistically, if you are smart and work in with your property manager, you can probably get 20%.
- Rent by room or rent fully furnished? Be careful with these options, but it can be a way for you to add value and improve cash flow.
- Add a bedroom - For residential, more bedrooms equals more rent and more value.
- Add a minor dwelling.
- Subdivide - For commercial, you might not be able to subdivide, but you might be able to split one bigger tenancy that is hard to rent into smaller tenancies that are easier to rent, and rent for a higher value overall. For residential, a subdivision can often easily add $100,000 in equity, plus give you the opportunity to have a new rental, with good tenants and low maintenance.
- Buy at a true discount. This generally means buying privately!
2. Work out the cash flow!
Ideally you want a residential property where the rent pays for all the expenses. Even more ideal would be if the rent can pay for all the expenses and some principal, so that you pay the rental off over 20-30 years.
NOTE: This means all expenses, so allow for fair repairs, rates, insurance, travel, accounting fees, etc.
If you are a Coombe Smith client, make sure you have our simple Rental Spreadsheet that helps you see the cash flow now, and over the next 10 years.
For commercial - watch the principal requirements. For example, your commercial property might be making $10,000 taxable profit. But your bank might require $15,000 principal repayments, plus $3,300 of tax = overall negative cash flow of $8,300.
3. Check the area.
- I google the population as a starting point for any area I am thinking of buying in. If the population is decreasing, I would be very careful buying. More people means more possible buyers and more possible tenants. Good population growth is likely to lead to rent increases, which is essential for cash flow!
- This is a great article on property values versus household income. If household incomes are too low compared to house values, you might struggle to get higher rent in future: https://www.interest.co.nz/property/house-price-income-multiples
- Look for recent articles and information, such as "100 jobs to go" - http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=11980396.
- If you are not from the area or buying without seeing, be careful that there is nothing in the area that affects your purchase. A property investor once purchased a rental in a different island, sight unseen. Unfortunately, it was right next to the sewerage works!
4. High Gross Yield doesn't necessarily equal positive cash flow
You might find a property in a small town. $120,000 cost and $275 rent per week. Based on 52 weeks (I probably wouldn't use 52 weeks in my real calculation), this is an 11.9% Gross Yield. But rates are $4,500, insurance might still be $1,200, interest might be at 4.5%, so $5,400. Property Management is often a higher percentage (might be 9.5% plus GST). Repairs can be the killer, as it often costs the same to repair in a small town as it does in a city. Suddenly, with low interest rates, this property is still making a cash loss of $1,298 using those figures, some accounting and bank fees and travel.
5. Don't believe developers.
Property is advertised as $600 per week rent – don’t believe it and get an independent rental appraisal.
Property is worth $700,000 – don’t believe it and either do your own research or get an independent valuation.
Property will give a 10% Gross Yield – is it too good to be true? What is the catch? Make sure you do your own research and if rent by room, or fully furnished, check with an independent property manager to make sure sustainable. You don’t want to rely on $600 per week, when realistically it might have to drop to $500 as no demand for rent by room (for example).
6. Have a plan and a goal - If the property you are looking to buy doesn't help you to achieve your goal, then why are you buying it?
7. Plan for change
- Interest rates may go up. I like to have some long term loan terms to protect against interest rate rises.
- Tax refunds might disappear.
- Better heating and conditions might become a requirement. Take this as a positive and think of Item 1 above, as you are likely to get a good return on these items, especially if the Government helps pay for them.
- Regular rent reviews.
8. Balanced Portfolio
An old saying was to have five cash flow positive properties to support your one capital gain property. This kind of portfolio should give you stable cash flow and stop you being so reliant on capital gains. Also, try not to have too many of the same thing. For example, if you have 20 rentals at Auckland university, what happens if the university suddenly closes down, or its student numbers drop by half? Having some newer properties also helps to balance the portfolio, as these will have less maintenance in the future.
a. If you already have two rentals, each running $5,000 negative cash flow per year. Then, if you purchase another, I would want it to be positive.
b. If you have five older rentals in Tokoroa, which have great cash flow, but you think no capital gain potential. Then you might buy the next one in Hamilton to have a more stable tenant base, maybe less repairs and less hassle, but higher chance of increase in rent and value.
I hope you enjoyed reading this.