Don’t get carried away with the property market!

2nd September 2013

The market isn’t booming yet and it’s still essential to do the basics right.  Buy a good property, in a good area and ideally with a twist that gives reasonable cashflow.

5% gross yield

Unfortunately this is what most investors buy as a rental property. For example, a $300,000 rental property renting for $300 per week has a 5% gross yield.

At the moment interest rates are around 5%, so if you are borrowing all or the majority of the money, the rental income of 5% is only just going to cover the interest.  So what about the rates, insurance, repairs and other costs?

I have done example figures on a $300,000 property giving $300 per week rent, interest at 5.5% and the cost per year is $7,500 approximately before tax.  If you are a high income earner and can offset the loss against your income, then the cost reduces to $5,000 per year or $100 per week of true, cash cost.

• What happens if IRD or the Government change the rules, so that the tax refund isn’t available? The cost then increases to the $7,500 or around $150 per week.
• What happens if you lose your job or business income decreases?
• What happens if interest rates go up? Interest rates in NZ over the long term average around 7.5% to 8%.  Using 7.5% interest into my earlier example increases the cost to $13,000 or $9,000 after tax refund at 33%.  So that is either $250 or $170 per week cost.  That is becoming a large cost, which is difficult to sustain in the long run.

Property values

Looking at www.reinz.co.nz gives information on what has happened to house prices.  Looking at the whole of NZ, the median house sold in November 2007 was $352,000.  In November 2012, 5 years later, the median is $383,250.

So over the last 5 years the property market has been very flat.  Comparing to historic data, this would hint that a period of property growth should be coming.  But there are no guarantees, and currently there are new and changing factors affecting NZ and its property market.

SO WHAT SHOULD YOU BE DOING?

There is no one perfect solution for everyone.

Investors with high, secure incomes, could look at lower cashflow properties which have a large potential to increase in value, such as beach property.  But this is higher risk and effectively you would be gambling on capital gains and using your other cashflow to prop this gamble up.

Most investors do not have really high incomes and cannot afford to gamble on capital gains.  In the last 5 years, a lot of investors who did gamble on capital gains are now regretting it and many have been forced to sell at a loss.

So if you are a normal investor looking to buy more property, I would suggest:

1) Take your time.  If you rush, often you get sucked in by the moment.

2) Make sure any potential property purchase has good future capital gain potential, as this is where property investors make their long term gains.

3) Don’t expect or require large short term growth, as this is unlikely to occur (even though we all hope it does). Instead have a 5 and 10 year simple plan and ensure this includes interest rates, and perhaps fixing some loans for 5 years at below 6%.

4) Make sure any potential property investment has good cashflow and can pay for itself. My earlier example of a $300,000 property getting $300 per week, is NOT good cashflow and will cost at least $100 per week.  So you need to find investments with a twist, such as:

• Multiple dwellings on one site.  Have a talk to Vaughan Heslop from Lodge (021 400515or (07) 838 0042) for some examples.
• Renovations or repairs to improve rent.  Having a good looking, warm and dry house can improve rent and tenant appeal.
• Minor dwelling.
• Turn garage into sleep-out.
• Turn a living area into an extra bedroom.
• Room by room rental – note: this is quite hard work.

A smart investment model is to have 3 or 4 high cashflow properties that support one high potential capital growth property.  But try to buy the cashflow properties first, otherwise the high capital gain property will suck your cash and ruin your borrowing potential.

Coombe Smith are property accountants and property experts in Hamilton, who help the Waikato property community and are proud to have property clients throughout New Zealand and the World. Do you need a property accountant to help with your rental properties?