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More Realistic New Investor 3 Rentals in 3 Years

18 April 2018

More Realistic New Investor 3 Rentals in 3 Years

Following my post yesterday about what was required for a new property investor to buy 3 rentals in 3 years, here is a more realistic approach of how it could work.

To start with, I discussed with Adam Thompson from www.mymortgage.co.nz, and he identified an obvious opportunity and also an under used one.

80% lending on new builds. So, to get ahead doing a new build could be easier, as long as you can still add considerable value.
Non bank lenders. These generally only charge 0.5% more than the main banks, and can lend up to 80%. Half a percentage is actually a small cost if it helps you get a good deal done!

Your personal house has some equity, you earn good money, and now you want to buy 3 rentals in 3 years so that you and your family can get ahead financially. What do you need to do?

Our case study has started with:

$750,000 personal house with $299,000 debt.
NO capital gains – I prefer not to gamble on capital gains and also expect very small gains in the next 5 years outside of Auckland.
$120,000 family income.

Summary to make this work;

Purchase sub-dividable property $600,000, Gross Yield only 3.9%.
Add Duplex (two rentals that are joined together). Total cost $710,000.
Gross Yield on all 3 properties is 5.76% based on 52 weeks and cost of development.
The rent pays all expenses (incl. fair repairs, accounting, as well as standard costs), and gives a small cash surplus at 100% borrowing and 4.5% interest rate.
The family income would need to increase to $130,000 to make this work.

I have based these figures on a current subdivision, but have been a little conservative with the figures, so the actual figures when completed could be better.

Big risk is interest rates. If interest rates increased to 5.5%, then negative cashflow by $10,200 per year. This isn’t allowing for any tax refund, as Ring Fencing is likely to come in.

MORE DETAIL:

Start

Buy a sub-dividable rental for $600,000, $450 per week rent = 3.9% Gross Yield.

$390,000 debt (65%) on the rental property, and $210,000 debt borrowed on personal home.

Next Step

Subdivide so that can build a Duplex on the back. Cost estimated at $110,000.

Value likely to increase by at least $250,000.

End of Year 1

Personal house worth $750,000, with $299,000 debt.

Rental worth $850,000 with $500,000 debt, plus $210,000 debt on the personal house, so $710,000 total rental debt or 84% LVR (using some personal house equity to allow this!).

Rental income $450 per week, or $23,400 per year, plus $120,000 of personal income.

Year 2 – Build Duplex

Cost estimated at $300,000 each or $600,000 total.

As a new build, the bank will lend 80% or $480,000.

$91,000 from personal home security, and $29,000 from existing rental house.

Rent expected at $500 per week for each Duplex.

End of Year 2

Personal house worth $750,000, with $299,000 debt.

Two new rental properties worth $550,000 each, plus existing rental house $450,000 = $1,550,000 total rental value, and debt $1,310,000 (84.5%).

Rental income $500 per week for 2 new properties, and $450 for the existing = $75,400 per year rental income, plus $130,000 of personal income (personal income would need to increase to $130,000 to make this work).

Year 3 – relax

Perhaps could renovate existing rental to gain more rental income too!

Kind regards

Ross Barnett

What Is Needed For A New Investor to Buy 3 Rentals In 3 Years?

17 April 2018

What Is Needed For A New Investor to Buy 3 Rentals In 3 Years?

Your personal house has some equity, you earn good money, and now you want to buy three rentals in three years so that you and your family can get ahead financially. What do you need to do?

Our case study is starting with:

$750,000 personal house with $299,000 debt.
NO capital gains – I prefer not to gamble on capital gains, and also expect very small gains in the next 5 years outside of Auckland.
Buying existing properties, so 65% debt.
$120,000 family income.

Summary to make this work

2 rentals purchased for $500,000 each, added value of $280,000 each, but renovations only cost $100,000 each. Rent $950 on each once renovated or 8.23% Gross Yield.
Renovate personal house, add $200,000 value at cost of $100,000.
This enables third rental to be purchased in third year based on equity for $500,000, rent $700 per week or 7.28% Gross Yield.
BUT – After discussing with mortgage broker, this would still not work, and household income would need to have gone up to $140,000 to have enough income for the standard banks to finance.

So, for a new property investor to buy three existing rentals in three years will be extremely hard. Would need fantastic rent, as well as fantastic value added, to enable the third purchase!

Overall, this example would be extremely hard to actually make happen. Make sure you like our Facebook page, as tomorrow I will post a similar example on how this could work!

MORE DETAIL:

Start

Buy a rental for $500,000, $700 per week rent = 7.28% Gross Yield. (I needed to use a high rental, otherwise in year 2 and 3, there is not enough income, so this is an important part to note).

$325,000 debt (65%) on the rental property, and $175,000 debt borrowed on personal home.

Next Step

Need to add $280,000 of value to the property but only at a cost of $100,000. (With 65% lending, this huge added value is needed later to buy the 3^rd rental – This would be extremely difficult!).

After renovation, $950 rent per week or 8.23% Gross Yield on cost of house and renovations.

Next Step

Renovate personal house, add $200,000 of value but only spend $100,000. (As above, this will be difficult).

End of Year 1

Personal house worth $950,000, with $399,000 debt.

Rental worth $780,000 with $425,000 debt, plus $175,000 debt on the personal house, so $600,000 total rental debt or 77% LVR (Using some personal house equity to allow this!).

Rental income $950 per week, or $49,400 per year, plus $120,000 of personal income.

Year 2 – Repeat, buying similar rental, same value, same debt and same renovations

Buy a second rental for $500,000, $700 per week rent = 7.28% Gross Yield. (I needed to use a high rental, otherwise in year 2 and 3, there is not enough income, so this is an important part to note).

$325,000 debt (65%) on the rental property, and $175,000 debt borrowed on personal home.

Next Step

After renovation, $950 rent per week or 8.23% Gross Yield on cost of house and renovations.

End of Year 2

Personal house worth $950,000, with $399,000 debt.

2 Rentals worth $780,000 each = $1,560,000 total rental value, and debt $1,200,000.

Rental income $950 per week for 2 properties = $98,800 per year rental income, plus $120,000 of personal income.

Year 3 – Repeat, buying similar rental, same value, same debt, no renovations at this stage

Buy a third rental for $500,000, $700 per week rent = 7.28% Gross Yield. (I needed to use a high rental, otherwise in year 2 and 3, there is not enough income, so this is an important part to note).

$325,000 debt (65%) on the rental property.

$11,000 borrowed on personal home and this then maxes out personal debt at 80% of personal house value.

$82,000 extra borrowed on 1^st and 2^nd rental, so now both rentals have $507,000 debt or maxed out at 65% of rental property values.

End of Year 3

Personal house worth $950,000, with $399,000 debt.

2 Rentals worth $780,000 each, and one at $500,000 = $2,060,000 total rental value, and debt $1,700,000.

Rental income $950 per week for 2 properties, plus $700 for one = $135,200 per year rental income, plus $140,000 of personal income. (Family income would need to be $140,000 to allow a standard bank to lend for the 3^rd rental!).

Kind regards

Ross Barnett

Ring Fencing of Rental Losses and 5 Year Brightline

4 April 2018

Ring Fencing of Rental Losses and 5 Year Brightline

In late March, there were two major changes to residential property investment in New Zealand.

1) The 5 year Brightline Test has come in from 29/3/18

- Existing rentals are not affected, but obviously you can still be taxed under other sections of the Income Tax Act (check out this Video on how property sales can be taxed).
- If a sale and purchase agreement is signed before 29 March 2018, then only subject to the 2 year rule.

2) Ring Fencing of Rental Losses - Why don't we make it fair?

This is only for discusson at the moment, but the paper gives a good indicaton of IRD's intention!

The IRD officials' issues paper released yesterday applies to residential rental properties, but not:

Business
Commercial Property
Personal home (i.e. flatmates or Airbnb, etc)
Holiday home
Farming
Forestry
Shares (i.e. can still borrow to buy shares and offset this loss against other income).

I would much prefer to see an approach where losses are only allowed for say four years for everything! So, if you buy a residential rental, you have four years to access the losses and turn the rental into a profitable rental. The same with a business, a farm, a holiday home, a commercial business, a forestry investment , a personal home getting rental income or investing in shares. Everything should be treated equally.

At this stage, it is only an officials’ issues paper, but it gives a fair idea of how IRD expect to apply this. So it is looking like:

1/4/19 start
Might be phased in over 2-3 years
Also apply to overseas rentals
Will apply to sole traders, companies, Trusts, partnerships, and LTC's. So will apply to all entities.
They are trying to make it hard to work around, but there are some obvious holes that can be exploited, especially for business owners.
If you trade properties, a loss from rentals will be able to offset this profit.

In the long term, this rule should not create any extra tax, as the losses are still there, they just carry forward to future years.

OVERALL – Commercial property could become more attractive to invest in. Otherwise, as we have been saying for a while, if you have a rental portfolio that is cashflow negative, it is important to have a plan to turn this positive over the next few years!

What effect do you think this will have on house prices? And on rents?

If you are worried about your rental portfolio, a great starting point is a free 5-10 phone chat with me, to work out the best way forward. Due to all the recent changes to tax, we are also offering existing clients a discounted meeting with your annual financial statements. But obviously if you urgently need some advice, we can have the meeting before your financial statements are done, if that suits you better! Just email me.

Kind regards
Ross Barnett

This Person Was Unaware of their $50,000 Tax Liability

13 April 2018

THIS PERSON WAS UNAWARE OF THEIR $50,000 TAX LIABILITY

Tax of overseas investments is an awkward area and there are a lot of ways you can get caught out on tax.

Sam was born in London. He moved to New Zealand when 25 years old, approximately 15 years ago.

He is a New Zealand tax resident.

Sam's parents still live in London and have a wealthy Trust that is generating $150,000 of profit that is retained in the Trust. As the parents are getting older, the famly agrees that Sam should be a Trustee of the Trust.

As the Trust is overseas, Sam does nothing in New Zealand.

Five years later, Sam is audited by IRD.

Sam should have completed a Foreign Trust disclosure.
As the disclosure has not been completed, any foreign sourced income is taxable in New Zealand. So approximately $50,000 tax bill in New Zealand for each year, plus penalties and interest!

How could this be avoided?

New laws came in on 21 February 2017 that Foreign Trusts must register in order to have an exemption on foreign-sourced income by 30/06/17. Or, there is a 4 year grace period for natural people, not in the business of trustee services.

So, if Sam had registered with IRD, then the foreign income from the Trust would not be taxable in New Zealand.

A Foreign Trust, in broad terms, is a Trust settled by a person that is not a tax resident of New Zealand at the time of settlement.

Some other potential overseas Trust issues

1. An overseas person has an overseas Trust. They move to New Zealand. They have 12 months to elect the Trust to become a complying Trust, which can give large tax benefits going forward. Or a non-complying trust can be taxed at 45%!

2. If you receive a distribution from an offshore trust: - Most likely some of this distribution is taxable and there are ordering rules that must be applied to work out what the distribution is made up of. First is current year Trustee income, second is trustee income that is not beneficiary income of an earlier income year, both of which are a taxable component in New Zealand. Any capital gains and corpus will not be taxable, but these come after the taxable parts which must be accounted for first.

3. In some cases, the New Zealand resident beneficiary needs to account for the income or losses on the underlying assets from the day of death of the parents.

Common Reporting Standards (CRS) - NEW!!

First reporting period 30/06/18.

If you have a Trust that meets both of these requirements:

50% or more of assets in financial assets (i.e. investment in Craigs Investments)
And the financial assets are managed (i.e. Craigs Investments manages the portfolio for you)

then the Trust will need to go through the self-certification process - Need to ask the account holder whether they are a relevant foreign tax resident. The Trust will need to keep a record of the self-certification and the process they used to obtain it. You can find more information on forms IR1052 and IR1053 on the IRD website: www.ird.govt.nz.

Kind regards
Ross Barnett

Desperate to Buy Your First Rental?

9 April 2018

Desperate to Buy Your First Rental?

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John and Lisa are desperate to buy their first rental and jump up the property ladder. They purchased an average first home in 2011 for $340,000 (around the NZ median at the time). They started with around a $270,000 mortgage, which they have managed to get down slightly to $240,000. John earns $90,000 per annum, and Lisa earns $30,000.

They are good with money, have no HP’s, and no outstanding credit card debt. John and Lisa want to get ahead and have just changed their loan so that it will be paid off over 10 years.

At the start of 2017, their property has jumped in value and is now worth $490,000 (around the NZ median at the time). They can now borrow 80% ($392,000), or an extra $152,000 towards an investment property.

They initially look at buying a normal rental, but with only 60% lending at the time through banks, it seems too hard and their price range seems too low. They could only buy something for $380,000.

They talk to an investment property company, who convinces them to buy new, as the banks will now lend them 80%! John and Lisa buy an investment property for $599,000 with a furniture package, and rented for $570 per week.

The rental would have a cash deficit of around $5,100, but after large chattels depreciation on a new property, the tax refund should be around $3,600 if structured in the best way. So’ overall’ a cash loss of $1,500 per year.

They earn $120,000 per year combined;

Less Tax $24,890

Less Personal House mortgage $29,568

Less rental shortfall $1,500

$64,042 remaining for everything else.

One year later – 2018

The tenant has moved out. The market has changed slightly and there are no longer tenants for fully furnished. So, John and Lisa rent for $490 per week without the furniture. They are lucky that they have a shed they can store the furniture in.

The rental cash deficit has increased to $8,700, and after-tax refund of $4,500, the cash shortfall is $4,200 approximately.

The property market has been reasonably flat, and John and Lisa purchased quite high through the property investment company, so their rental is still only worth $599,000, if they are lucky.

Another year later – 2019

Labour and IRD have ring fenced property losses (expectation at 8/4/18). The rental is now a cash deficit of $8,700, but no tax refund. So it is costing them $167 per week to top up the rental.

The property market has been reasonably flat, and John and Lisa purchased quite high through the property investment company, so their rental is still only worth $599,000, if they are lucky.

They still earn $120,000 per year combined;

Less Tax $24,890

Less Personal House mortgage $29,568

Less rental shortfall $8,700

$56,842 remaining for everything else.

HOW DOES THIS STORY END?

There are multiple possible endings, and you can choose your own ending!

1) Property prices jump in value. John and Lisa’s personal house has jumped to $790,000 value. Their rental has jumped to $700,000 value. John and Lisa are extremely happy and looking to buy more rentals.

2) Interest rates go up 1%:

a. John and Lisa’s personal house payment goes up $1,404 for the year

b. The rental cost goes up to $14,700 per year or $282 per week.

c. Their remaining cash for other costs is down to $49,438 per year.

3) Property prices remain flat for 5 years:

a. John and Lisa have put $32,000 approximately of their own funds (after tax refunds) in the rental to top it up.

b. The rental is still worth $599,000 on a good day and the mortgage is $599,000. So, no equity.

4) Property Prices have fallen over 5 years:

a. $32,000 top up

b. The rental is worth $549,000, and the mortgage is $599,000, so negative $50,000 equity.

5) John gets cancer and can’t work …

The one good thing that is happening in all options, is that John and Lisa are quickly paying off their personal house. So, if they can get through 10 years, and have paid off their personal house, then they will have surplus cash that could pay off the rental. They also have a reasonable household surplus, so can perhaps afford to tighten their belts a little and push through harder times.

I don’t have the perfect answer how this will end either. In my opinion, this isn’t a great situation to be in. John and Lisa are stuck and really reliant on capital gains. They will struggle to buy more rentals until their current properties have jumped in value. Ideally, I think they should be saving a little harder and paying principal on the rental to create a buffer in case something goes wrong. And obviously point 5) highlights that they should discuss their affairs with a risk broker and maybe have some income protection insurance, trauma or life insurance.

I hope this has got you thinking a little bit? What is your goal, and if you are buying a rental, will the rental actually help to achieve your goals?

I think the simple goals for most people are a debt free personal home and passive income!

Kind regards

Ross

YES! I want to learn more about property investments.

Best Accounting Advice Promo Blog

More Realistic New Investor 3 Rentals in 3 Years

More Realistic New Investor 3 Rentals in 3 Years

What Is Needed For A New Investor to Buy 3 Rentals In 3 Years?

Ring Fencing of Rental Losses and 5 Year Brightline

This Person Was Unaware of their $50,000 Tax Liability

Desperate to Buy Your First Rental?

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