Property investment: Is it still worth it?

Thursday, 2 May 2019

Who'd be a property investor in 2019?

A capital gains tax might be off the table but there are still several changes happening that make it less appealing. Properties will soon have to be brought up to higher standards of insulation, ventilation and heating. Losses on rental properties are now ring-fenced, so they cannot be used to offset other income. The bright-line test, applying income tax to capital gains, has been extended to properties bought and sold within five years.

With the prospect of capital gains slimmer for the time being in many major centres, it might make you ask whether it's a sector worth dabbling in, at all.

But many New Zealanders still cling to property investment as the best way to 'get ahead' and prepare for retirement.

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Last year, 313,596 taxpayers - excluding companies - filed returns that declared rental income for residential, industrial and commercial property investments.

Property investment is more tangible than shares. The fact you can borrow from the bank to get started also amplified potential gains (although it would also magnify losses). 

Rental returns are getting better: Corelogic data shows since the start of 2018, rents have risen at almost double the rate of house prices across the country.

If you've been thinking you'd like to get stuck in, here's how you might do it.

Starting out:

The easiest way to get started is probably to buy your own home first, build up equity in it (as prices rise, you pay down the mortgage, or both) and borrow against it.

When you are buying your own home, you can use your KiwiSaver money and might be eligible for other grants - these are not available for investment property purchases.

At the moment, the banks are required to ask for at least a 30 per cent deposit from all investor buyers.

That's a significant amount if you're buying in Auckland, where the median price is now $856,000, according to the Real Estate Institute,.

But if you bought a house five years ago, when the median in Auckland was $570,000, you might have built up enough equity to borrow against to buy another place, particularly in a cheaper area.

Broker Glen McLeod, of Edge Mortgages, said banks would allow buyers to increase the debt against their own homes to up to 80 per cent of the property's value. They could then use that money as a deposit on an investment.

If you don't have a hope of getting that much deposit together, McLeod said there were other ways.

'We have a couple of non-bank lenders that will enable customers to borrow up to 80 per cent or 85 per cent [of the purchase price] depending on the circumstances.'

He said this would sometimes mean paying a higher interest rate.

McLeod said banks would look more favourably on an application from a new investor if there was no short-term debt or the borrower could consolidate it with the new loan.

Banks include 75 per cent of projected rental income in their calculation of whether you can afford to pay back the mortgage.

What to buy

Investors usually approach their purchasing decisions with one of two aims: Either buying a place where rent will more than cover the mortgage, and give an ongoing stream of income, or picking somewhere where they expect capital gains.

Generally, more expensive houses have yielded better capital gains but poorer rental returns.

If you bought a Southland house, which Massey University's latest survey shows are the most affordable in the country, and it increased in value by 10 per cent you'd make about $30,000.

But if you bought a Wellington house, you'd make just over $60,000.

Property investors solely seeking capital gains might hold off in the current market where prices are showing weakness.

But those looking for income can probably find opportunities, regardless.

Corelogic data shows that someone who bought a house at the average value in Wairoa would get an annual return of 9 per cent on their investment at present - about three times what you might get in a bank savings account.

'Add in the growth that some of these areas have also seen in property values over the past year and the total returns look even more impressive – typically at least 20 per cent for the areas in this list,' said researcher Kelvin Davison.

He said while the lowest-yielding suburbs, all in Auckland, had 'depressing' yields as low as 1.3 per cent and property values sliding, that was after huge capital gains in recent years.

Strategy

Over recent decades, investors have ridden capital gains to increased wealth - seemingly without having to do a lot.

Economist Cameron Bagrie, of Bagrie Economics, says that situation has changed and many will need to reassess their strategy.

Graeme Fowler, a property investor and mentor, said it was harder to use property to create wealth quickly in a slower market. People would usually do this by buying, renovating and selling for a profit.

'This is far more difficult to do in a declining market because when it comes to sell the property maybe a couple of months later, prices may have dropped even further.  Also, there are a lot less buyers around to purchase properties in a down market and the property trader may get stuck holding these trade properties for a very long time.'

But he said those who were buying and holding - a strategy he called 'wealth retention' - could benefit in a declining market.

'When the supermarket has a sale, people rush in to buy way more than what they normally would - as they're getting a bargain.  When the property market has a sale, most investors run away from it like a scared cat, however the smart investor would be like the smart shopper and look seriously at buying more.

'So, if you can purchase rental properties at a bit of a discount with good yields, above 7 per cent gross, then it doesn't matter at all what prices are doing.  What the property may be worth 20  to 25 years later when the mortgage is fully paid off is of very little importance.'

He said some investors would try to use buy-and-hold strategies to create wealth, hoping to ride house prices to big gains.

'For these investors, they are always concerned about what property prices are doing, trying to guess what's going to happen and waste a lot of their time thinking about something they have no control over.  By having good safe strategies in place - what prices do over a five-, 10-, 20-year or longer period has no effect on their overall plan, as it will work well no matter what property prices are doing.'

He said investors should build a solid foundation and a safe strategy, paying down mortgage debt each year.

'By sticking to the basics, I mean buying properties that are the typical type of property that tenants like to rent in your chosen location.  Where I live in Hawke's Bay, the easiest and most popular properties to rent are three bedrooms, a good size section, post 1960s and preferably have a garage as well.'

He said investors with yields too low could hit cash flow problems if they had to pay for maintenance or to meet new regulatory requirements.