For a huge number of New Zealanders – more than 130,000, in fact – owning an investment property is a key part of their wealth creation plans.
Whether it’s a single property bought with the aim of creating a secondary passive income to help in retirement, or a growing portfolio that expands year by year, investing in homes just makes sense to many of us.
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Why invest in property?
Choosing a place to invest
Eligibility for buying property in New Zealand
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10 mistakes to avoid in property investing
Property investor’s checklist
New Zealand needs rental properties. The number of households renting is increasing each year and the bulk of those are living in homes provided by private landlords. This creates plenty of opportunity to use property as a way of building your own wealth.
For many investors, the appeal is that, when you’re buying a rental property, it’s an asset that you can see and feel.
If you want to know how your investment is faring, you can pop over and have a look (with adequate warning to the tenant, of course). Because we all understand how a rental property works, it can be easier to relate to investing in a home than in something less tangible such as shares.
Property investment is one of the few investment vehicles in which you can use other people’s money (in this case, your lender’s) to get to your goals.
You know you want to be a property investor. But where do you want to invest?
Some people choose to buy investment properties in their own neighbourhoods because they know them well. They know which sorts of properties are popular, understand what tenants are looking for and know the things to watch out for when selecting a place to purchase. Buying an investment near your home can be helpful if you’re planning to manage the property yourself, too.
But other people look further afield, particularly if they are investing in several properties. Diversification gives you broader exposure to the market and you may identify opportunities in areas that are a little further from home.
There are a few things to consider if you’re deciding where you want to buy.
There are still some parts of the country that have very cheap house prices. While these may look like a great deal, there are some points to ponder before jumping in.
Consider the population of the area. Is it made up of young families, or mostly older people? Is the population noticeably ageing? This can affect the sort of property that people want to rent, how much they can afford to pay and the pipeline of future tenants.
What sort of employment is available locally? People usually want to live near their jobs (or where they are studying). If there is limited employment in the area, that may mean less demand for housing. If there is only one key employer, you may be vulnerable if that business was to decide to move out of town.
How is the local economy faring? We talk about the country as a whole but it’s often a mixed picture between regions. Some might be booming while others struggle. You’ll tend to see the best rental price growth and capital gains in places that have a strong local economy. Understand what drives it before you jump in.
Standard advice is often to look for a place that is near key public transport infrastructure and roads, with good access to local amenities. Being in a convenient location not only makes your property desirable to tenants but pushes up the value.
If you know there are key developments planned for an area, you could look to buy before others cotton on to the increasing opportunity. Good examples of this are areas where new roading or public transport connections are planned, or commercial hubs that will attract jobs.
You’ll also need to decide whether you want to buy a new or existing home. There are benefits and drawbacks to each.
A new home should have very few maintenance issues, at least for the first decade or so. You can also pick exactly what you want and ensure it meets all the required regulations, and you’ll have a warranty from the builder.
The benefit of existing homes, however, is that they tend to be more plentiful in the sought-after central suburbs of cities and towns.
You can also thoroughly check out what you’re buying before you sign the agreement and won’t get caught by any unexpected or expensive delays during the building process.
There is usually more opportunity to add value to existing homes than there is to new builds – you may be able to get an existing place that is a bit rundown at a sharp price and spend a bit of cash on it to significantly improve its value.
One of the questions that many new property investors have to grapple with is whether to pursue an investment for its capital gains or yield.
In Southland, where the median purchase price was just under $340,000 in September 2020, the median rent on TradeMe was $340. In Auckland, the median house price was $955,000 and the rent $570. That means the yield on the cheaper house is much higher.
Yield is calculated as the annual income of a property divided by its purchase price.
The catch is that capital gains are usually better on more expensive properties.
Even if all the houses in a city increased in value at the same rate, one that is worth $500,000 will only increase by $50,000 if prices go up 10 per cent, while one that is worth $2 million will gain $200,000. It’s often the case that more expensive areas have stronger value increases, or have less weakness in downturns.
Whatever your strategy, it’s a good idea to think through why it’s appropriate for you and what you hope to achieve.
Generally, cheaper properties have higher yields. That is because the difference in rent between a cheap house and an expensive one is not as great as the difference in purchase price.
In 2018, the New Zealand Government passed legislation to prevent most overseas buyers from buying real estate in New Zealand. The legislation was designed to slow down foreign capital pouring into an already overheated housing market.
If you are a New Zealand citizen living overseas, or a permanent resident residing in New Zealand, then the new law doesn’t apply to you and you are free to buy property. If you are overseas and need to borrow money, the property will be deemed for investment and the maximum loan to value ratio will be 70 per cent, meaning you need a 30 per cent deposit.
The same is true for Australian and Singaporean citizens who can purchase in New Zealand due to free-trade agreements with both countries.
Developers can apply for an exemption for their developments and foreigners can buy into these developments.
As far as borrowing goes, banks are typically hard to deal with when it comes to foreign based income. They will only accept PAYE income and from reputable employers in reputable countries. If you are self-employed or a contractor, then it becomes very difficult to satisfy bank criteria even if you are a New Zealand citizen.
Rents in New Zealand will be too low to demonstrate servicing purely off that income so there will be reliance on offshore income to meet bank criteria.
Banks will shave foreign income by 20 per cent to 30 per cent before they calculate servicing and in New Zealand the ability to service a mortgage is tested at the servicing rates of 7 per cent we talked about earlier.
You are likely aware that LVR rules have changed recently and most banks are now considering up to 80 per cent lending for property investments, however for overseas purchasers this is deemed higher risk and banks still have a minimum of 30 per cent deposit required.
Banks will be difficult to arrange finance through, so foreign buyers who are not citizens and that need to borrow some of the purchase price will need to get funding through non-bank lenders. This is typically at mortgage rates of 3.39 per cent to 7.5 per cent.
Non-bank options can go as high as 80% LVR for New Zealand or Australian citizens working in Australia and the servicing criteria.
Everyone has to start somewhere, so rather than launching straight into building a 5-storey apartment block complete with underground parking and tennis courts, it’s smarter to start out a bit smaller and closer to home.
Making this decision should be based on some goals and a good strategy. Ask yourself honestly: does my house fit the bill? Is it likely to yield good results or go up in value? If the answer is no, then you’re better off selling up and using the money to buy a better investment.
They make sense on so many levels and can also help you buy in an area you might not otherwise afford. It’s a great idea to look for actual grannies to live in your granny flat. They tend to value the security of having a family close by, are reliable and quiet and much more tolerant of family noise than other types of tenants. Good old nan.
Ensure when you’re considering buying or developing that it’s permitted and consented as either a home and income or home and granny as different rules apply around separate tenancies. Any additional utility rooms like kitchens and bathrooms need to meet the appropriate council requirements and be signed off. Failure to do this often invalidates your insurance and makes the property unacceptable security to a lender.
It might feel like you’re adding value and cashflow to a property but if it’s not done right, it can reduce the value and appeal of your property as it won’t meet bank criteria. Banks won’t count two rental streams from one property if it is not legally recognised as two places of residence on the legal description.
You need to add value to your properties so you have more equity to borrow against. Home and income properties are popular and perform well in every market as long as they are compliant.
Sacrificing higher rents in the short term can be a hard decision, but it’s much smarter to invest in a lower quality property where you can own more equity. This is the old “location, location, location” thing. Good school zones and proximity to public transport and shops will always perform better than poorly located isolated properties.
These are apartments of less than 45sqm and properties with more than 3 incomes. Get rid of them, even if they’re cheap and give you good rents; banks will typically only lend up to 70% of their value (if that), so they’ll hold you back from borrowing what you need. Same with serviced apartments and student accommodation – these can absorb more of your home’s equity than you realise.
You’ll want to put as much into your investment property as possible so it’s tax efficient. The way to do this is to sell your existing home to a Look Through Company or an LTC, which you own. The LTC buys the home at a fair market price and then borrows 100% against it. You then provide a personal guarantee to the lender using your new property as additional security.
You use the proceeds of the sale to clear the mortgage on the old property and put any extra into your new home. In this way you can move the equity from your old property to your new home.
In 2020, we no longer qualify for actual tax returns based on the losses on your rental property but they do accrue and stay in the entity until it becomes profitable. Then once those losses are fully absorbed your rental property can become taxable income. This is based on surplus income after all the expenses of rates, interest, insurance, body corp etc.
In practice you can sometimes have a tax bill on surplus rent over expenses while you still have a mortgage at home.
NB: the principal portion of a rental property mortgage is not a deductible expense. We avoid the language of tax deductible now and prefer tax efficient.
Town planning rules artificially drive land values, so it’s worth understanding them and keeping up to date. For example, under the current Auckland plan, land that has changed from commercial or residential to mixed-use can significantly change the value of land.
For example, have you got the money to cover three months’ home loan payments if your property lies empty or the rent is unpaid for a time? It’s a good idea to have a flexi overdraft home loan account for say, $20,000 to cover unforeseen expenses and gaps in income.
For the majority of us, a property manager can be well worth it. They will both increase your capacity to own more and reduce the worry and pressure that can come with owning multiple properties.
Body corps sometimes have a loss of rent included in the insurance as long as you are meeting the inspection requirements and have done credit checks and collected bond, vetted tenants and reference checks up front.
Explore the option of having landlord inspection insurance.
Only if you are going to hold them to the same standard as a tenant. If you make the rent too cheap then IRD may consider you are depriving yourself of income and that discount may be subject to taxation so ensure you are within an acceptable and comparable range of like properties. You can be at the low end, but not $200 a week for a $400 a week property. Ask yourself: when family don’t or can’t pay, what are your rules?
Ensure you are educated and informed prior to settlement day of your rental property and that you have engaged with your mortgage adviser. The bank is fully entitled to request all proceeds of the sale. Any residual loans you have are also considered by the bank because they want to ensure you can still afford the loans that you want to keep.
Sometimes investors have many properties plus their home, with multiple loans. The investor attributes a loan to a property whereas the bank looks at all your lending and security. This means you don’t always have to pay down the loan you took out for that particular property. There may be a loan with a lower break fee or a combination of reductions that can be applied to the settlement scenario. Be sure you have a plan on the way in and on the way out that is both understood and supported by your lender.
The banks have to subscribe to a responsible lending code which means they have approved your loan for 25 or 30 years. So for example if you have been paying interest only for 5 years then you only have 20 years to pay off a 25 year loan meaning your payments could be substantially higher.
Interest-only is basically renting your money from the bank. If your plan is to have passive income in retirement then you need to work towards paying the loan off in time. The most efficient way to get there is a principal-and-interest strategy from day one.
A reduction in value would only matter to the bank if there was a sale. It might assess the loans you want to retain and the value of the securities the bank has, coupled with the reserve bank LVR policy of the day.
Interest-only is a strategy for cashflow efficiency and that’s it.
Firstly, why is the bank saying no?
If it’s affordability then you need to ask yourself whether the bank might be right. Can you really afford it and does the bank understand your income and expenses fully from all sources?
It might be a no because of the quality of the security if there are unconsented works or improvements on the property. This could be a granny flat with no permit, no firewall for a kitchen, load bearing walls removed, the list is endless. You’ll need to understand the insurance risk around the issue and if you still want the property then you can negotiate some time and allocate some funds to get a COA (certificate of acceptance) from the council and insurance company and present that to the bank with a quote of all and any work that needs to be done to make it compliant.
If it’s a plaster house and there could be weathertightness risk, or issues that may mean the property may not be able to be legally tenanted, you may need comprehensive testing to provide evidence to the lender the home is ok. If it needs a reclad then full costs and quotes will be required and assessed for affordability as well.
If after all your considerations you still want it and banks are saying no, then there are non-bank lending solutions that range in price. There is often a Yes out there but it comes with a price such as bigger deposits or multiple securities. Your mortgage adviser can explain the total cost and pathway into and out of these things as you need to be clear on what is required of you and what is your exit plan back to main bank and best priced lending.