The traditional favourite for New Zealand investors
Investment property has been a very popular investment up and down the country for reasons including the following:
- Leverage. Real estate is one of the few investments where you can borrow funds to invest more than your available capital, and increase your overall return on investment.
- Control. You have control over most parts of the investment. This includes control over:
- Whether you or someone else manages the property
- Any improvements that can be made (renovations)
- How you structure your lending for the property.
- Rental income. Rental income can be put toward repaying a mortgage and/or providing passive income.
- Tax advantages. There is a chance your rental property will give you tax deductions you can use against your other income, reducing your overall tax paid.
- Security. Buying an investment property means you’re buying a physical asset you can literally touch if you wish. Many people can be more comfortable with this type of investment when compared with a range of other investments.
Rental income - calculations are key
To make the most of the advantages above, a key step to successfully investing in property is to do so with minimal emotion and ensure that your long-term goals are backed by robust calculations.
Costs can easily make the difference between an investment property purchase being a good opportunity versus a long-term drain on finances. To help identify this, two common measures are:
Gross rental yield
Gross rental yield is the rental income received relative to the value of your investment property. To calculate gross rental yield, divide the annual income from the property by the purchase price and multiply by 100 to get the percentage rate of return (yield).
Rental Return on Investment (ROI)
Rental ROI is the rental income received relative to your equity or investment in the property. It's important to factor in the costs associated with the borrowing required to buy the investment property, along with the other expenses incurred from maintaining and managing it such as rates, insurance, property management, and upkeep. To calculate Rental ROI:
- Determine the total rental income per year and subtract total expenses associated with the rental property for the year (such as mortgage repayments, insurance, rates, maintenance etc). The resulting figure is also known as the ‘net operating income’.
- Divide this by the total amount invested (your equity or investment in the property). Also include the cost of any improvements you’ve made.
- Multiply by 100 to calculate the percentage Rental ROI.
Potential for capital gains
Along with rental income, capital gains are the second form of income from any property investment you make. You achieve capital gains when the value of your investment property increases.
Returns from capital gains depend on movements in the housing market and usually take longer to achieve than rental income returns. Keep in mind that while property values tend to increase over the long term, they can go down as well as up. One strategy for achieving capital gain is to look for investment properties that you may be able to purchase for below their market value, or in areas where you think house prices will increase because of factors such as rapid population growth or the development of new infrastructure in the area.
Combining rental income and capital gains
As an investor, it’s usually wise to buy investment properties that can provide both types of investment return. Different investment properties will provide different levels of capital gain and rental income. It’s up to you to decide on your investment goals and the most suitable properties to achieve them.
The impact of leverage on the return from your property investment
In a property investment sense, leverage is the term used to describe when you buy an investment property using funds you have borrowed - most often from a bank - instead of using your own. Property investors have access to much more leverage than investors in many other asset classes. The more you borrow, the more you're said to be "leveraged". Leverage is one factor that can accelerate your investment return. If your investment property goes up in value, the higher the return on the actual money you have personally invested. On the other hand, it also increases the risks if your investment property or properties go down in value.
This is when your expenses and outgoings (such as interest repayments on your home loan) are higher than the rental income, which often happens during the early years of owning an investment property. In effect, you are making a loss on your investment - but you can offset that loss against your income tax. This tax advantage is one of the key benefits of negative gearing.
Investors following a negative gearing strategy often choose interest-only loans, because they increase the tax-deductible expenses on your investment property (as you’re not repaying any principal). You should seek professional advice when following a negative gearing strategy.
Financing investment properties
Getting funding from a bank or other source is usually the easiest part of the lending process.
However, many people don’t think about how they structure their property investment lending, for example, whether they should be principal and interest, interest only, or revolving credit. Often, a modest sum on a revolving credit account can be good for property investors because rent payments could come in and immediately offset the interest accruing on a loan, while most of the remaining lending is fixed to take advantage of lower interest rates.
To make the most of property investment, and protect yourself from certain risks, there are also plenty of other considerations for property investment financing. These include separating your property investment portfolio and using different methods to unlock equity in one property to purchase another.
Talk to an expert
Over recent years, many areas of New Zealand real estate have experienced significant increases in value, though unfortunately for property investors, rental incomes have not experienced the same growth rates. Additionally, most commentators agree that returns from New Zealand property over the next 10 or so years will not be the same as the last 10 or so years. This means that seeking advice from an expert, preferably an Authorised Financial Adviser (AFA), regarding affordability is a must.
As property investment is such an interesting subject, many of your friends, relatives, and colleagues will readily share their own tips on property as an investment. When given such advice, proceed with caution, as although many of these people may mean well and are often successful property investors themselves, this is no guarantee of future success in the continually developing property market. This is where Milestone Direct’s AFAs can provide professional advice based on economic fundamentals, helping you remove emotion from the situation and focus on what you want to achieve.
For your information, our free resource, the Periodic Table of Investment Returns, is a graphic display of annual returns for various asset classes (types of investment), ranked from best to worst across the last 10 years. It displays the yearly return for New Zealand property in dark green.
Owing to years of growth in residential property, the capital gain from real estate has been a great way for many Kiwis to build wealth for retirement. As rental income in relation to property value is now typically quite low in the main centres of New Zealand, it can be tough to live off the rent after all expenses are paid.
Therefore, if you’re aiming to retire with a robust passive income flow, calculating the investment yield on each property is crucial to understanding the current or future income that will be provided. In many cases, on reaching retirement, Milestone Direct clients decide to sell some or all of their property portfolio and invest the proceeds in a more diversified portfolio which can better provide their retirement income.
To assist you with investing in real estate, Authorised Financial Advisers from Milestone Direct can find you a great mortgage rate, confirm your cash flow and budget options are viable, and also ensure you have a solid team of legal and real estate professionals on your side.
For a free, no obligation consultation with an Authorised Financial Adviser about how property investment can work for you, call 0508 MILESTONE (0508 645 378) or leave your details and query below. We'll respond within one weekday.