Becoming a residential property investor

Start with the end in mind. Property is a long-term investment, and unlike Monopoly where you buy pretty much everything you land on you’ll need to outline your financial goals and develop an investment strategy towards achieving them.

We can help you consider all your residential property investment options.

Can you afford a rental property?

Property investment is a great way to build wealth over the long term, with the returns from property derived two ways; the rental income or the capital gain on future sale. Depending on your goals, your property investment strategy may favour one of those more than the other.

Properties that tend to have higher capital growth rates tend to have lower rental yields and in some cases be negatively geared (meaning the rent doesn't cover all the property related expenses requiring you to top up a portion of these). For that reason most first time investors will target positively geared properties where the rental income covers all expenses for their first investment purchase.

To borrow towards purchasing an investment property you need:

  • Serviceability: You need to evidence you can service the loan at the lenders test interest rate over the loan term.

  • Deposit or Equity: You need to contribute 20-40% of the value of the purchase. This can be via a cash deposit, but it can also be via equity you have accumulated in other property.

Using Equity in your home to buy a rental property

Many first-time property investors get started by leveraging the available equity they have in their home.

Here’s how it works:

  • You purchased your home for $500,000 with a 20% deposit ($100,000) and so your initial loan was $400,000.

  • 4 years have passed since then and your loan is now $360,000 and your house has gained in value to $680,000.

  • Because you can borrow up to 80% of your home's value, the bank is prepared to lend you up to $544,000 against your home.

  • That additional $184,000 that you can borrow is called your available equity and can be used as your ‘deposit’ towards your investment property. If the lender only requires 20% ‘deposit’ that means you could buy investment property worth $920,000 ($184,000/0.2) assuming you meet servicing requirements.

  • In actuality you are still borrowing the full amount of the investment property, but this available equity allows you to do so.

Existing vs New Builds

There is no right or wrong answer as to whether you should buy existing homes, build new or buy off the plans. It comes down to your investing strategy and there's two major aspects to consider. Your financing strategy and whether your seeking yield or growth.

  • Financing strategy: Banks treat existing homes and new builds differently. The biggest consideration is that new builds are exempt from the Reserve Banks LVR policy. That means most major banks will lend up to 80% of a new build’s price, where they will only lend up to 60% on existing homes (although there are second-tier lenders who will lend 80% on slightly higher interest rates). That deposit variance can mean a big difference in what you're able to afford.

    The other consideration is that new builds can encounter cost overruns. So even if you have a fixed-price contract with a builder most banks will account for at least a 10% increase in the build cost. If your servicing is tight, then this might make an existing home a more achievable option.

Other things to consider:

  • New builds often come with a 10 year Masterbuild Guarantee and should require little maintenance in their first years.

  • New builds can be sourced directly from builders and developers, reducing the hassle of having to participate auctions and tenders.

  • New builds are immediately compliant with current tenancy laws and generally easier to rent.

  • Older homes are often centrally located or sitting on larger parcels of land with future development potential. As land is what appreciates these can often have higher capital growth.

  • Older homes may require updating to meet current rental standards.

Property vs other investments

Property is New Zealand's favoured investment asset and for good reason. Let’s look at some of the pro’s and cons of investing in property vs it’s closest alternative the share market:

Pro’s

  • Many investors like the tangibility of owning bricks and mortar (there is a very low chance the asset will go to zero).

  • New Zealand doesn't have a capital gains tax.

  • Property investment can be highly leveraged, allowing investors to use large amounts of the bank's money to invest.

  • It can provide stable and predictable earnings for passive investors.

Cons

  • Limited diversification, although if it forms only part of a balanced portfolio diversification can be increased.

  • Less liquid (takes a longer time to sell) and has a higher transaction cost (real estate fees).

  • Personal liability for full loan value plus costs, whereas with shares you are limited to the value of your investment.

  • Property management can be outsourced but does require some input from owners.

Creating a property investment strategy

At its simplest, there are only two property investing strategies:

1. Buy and hold - renting the property out

2. Trading - buy and sell for profit

However below the surface there are a bewildering number of different approaches - each suitable for differing types of people, approaching different goals. But before we dive into these approaches it’s important to consider the two overarching strategies and how these ultimately meet your financial goals, including how active or passive you want your investment to be and the level or risk you're willing to take on.

In reality most successful long-term property investors portfolios contain a bit of both. In addition to the diversification that offers it helps them grow their portfolio faster, as both equity and serviceability are required for a good long-term financing strategy.

Buy and Hold:
So you're holding for the long-term, is your goal passive income or a future windfall.

Understanding your goal will help you determine what properties you’re looking to buy. Cash flow positive properties (which cover their expenses) to provide regular income, or high capital growth properties which are often cash flow negative and require you to help cover their expenses over the short to medium term.

The Ultimate Guide To Property Investment

The ultimate guide to property investment

At Simpler Financial, we’ve got our fingers on the pulse of the property investment industry.

If you’re serious about achieving financial freedom through property, then this guide is for you.

We can help you avoid the common pitfalls, steer clear of the costly mistakes and reach financial freedom in the shortest possible timeframe.

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