The ultimate guide to buying an investment property

Property investment is a way to make your savings grow. If you can afford to buy a second, third or subsequent property, your tenants will pay much or all of the mortgage and other costs as you slowly build up capital gain in the background.

It’s a great way to set up your retirement. Investment properties can give you passive income - that’s money you earn even when you’re not working. Or you can sell the properties in retirement and supplement your New Zealand super with the money.

OneRoof has written this guide as an introduction to property investing and becoming a landlord. It covers how to buy right, manage your property and tenants, and many of the legal and tax issues involved. Armed with information you can become a successful investor from the beginning.

THE BASICS: YOUR FINANCES AND STRATEGY

• YOUR DEPOSIT: Most investment properties require a higher deposit than those properties bought as main residences. The Reserve Bank of New Zealand sets minimum loan-to-value ratios (LVRs) for investment properties but banks can require an even higher deposit. Many first-time property investors borrow against their own home to release a deposit for their first investment property.

• YOUR MORTGAGE: Investment property mortgages are often the same products offered by banks to owner occupiers. Investors, however, often choose to pay interest only, rather than interest and principal. Monthly repayments on interest only are lower, which means the rent is more likely to cover your costs. Some investors choose a revolving credit mortgage, which is like a giant overdraft, because it makes it easier to withdraw capital for new properties. Investors can sometimes struggle to get loans from banks and turn to non-bank lenders such as finance companies, which often charge a higher interest rate, but can be more flexible in their lending rules, says Rupert Gough, mortgage broker and chief executive at The Mortgage Lab. A broker can help you through the pre-approval and loan application at no extra cost to you. They can also avoid dangers such as “cross collateralisation”, which is where banks get you to sign an agreement that links all your properties together. If you can’t pay your mortgage, the bank can then choose which of all your properties to sell first, including the one you live in.

Check with your bank as to how much deposit you’ll need. Photo / Getty Images

• STRATEGIES: Your strategy is a plan of what you want to achieve in property investing and how you will go about it. You may be a “buy and hold” investor who buys and lets standard three-bedroom homes long term to tenants. Or you could be a trader, who buys to resell. Some property investors buy homes on large sections that can be subdivided or add minor dwellings (small homes) to the property to increase the rental return. You might buy “boarding houses” where tenants rent by the room. Or you might prefer beach properties to list as short-term rentals on the likes of Airbnb or Bookabach. Some investors prefer apartments because there is a lot less maintenance to do.

WHAT TO BUY

An investment property will most likely be very different to your own home.

Where to start? Start your hunt for the perfect investment property by setting up a search on OneRoof. You can narrow the search down if you only want a free-standing house, for example, or a property in Fielding or Oamaru. If you don’t know what to buy, says says OneRoof property commentator and property investor Ashley Church, keep your search very wide. Play around with the functionality. Wherever you’re buying you need to consider the local economy. Is the town going up economically, or down? Is the population going to rise or fall? These factors will affect the rent you receive.

• SMALL TOWN OR BIG CITY? Your deposit may not be sufficient to buy in the city or suburb where you live. Plenty of investors look elsewhere in the country. The town you come from originally is a good place to start, says Church. Small towns often have lower property prices (and rent) but have better overall returns. Check out OneRoof’s market trends and property reports for the areas you’re looking at and dig deep into the data. Search on an individual property and you’ll find a wealth of information about it, question including the rental return , median rent and annual capital growth statistics, broken down into types of homes. You can also check out recently sold properties in the area, which will give you a feel for what you should be paying. OneRoof has very detailed data on affordability, school zones, and a dedicated investment property search.

Properties outside of the big metros may be cheaper to buy and offer higher yields. Photo / New Zealand Herald

• THE PROPERTY CYCLE: Property goes up in value (and occasionally down) in fits and starts. It’s not a straight line, and your capital gains and rental returns will be better some years than others. The cycle is often described as clock. The boom is at 12pm, the bust at 3pm, the market bottom at 6pm and the recovery at 9pm. If you’re buying to make a quick buck on a rising property market, then the top of the boom is a bad time to start. If you’re buying for the long term, however, the cycle will come around.

CHOOSING A PROPERTY

The basics of choosing an investment comes down to the type of property, the location, and your price point. You’ll be looking for a property that commands good rent in relation to what you paid, and preferably good prospects for increasing in value over time. You can’t always get the best of both in one property.

• LOCATION: Just like your own home, location is important, but you need to think like a tenant. Being close to employment is a selling point. If you’re buying in a smaller town that has one major employer, consider what could happen if that employer closes. If the tenants are young, they may want to be close to the centre. If they’re a family, then proximity to good schools matters. Good transport links can be a real selling point. If you can afford it, buy a property in better streets and suburbs. Don’t make the mistake of buying next door to the gang headquarters or in a street with a history of burglary. It happens. Likewise, be wary of being too close to smelly industrial areas, or under flight paths. Unhappy tenants move on, and turnover costs you in advertising costs and lost rent.

Apartments are popular with first home buyers, renters and investors. Photo / Fiona Goodall

• PROPERTY TYPE: Investors often favour three-bedroom free standing houses. These tend to rent more easily than properties with fewer bedrooms. As a first-time investor, a smaller low maintenance property could be a steppingstone. Apartments used to have a bad name, says Church, because of the poor construction methods and materials in the early days. They’re becoming more mainstream in all parts of the country and can be a good investment. The body corporate will maintain the outside from your annual levies, which makes an investor’s life easier. The disadvantage of some blocks of flats, apartments and homes on cross leased sections, is you will be limited in ability to make alterations. Some investors buy properties that need work to bring it up to rentable standard. You’ll pay less relatively for a do up. As a first timer, however, you might want to buy a property with the work done to reduce the learning curve. That is unless you have a strong trades or DIY background and are used to scoping out and completing work, says Church.

• DOING YOUR HOMEWORK: When buying a rental, you need to do your “due diligence”, which is a term that means homework. That means investigations about the property’s physical structure as well as potential issues such as difficulty to mortgage or insure, or problems with the title. Paying for an independent builder’s report, could uncover potentially expensive problems with the property such as rot or leaks. You’ll also want to read the council’s Land Information Memorandum (LIM). It can tell you about zoning, heritage information, land hazards. It also contains a summary of building consents for the property and records of Code Compliance Certificates. Many investors also look at the full council file, which will contain additional information such as any construction problems. Always make sure that your property is insurable before you sign the sale and purchase agreement. It can be expensive to do your due diligence in a hot market where you have no guarantee of winning at auction. It’s essential, however, to ensure you don’t buy an expensive lemon.

SHOPPING FOR AN INVESTMENT PROPERTY

Just like buying your own home you need to get out and visit as many properties as you can, especially for your first investment. It’s not uncommon for investors to visit 100 homes, shortlist 10 and buy one. You want a property that is desirable to tenants and always consider what they might be looking for. They might have young children and want a fenced back yard, for example. If the property has been rented previously, try to find out from neighbours if it attracted the right sort of tenant who stayed long term. Off street parking makes the home easier to rent and a garage is one step better. Internal garages are popular and so is indoor/outdoor flow, and ensuites. Heat pumps and insulation are a great selling point to tenants. The Healthy Homes Act makes insulation and a fixed form of heating in the lounge compulsory. Tenants rarely like living on main roads, near high voltage power lines, on properties overlooked by neighbours and those with poor natural light.

DOING THE NUMBERS

Too often first-time investors fall in love with a property. Investing, however, is business and the property needs to make sense financially. After all you don’t get emotionally attached to your bank account, says Church.

Factor maintenance costs into your finances. Photo / Getty Images

• RENT LESS COSTS: When doing your due diligence on a property, you need to get a rental estimate and then crunch the numbers to see if you can afford to own it. Ideally, you’d like the rent to cover your outgoings including mortgage, maintenance, insurance, property manager, and rates . Quite often, however, you might need to top up the rent from your own pocket to cover those expenses. Investors do that because they know that by holding the home the rise in value will make up for these ongoing costs. Most properties will double in value every 10 to 12 years, says Church.

Once you have an idea of the rent you can charge realistically on a property multiply it by 48 weeks, rather than 52, because invariably it will be empty for a short while between tenants. You then need to add up your annual expenses. If these expenses are more than the rent, you receive then you’ll be making a cashflow loss. You may be able to claim this loss against future profits on the property.

• MAKING A PROFIT OR A LOSS: You’ll hear negative and positive gearing talked about in property investment circles. A positively geared property makes a profit after expenses are deducted from the rent. A negatively geared property makes a loss. Many investors structure their investments so that on paper they make a loss.

MANAGING THE PROPERTY

Buying the property is only one part of property investing. You’ll need to find tenants and manage them or outsource some of that job.

• DIY management versus using a property manager: Tenants are human and it’s not always easy to manage an investment property. Some investors do become good landlords, but it takes a certain set of skills to manage a property, says Church. For some investors tenant management is a nightmare, and they end up losing thousands of dollars from unpaid rent or property damage. If you manage your own property, you’ll need to be available 24/7 to deal with emergencies and be on top of rent payments, inspections and other issues arising. Some landlords pay a professional property manager to do the day-to-day tenant/property management. It will cost around 8 to 10 per cent of the rent for a manager to handle tenant selection, prepare tenancy agreements, do inspections, handle tenant enquiries, deal with Tenancy Tribunal matters, and organise repairs, which you pay for separately. Church recommends you use property managers who are members of the Property Managers Institute of New Zealand (PROMINZ). Many property managers work from real estate agencies and are members of the Real Estate Agents Institute of New Zealand (REINZ).

A property manager can help unsure investors better handle their portfolios. Photo / Getty Images

TAX

Property investment is a business, and you need to pay tax on your income.

• TAX EFFICIENT: One of the reasons that Kiwis love property investment so much is that it’s tax efficient. That means you could pay less tax overall than if you invested in other ways.

• SEEK ADVICE: Tax isn’t straightforward. First you need to “structure” your property investment in the best way possible to ensure you minimise your tax bill, legally. You can own properties in your own name, with someone else, or in a family trust. But these aren’t the most tax efficient structures in which to own properties. A property accountant or lawyer can advise on how to use other options to your advantage such as limited liability partnerships and companies.

• CAPITAL GAINS AND THE “BRIGHT-LINE” RULE: Building capital is one of the key reasons to buy investment property in New Zealand. Unlike many other countries we don’t have a capital gains tax (CGT) in New Zealand, so you won’t usually pay tax on gains from properties owned for the purpose of rental. If, however, you’re a property trader, buying and selling homes in quick succession, you’ll pay income tax on your capital gains. In the past traders tried to fly under the radar and pretend to be investors. The government has cracked down on property trading in recent years, however, bringing in what it calls a “bright-line property rule”. If you buy and resell within five years, you’ll pay tax on your gains. Other tax rules that could catch you out include the “associated person” rule. You pay tax on the sale of a property if you had an association with (such as being married, related to or working with) a property dealer or developer when the property was bought or a builder or in the building business when significant home improvements started. Download the IR361 from the Inland Revenue Department for more information about tax and your property transactions.

PROPERTY INVESTMENT JARGON

Like every industry property investment has a lot of jargon. You’ve already learned quite a few terms. You’ll also hear about “yields”, “negative gearing”, “depreciation” “leverage” “equity” “cash flow” and others.

• YIELD: The return on a property is expressed as “yield”. Yield is the percentage figure you get when you divide the purchase price of the property by the annual rent. If the purchase price is $500,000, and the rent per week $500 ($24,500 per annum) your gross yield before expenses is 5.20%. You’ll find the current yields for suburbs in OneRoof’s property data.

• EQUITY: Put simply this is the difference between the current value of your property and the amount you owe on the mortgage.

• DEPRECIATION: This is reduction in value of a building or chattels over time. You cannot claim deprecation on a building that is designed to last 50 years or more and its fixtures.

• CHATTELS: Your chattels are items in the property, but not fixed to it such as stove, blinds, curtains, floor coverings, light fixtures, dishwasher, whiteware, TV aerial, alarms, heat pump, awnings, clotheslines, furniture, mailboxes, waste disposal units and water heaters. Most investors get chattels valuations, to identify and value all possible chattels and then claim the annual depreciation as a cost. Chattels depreciation claims are one of the ways that investors make property profitable.

• FIXTURES: These are items that are fixed or integral to the house such as a garage, garden shed, carport, showers, electrical wiring, and swimming pools.

• LEVERAGE: Leverage is using money borrowed from the bank to buy a property. It’s leverage that makes property investing more attractive for some people than other investments. It means you can put less cash into the property and earn income/capital gain on the bank’s money.

THE PSYCHOLOGY

A good chunk of becoming a successful property investor comes down to psychology.

There are many emotions to overcome if you want to be successful. That might be your risk tolerance. Some people are too risk averse to even buy an investment property in the first place. Or once they’ve bought, they find they just can’t sleep at night once they become an investor.

Finally, property investing can seem like a whole lot of hard work. It is. If you can nail it, your financial future is likely to be secure.