Rental property investors
- Are you considering the idea of buying your first rental property?
- Perhaps you are buying a new home, and would like to explore the possibility of keeping your current house as a rental property?
- You could be a seasoned property investor with a number of properties, considering your next move?
Whether you are just starting out, or already have a number of rental properties, contact me now. I am a dedicated property investor myself, so I have personal experience as well as mortgage finance experience. I would be happy to have a discussion with you to identify how I can help you achieve your property investment goals.
In this section, read about the principles of property investing, some basic tax information and my own story of property investment.
The Principles of Property Investing
The basic principle is that property values and rents increase over the years, while your debt stays the same (or, ideally, reduces). So you are building up an asset base that is worth considerably more than you originally paid.
If you are borrowing a large amount to buy a rental property, chances are that, in the early years, the rental income will not totally cover the outgoings, such as your mortgage payment, house insurance, council rates and maintenance costs. Therefore you will need to fund the shortfall from your personal cashflow.
However, the good news is that any losses plus the expenses incurred in managing the property may be able to be offset against your tax. So, in effect, you have the tenant and the tax department helping to pay off your capital-appreciating asset. And that, in a nutshell, is why property investment is so popular in New Zealand.
If the value of your own home goes up and the mortgage on it stays constant (or reduces), your equity, - or 'net worth' - increases. The bank allows you to borrow against that equity to fund 100% of the purchase price of a rental property.
Then, if the value of your own home and the rental property goes up and the mortgages on them stay constant (or reduce), your equity has increased again, and you can use that equity to buy a second rental property.... and so on.
Establishing the correct ownership and borrowing structure is extremely important, as this ensures that both flexibility and tax benefits can be maximized. The most common ownership structures include Look Through Company (LTC), Qualifying Company (QC), Family Trust, or individual ownership. I can liaise with your solicitor and accountant to determine the most effective ownership structure for your personal circumstances.
What about Tax?
All expenses "incurred in gaining assessable income" are tax deductible, so it pays to keep good records of all expenses incurred in your rental property business.
If the rent does not fully cover the interest payments plus expenses, current legislation permits you to claim this loss against your income from other sources (i.e. employment) provided your intention is to eventually earn income from your rental property.
If you earn more than $70,000, your top tax rate is currently 33%. Therefore, any deductions you can make will be "saving" you tax at the top tax rate. The tax benefits may be so high that you need to contribute very little from your own pocket towards the ongoing costs of your rental property.
In some cases, you may apply for a special tax code which allowers property investors to obtain tax deductions throughout the year rather than having to wait for year-end to obtain tax deductions. Contact me for further information
Tax deductibility falls into two categories, capital costs and revenue costs.
Capital costs are these not directly deductible against rental income, but are capitalised (i.e. added to the capital cost of the property) and then depreciated. Examples of capital costs include:-
- Purchase Costs (e.g. legal fees, registration of title etc)
- Improvement Costs - there is a difference between improvements and repairs. For example, if you bought a house which needed immediate painting and re-roofing before you rented it out, these costs would likely be considered as improvements. On the other hand, if you bought a property in good condition and re-roofed it some years later, due to wear and tear, these costs would most likely be considered as repairs and directly tax deductible.
- Sale costs (e.g. real estate commission on the sale of a rental property and a portion of legal fees on sale of the property).
Revenue costs can be directly deducted against all other income. Examples of revenue costs include:-
- Interest on borrowings
- Borrowing costs (loan application fees, valuation fees, lenders mortgage insurance, search fees etc)
- Property Manager's commission
- Repairs (check the distinction between repairs and improvements with your accountant if unsure in a specific situation)
- Gardening and Lawn Mowing
- Accounting fees and bank charges
- Body Corporate fees
- Car (If you travel to inspect your property or to under-take rental property activities (e.g. obtain quotes or purchase property-associated items), you may claim mileage. Rates are set by Inland Revenue –refer to www.ird.govt.nz).
Case Study - Sonya Reid
I acquired my first house in Sydney, Australia, having scraped together a 5% deposit, plus another 5% to cover the stamp duty and fees they charge you to buy a house in New South Wales. A few months after moving into my own home, I read a book on property investment by an Australian author called Jan Somers.
This book set out the basic principles of property investing for the long-term, and inspired me to take action. I arranged a meeting with a mortgage broker to enquire how much I could borrow for my first rental property (I was a recruitment consultant in the finance sector at the time). He gave me an honest appraisal of the situation and said that I could afford a rental property in the low price range, and it would need to return a relatively high rental. Rental yields weren't very high in Sydney at the time, but I was undaunted. I knew exactly what type of property I needed to find to qualify for a mortgage, and it didn't take long to find it. Three months later, I was the proud owner of a three bedroom townhouse in the western suburbs of Sydney. It had an ensuite and garage with internal access - two features I still haven't managed to acquire in my own home - such is the life of the property investor!
Twenty years later, my partner and I own a number of rental properties in the Wellington area. In between times I have moved countries, changed careers, and had children. The point is that property investment is a flexible pursuit. While it is important to start as soon as you can, take your time adding to your property portfolio - there is no race.
Principal & Interest, or Interest-Only for Rental Properties?
Only the interest portion of your investment loan is tax deductible, not the principal portion.
Originally, I set up all our investment loans on an interest-only basis to preserve cash-flow. Any spare cash we had went onto our own personal mortgage, as there is no tax advantage in personal debt. Once we paid off our own home (and our rents increased over time), I gradually changed the loans over to a principal and interest basis.
What sort of Properties to Buy?
Personally, I subscribe to the view that land appreciates and buildings depreciate. With that in mind, I try to stick to houses or townhouses that have a reasonable land component as I believe capital gain is stronger for these properties. However, I have plenty of clients who invest in units and apartments who are happy with the results of their property investments. The advantage of property investment is that you can employ a strategy that suits you.
I tend to buy in the lower price range. For example, I would prefer to buy two rental properties for $350,000 each rather than one property for $700,000. This is because I believe there is a much bigger pool of tenants and prospective buyers in the lower price range. Having said that, I have friends and clients who only buy in the higher price range because they believe a superior property attracts superior tenants and that's fine too.
Selecting and managing tenants
These days we use a property manager but, prior to that, we managed our properties ourselves. I realise that prospect is off-putting for many new property investors! Actually, we had very little trouble over the years - tenants are generally well-mannered and pay their rent on time. It is important to monitor the rent going into your bank account. Be aware of the date rent is due, and check your bank account online on the day it is due. If the rent is not there, don't hesitate to contact the tenant immediately. Tenants respect the fact that you are paying attention to the situation, and will be less likely to get into arrears if they know it isn't going to take you six weeks to notice they are behind in their rent!
If managing tenants is not for you, hire a reputable property manager to manage your rental property for you. It is advisable to ask around among other property investors for a referral. A lot of people complain about the weekly cost of having their properties managed. Remember to keep the big picture in mind – it is a small amount of money which is a deductible expense. And, if it saves you from selling a property simply because you are sick of dealing with tenants and/or tradespeople, it will be money well spent!
Download rental forecast calculator
Enter your expected rental income and estimated property expenses into this handy calculator to forecast your cash inflow/outflow after tax.
Please note the tax rate of 33% is used for all calculations. Check back later, as we plan to upgrade the calculator to handle all tax rates in future