How to get the most out of Residential Property Investment
Much talk is often made in the media about ‘investors’ in New Zealand’s residential property markets reaping huge benefits – yet the focus of that headline-grabbing chatter is usually about just one potential aspect of a far bigger picture of opportunities… capital growth.
WHILE CAPITAL GROWTH IS USUALLY THE number one focus for property investment, the actual reality is that at the ‘coal face’, there are multiple different strands to residential property investment.
Bayley’s Real Estate managing director Mike Bayley said buying residential property for capital growth was literally an entry point into this sector of investment - with a multitude of other opportunities available for New Zealanders wanting to add value to their real estate asset.
“The degree to which property investment is undertaken is affected by such factors as experience, motivation, appetite for risk, access to capital, business planning, and how much time and resource investors are wishing to dedicate to the specific investment opportunities they are eyeing,” Mr Bayley said.
“As with most business ventures, the outcome of the enterprise is often influenced by the amount of effort put into the project, combined with timing.
“Investing in residential real estate is in some respects just like investing in shares, currencies, or commodities. The more and better the quality of advice sought before entering into the process, and then throughout the course of the investment, the greater the chance of the investment succeeding – whether that be short-term, medium-term, or long-term,” Mr Bayley added.
Here then is the Bayleys Real Estate ‘how to guide’ to get the most out of residential property investment.
1. Buying for capital gain.
Under this scenario, a dwelling is purchased in the expectation that over time its value will rise. The strategy for this has proven to be highly successful during the ‘up’ phase of any property value cycle – most recently 2012 – 2016 where in Auckland at least, values have risen year after year by approximately 10 percent annually.
2. Buying for yield.
In this category, a home is bought and subsequently let to tenants. In Greater Auckland, gross rental returns (yields) of between three – four percent are now the norm’ from residential property. From the annual rent received, operating costs such as mortgage repayments (if any), rates, insurance, and maintenance are subtracted to give net annual return.
Massey University’s real estate analysis department says that as a guideline, 22 – 23 percent of gross income should be kept aside for operational running costs of a residential investment property.
Rental returns by dollar value are higher from standalone residences in suburbs such as Herne Bay, Parnell and Takapuna compared to properties in Ranui, Otara and Manurewa. Balancing that out in the yield equation, the purchase price of standalone homes in Herne Bay, Parnell and Takapuna is markedly higher than addresses in Ranui, Otara and Manurewa.
The purchase price and rental return equation brings all suburbs onto a level playing field by simply quantifying returns in a percentage – rather than dollar – figure.
3. Owner/occupier landlord.
Typically, an option employed by younger home owners, where they purchase a two, three, or four-bedroom dwelling, allocate one bedroom for their own personal use, and let out the remaining rooms to derive income.
Under this ‘flatting’ scenario, fellow tenants – flatmates - are responsible for a portion of power, water, and potentially contents insurance, but not the building portion of insurance, nor rates. Budget on rent of around $240 - $270 per room/flatmate in suburban Auckland, more if you’re buying in the CBD or city-fringe.With a marked rise in the number of international students now studying at New Zealand high schools and tertiary education centres, more and more Kiwi families have taken to ‘hosting’ foreign students in the homes.
This arrangement generates gross weekly income of $220 - $250 per student. From this, costs such as feeding the student, along with their portion of power and water usage can be removed to calculate a net income figure.
4. Internal reconfiguration of an existing residential property to create a ‘granny flat’.
Typically undertaken in larger homes where the number of rooms and layout configuration allows the dwelling to be used for two or more parties to live independently of each other under the one roof.
This option works well where a dwelling has several stand-alone bathrooms, multiple sinks or basins plumbed in which are suitable for use as a kitchen/kitchenette, and multiple door access points to the building.
Granny flats are usually the resulting studio, one, or two-bedroom units with their own entrance, bathroom/toilet and kitchenette amenities. They can have their own power/gas connection, allowing the tenant to pay for just what services they use. Water can be serviced as a separate utility connection for each tenancy, although the cost of creating of this off the mains can be several thousand dollars.
The ‘intention’ for the creation of a granny flat is for a family member to take on the tenancy to be near their next of kin. That intention may of course change over time – allowing for the residence to be let to non-family members.
Costs for the creation of a granny flat depend on the lay-out of the property and what internal building work has to be undertaken, along with the potential refurbishment of bathroom and/or kitchen amenities, along with rewiring and utility connections.
Accordingly, costs could range from $10,000 at a basic level, up to $60,000 for a more major refitting project which may include new carpet, paint, drapes, window fittings, and doors.
5. Internal reconfiguration of an existing residential property to create a ‘home and income’.
The difference between a ‘granny flat’ and a ‘home and income’ is that the ‘income’ part of the home has been consented by the respective local body authority to potentially operate as a commercial venture.
When buying a property advertised as ‘home and income’ it is essential that you check the Land Information Memorandum (LIM) report that the ‘income’ portion of the dwelling has been duly consented by the local authority. Otherwise, it’s a ‘granny flat’.
6. Installation of a minor dwelling on spare land within an existing section.
The creation of a minor dwelling home on an existing section allows for a second residence to occupy one plot of land without the need for any subdivision.
Specialist minor dwelling building companies undertake the construction of such dwellings as their core business and advertise in local newspapers and property press. Under council by-laws, minor dwelling-classified homes can only contain up to 65 square metres of living space – which should be enough for three bedrooms.
Budget for $150,000 - $200,000 including appropriate council consents, with construction taking three or four months depending on site topography, access and the construction firm’s scheduling.
7. Subdivision of a section, then selling the bare land.
When an existing section is effectively ‘sliced up’ into smaller portions. A new title is then created for the secondary portion of land, which can be taken to market for sale.
Indicatively, the cost of a subdivision consent from Auckland Council is in the region of $70,000-plus. Real estate agency commission fees for the sale of the bare land through a real estate company will be in the region of three to four percent, plus marketing costs. Remember to add your lawyer’s conveyancing fees, and the cost of any borrowings to fund the development.
8. Subdivision of a section, then building a new home or multiple dwellings on the subdivided site and selling that property or units.
The next step up the property investment ladder from options 6 and 7 – requiring more capital input throughout the process, and greater project management skills, but potentially delivering a greater return-on-investment than simply selling off the land, as there has been an added-value element to the property.
So, start with subdivision costs of $70,000 then add in the cost of a new dwelling – which can fall anywhere from $300,000 to well over $1million depending on where you are building, the size of the new dwelling, and of course the quality of build and fit out.
So how do you fund your chosen investment/ development option?
That pretty much depends on what option your choosing, how much equity you have in any existing property holdings or other liquid investments, your motivations for undertaking the venture, the level of risk exposure you wish to undertake, and how much commercial competence you have.
Here are the most common funding options…
1. A mortgage with the bank/lawyer’s trust.
The easiest funding option. With the recently announced easing of loan-to-value-ratios by the Reserve Bank of New Zealand, retail banks now ‘technically’ require loan-to-value ratios to be 20 percent of the asset value of your home, with 35 percent for investment property. But, there is some leeway and exemptions could be available, at the discretion of your bank manager, which could see an assessment on property within your overall property portfolio – so not only the long-held family home, but potentially any rental or investment properties. New build properties also have lower minimum deposit requirements.
The Reserve Bank’s announcement on LVR changes also gives the high street banks greater discretionary movement on how flexible they can be with lending ratios – so if you have enjoyed a long relationship with your bank, and your finances are in a strong position, that will also count in your favour on the amount which can be borrowed.
Lawyer’s trusts are similar to banks, but have mortgage repayment rates slightly higher than the banks.
2. Cashing in your KiwiSaver contributions.
For first home purchases, you will also be able to withdraw a substantial portion of your contributions. For those who have been regularly making payments into KiwiSaver since its initiation in 2007, it should be relatively easy to access to somewhere in the region of $50,000. Check with your KiwiSaver provider.
For qualifying purchasers and properties, the KiwiSaver HomeStart grant will give you access to up to $10,000. All of these will of course vary from individual to individual.
3. Funding contributions from the parents.
Tap into the Bank of Mum and Dad. If they’re well-off or feeling generous they may tip in a six-figure deposit with no strings attached (that is you don’t have to pay them back).
More likely though, there will be some type of interest and principal repayment arrangement in place, although being mum and dad, it’s most likely to be quite favourable and certainly not onerous on the budget.
Be prepared though….. if you’re in a boyfriend/ girlfriend husband/wife arrangement, be prepared to sign a pre-nuptial arrangement outlining you or your partner’s potential entitlement to half the property should you separate at some stage in the future.
4. Setting up a limited liability company and selling shares in that entity.
Under this scenario, you become a CEO/managing director of a property company. You can then sell off shares in that company – which brings in the option of investment by the Bank of Mum and Dad - and use the proceeds from the sale of those shareholdings to undertake the real estate venture.
Setting up a company is simple and can be undertaken online. Selling shares in the resulting entity will require some legal oversight – incurring lawyer’s fees. Allow for around $2,000.
While your personal debt exposure is lower – as you’re using other people’s money and a limited liability company format – so too is the profit margin, as you will be paying a pre-arranged dividend back to the shareholders, or winding up the company once the venture has been completed and splitting the proceeds according to shareholding percentages.