Investing made easy: Building solid foundations
Building a residential property portfolio is not as easy as it used to be, with the tough economic times beginning to expose those who fail to plan properly.
Wednesday, September 9th 2009, 12:00AM
by Sonia Speedy
But by doing your homework and expecting the unexpected, a solid foundation can be laid.
Craig Moffat, ANZ general manager of specialist distribution, has seen some valuable lessons about planning successful property portfolios learnt during the recession.
"Some people believed that the capital gain run would go forever. In reality when that dried up they've realised that they're over exposed to the market and their cash flow isn't necessarily strong enough to sustain their investment," he says.
Some investors have been caught out buying what Moffat describes as "non-standard" properties that they hoped would bear greater returns. This includes vacant land and coastal properties.
Planning around the location of investment properties and exit strategies can be another sticking point.
"A big issue that we have run into is where people have slowly bought houses in the same suburb - and even in the same street. When they're looking for an exit, you drive down the street and there are 25 ‘For Sale' signs which can only drive the value of property down," Moffat says.
Ben Duflou, director of Wellington-based business advisory and chartered accountancy firm All Accounted For, says that with banks tightening lending criteria it is more difficult to build property portfolios now.
"You can't now build equity through just holding the property as when we had house price growth of 10%, 12%, 15% per annum. Those days are gone, so you've got to find other ways," he says.
Building equity
Alternative ways to build equity include buying a property significantly below its fair market value, or a property that value can be added to.
Equity is the amount you actually own of the property - its value, less what you owe on it. As the saying goes: you make your money when you a buy a property, not when you sell it.
"Even minor things like painting, replacing curtains and carpet can add quite a lot of value," Duflou says.
Creating strong relationships with tradesmen is beneficial in order to get good service and keep the costs down. Do a good job on renovations and an investor can build enough equity in their existing properties that the bank may be willing to use in place of a deposit on a further property. Bear in mind that investors can ask the bank for extra money to fund these renovations at mortgage application time.
But property investors also need to be prepared for the "what ifs" of investment. What if the property sits untenanted for six weeks or there is a rise in interest rates? How will this impact upon cash flow?
Michael Springford, owner of LJ Hooker franchises in Warkworth and Whangarei, suggests investors should always budget on interest being 2% more than what it currently is. Meanwhile, Canterbury Property Investors' Association president Kim Willems says investors need to plan to deal with the worst-case scenario.
"If you're talking about standard residential investments, then for people to know what kind of tenants they're going to be able to put into that property and what to do if they can't get a tenant in - how well they're equipped to be able to adapt to that," she says.
Springford warns that investors also need to consider potential changes in circumstance: what happens if the wife in a couple gets pregnant and has to stop work? How well could you handle any fluctuations in the property market?
The importance of cash flow
This is something banks will look closely at, Duflou says. He suggests rents must at least cover interest costs, but he himself does not consider investment properties with a return of less than 7%, or capable of returning that. He also uses a rule of thumb of only carrying out renovations that translate into a 10% return.
Duflou suggests preparing two sets of cash flow forecasts; one pertaining to what the property currently returns and another to what it could return after some work and/or a rent increase. Factor some "what if" scenarios into these forecasts.
Security
Investors need to understand the concept of cross security - essentially that they put their existing property at risk when they use the equity in it as a deposit on another place.
In situations where an investor buys an investment property through another entity, such as a company structure, trust, or partnership arrangement, the bank may require personal guarantees. This works in a similar way, with the individual liable for any outstanding costs should mortgage payments on the property not be met. Duflou says investors should discuss these concepts with their accountant, lawyer and bank to ensure they fully understand them.
Talking with your bank early on and getting mortgage preapproval can help an investor move faster when they spot a potential bargain and may even help encourage the vendor to shave a little off the purchase price.
Other options
For those struggling to get into property investment alone, partnerships can offer a useful solution.
"You may not get all of the upside return, but also you don't get all the downside risk," Moffat says.
John Bolton, principal of Squirrel Mortgage Brokers, suggests partnering with people who have a good income.
"Deposits are important, but the most important thing is income. The more income you've got the better it is," he says.
He also suggests spreading your mortgages among different banks.
Taming tax
Talking to your accountant from day one is essential to ensure that any nasty tax complications are avoided. Your accountant and your bank can also serve as useful sounding boards as to whether your investment plans really stack up.
Duflou says that in some circumstances, renovation work can be claimed as an expense in the year it occurs, rather than depreciated over several years. For those offsetting property losses against wage and salary earnings, getting a special tax code can mean getting any tax refund due during the year, rather than having to wait until year end. Both can aid cash flow.
As Springford sums up, property investment is "a good game played slowly". The key is not trying to build a property portfolio overnight, but when the time and finances are right.
"Don't put yourself under undue pressure because otherwise, if you get too impatient and want to do it overnight, you'll lose money," he says.
To view the previous article on "Knowledge is power", click here.
Disclosure: The views expressed in these articles do not necessarily represent those of ANZ National Bank Limited (ANZ). ANZ does not endorse the views of others expressed in these articles.
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