By Elizabeth Kerr
This week l want to write about property investment from the lens of your money machine for those who are either thinking about property investment to fund their early retirement/money goals; or are wondering if they have brought the right investment property already.
These days everyone has an “expert” opinion on property, and none more so then after the summer holidays which traditionally brings a deluge of property paparazzi and get rich quick stories to get your juices flowing.
However owning one's own home does not make one an expert at property investment ownership.
Similarly, buying just any old house does not necessarily guarantee you a golden egg for your future.
The message de jour is that property is a safe bet regardless of what you buy, but this is not entirely true and the best way to ensure your real estate investment is a personal success is to view it through the lens of your personal money machine.
Why else would you buy a property if you didn’t want it to help fund your own goals?
Property can do two things. It can either be a money machine or it can be used to fund a money machine; however it is not necessary to invest in property to achieve financial independence.
Got that?
If you’re not interested in real estate investment for any reason, and you have educated yourself enough to understand the impact of that decision, then of course you can achieve financial independence without it.
With all the emphasis we put on property in NZ people still tend to look at investors who don’t own any with the same disdain society still has for women who don’t want children.
Positive cash flow
So having got that out of the way let me begin ...
If you purchase a property which you then rent out, and the rental income is bringing in more money than the property’s expenses going out, then what is remaining is yours to keep and do with what you want. In real estate circles this is called “Positive Cash Flow” but I like to call it a Money Machine – because when a property spits cash at you each week in the guise of rental income that’s exactly what it is – a money machine!
If you could further reduce the expenses on this property then you would get to keep more of the weekly rental income.
A mortgage free property that rented at $500 per week would essentially give you $400 a week (after putting aside enough for your average rates, insurances and expenses) and that is an excellent supplement to your lifestyle design, is it not? A guaranteed $20,800 per year is nothing to sneeze at. How many hours do you have to work each week to get that much lazy cash for your own lifestyle pleasure?
If this option matches your goals then you may want to find a property which has good tenant demand, collects a decent rent, and which is not going to cost you a fortune in renovations and repairs.
But a warning – just because a property is cheap to buy does not mean it will be a good “positive cash flow” asset. Cheap properties in your local badlands can attract all sorts of tenant nightmares and might be one good southerly from falling down, so it’s a matter of achieving what you think is a good balance between that risk and a worthy rental return.
Please note this money is considered taxable income.
The other way property can be viewed is as a way of funding your money machine.
For example, if you buy a property worth $465,000 today and sell it in 5 years for $600,000, then the $135,000 profit that you have made from the sale can be deposited into your money machine account, with your other savings, whereby it could be invested to collect compound interest and grow nicely until you are ready to live off the dividends.
OR, this money could be used to pay off a lump sum on your personal home mortgage, or pay off your student loan or help you throw in the day job ... the options for a big wad of cash are endless.
This money is not considered taxable income.
If this is more in line with your money machine strategy then you would want to buy a house which is tipped to be in a high growth area so you know it will eventually sell for more.
Speculation
At present everyone is touting Auckland and Christchurch being great places for this strategy to work because of the lack of supply and high demand; however property speculation is exactly that, speculation.
While you can research the minutiae out of a house with some great tools and trending reports to support your purchase, in the end no one can tell you with any certainty that you will make money on it, or that an enormous geyser won’t open up in your back yard. It is up to you to understand the risks of this type of purchase and be okay with them before you sign anything.
Properties tipped to increase in value are usually in high demand therefore commanding a premium purchase price, and they generally don’t receive enough rent to cover the expenses, so you will likely have to come up with the extra money from your personal income.
If you are already stretched in meeting your personal expenses week to week, or your job is on shaky ground, then clearly this option isn’t the best way forward for you.
If you can afford to top up the mortgage repayments and expenses then you had better be sure that the increase in the property value is more than you are sinking into it from your personal income – otherwise this investment is not making you any money at all.
It is important to think of real estate investment in light of your money machine goals and you need to be very clear about which strategy is best for your individual circumstances. For example: If you’re keen on travelling the world then you might want a money machine property, aka positive cash flow property, to take the pressure off not having a steady job or income.
If you’re starring down the barrel of retirement in 4 years, and you haven’t got enough money set aside to fund this lifestyle then you might prefer a ‘gain maker’ which will, once sold at a profit, be added to your savings and increase the amount of money you have for retirement.
There are at least a dozen ways to manufacture each of the above investment scenarios but that’s not the point of today’s column.
This week I welcome comments below but please remember the target audience today are those who are
a) thinking of using property to help them with their early retirement/ wealth making goals or
b) wondering if they have brought the right property to begin with.
If you want to shoot the breeze about anything that I have written to date, or you have some questions about your own lifestyle design and money machine goals then pop me and email at Elizabeth.Kerr@interest.co.nz. As they say the only dumb questions are the ones you never ask ... so go on ... I know you want to!! *wink*.
18 Comments
Hi problem is that in most western economies house prices are way out of line with traditional values A whole generation are growing up used to using the house as a personal ATM and with historic low rate to back this up. Both in NZ and Oz there is almost Zero return on renting single "occupancy" houses with the wishfull thinking of huge capital growth to compensate.
This will end at some stage for sure and history is there to proove the fact.
I always think any investment you undetake must hace a reason behind it ie Income, capital growth, or you plan to live inthat property when you retire To just follow the herd is not a stategy. Also many of my friends are buying a number of leveraged rental properties in the same location and call that a diversified portfolio!
BTW Liz always enjoy your perspective and ariticles..you certainly are on the ball !
Thanks alpappy. Yes this follow the herd phenomenon you so rightly pointed out is what motivated me to write this weeks column. I have to forceably bite my tongue when i hear of someone optimistically buy an investment house without giving thought to their individual strategy.
Whoa ... i've led you all down the garden path slightly re my comment that income on capital gains is not taxed. Thank you to one very smart reader to picked up on that.
If your intention when buying a property is to resell it for more money then the gain WILL be taxed. It all comes down to three main things 1. your intention when purchasing the property 2. your previous property buying behaviour and 3. your involvement with builders, developers or property dealers.
Lets be honest, in the example above the intention is very much on re-selling for profit so that gain would be taxed. However in real life it's all very much based on your individual circumstances so my advice is to see a good accountant.
How come the tax take is down then??.
How about an article on just how many of our illustrious leaders and other beneficiaries of a rentier movement are making hay while the sun shines.
It seems to me to be one reason why we have this property fetish, whilst other countries not taking part, but using our known loopholes in law, also benifit from the QE policies overseas, that are shipped from one country to another.
It is a money go round and a merry go round for some.
But then affordable housing, would not work, would it. And one reason quite why it hasn't.
Because prices would drop, not escalate so rapidly.
QE, exported and implemented via inflated expectations, is not an answer for some, but some past Masters are making a "stupendous Capital Gain" out of nowhere and all at the savers expense. I am sure that was why the print money sytem was termed QE. It misleads.
It is also used by our own miss-leaders to obtain an inflated benefit as well as an inflated salary and an inflated net gain as they got in first.
Using excessive Debt is not usually the answer to get ahead, but it explains, quite a lot to me, when claimed as a tax deduction as a write.
Nuff said.
Please consider this angle for your next project.
Then a further one for other such issues, such as bailing out, by bailing in. So the saver loses twice, if an OBR should be implemented.
Oh my lord I wrestle with this issue every day!
Completely priced out of buying in Auckland, we feel our only options are the two you've identified above. Rental yields in places like Tauranga and Hamilton are much better than Auckland, but problems maintaining a rental in another city are obvious.
And on the other side the capital gain rollercoaster just looks like a massive gamble for over a decade of hard work... not to mention that I disagree with the way our deregulated market is fueled by speculation and cheap and dirty money. Clearly ethics don't matter much in New Zealand but it's a personal argument.
The reality is however, I don't want to be a landlord - I just want to own my own home so I stop getting kicked out of rentals. It just happened again last week and I'll have to find somewhere else to live, yet again. It's exhausting and demoralising...
The NZers I talk to are totally fearful of owning shares which in my opinion is completely unjustified. Then they go and invest thousands in 'bricks and mortar', without seeing the parallels to investing in the sharemarket or anywhere else for that matter. They're then left dangerously undiversified.
Person buys investment property and makes regular losses (great investment that...), and then one sunny day sells it for a whopping capital gain. Very hard to think that they did this for any purpose other than converting taxable income to future capital gain.
IRD should view any rental that operates in this fashion to not be accidental and thus incur full taxation on sale. The “I didn’t mean to” excuse is just a joke, I’m personally amazed that it has survived thus far without IRD requalification.
Yes I agree that investers that flick properties need to pay tax on the capital gain regardless of the story they make up about the reason for selling.
Regarding properties that are purchased with regular losses - I have purchased several properties that made losses when purchased and have been patient as weekly rents have increased approx 4.5% per annum. Now the properties are cashflow positive. That was my plan 12 years ago when I purchased these properties and I still own them with no intention to sell.
There is something to be said for being patient - patience attains all that it strives for.
Yes buying properties which are negatively geared and speculating on an eventual increase in rent to cover themselves is also a fair strategy. You obviously had enough income to support the losses in the meantime.
Conversely one may start off cash positive or neutral and if a rental house (or any other business) happens to increase in value one would take mortgage secured against the family home and swap it onto the rental. Then the rental will appear to be negativley geared, but the 'losses' are just interest payments one would otherwise be paying on the family home - except now as an expense.
Yep that would be what the "Averageman" would think.... unbelieveable how idiotical self-orientated their worldview is.
Lets set you up with a 400k mortgage Averageman. nice simple 6% interest rate, just you, your investment property, and your daily slog income....
Now lets say you are making regular losses. She the wife left you, or tenants damaged the place and you can't let it until it's repaired, or just needs a coat of paint which you can't afford to get done professionally (again, since the last guy stuffed it up and left town after starting)... or the aircon turnout to be a polished up non-compliant white elephant, or just the rent market dropped, ... or your own property/car got damaged and you needed to borrow more on the mortgage than you thought... or a large employer closed down reducing the number of people looking for housing in the area. All these are possible as I've had all happen to me personally, except the painter, who was a friends place.
Now Mr Averageman...just how long are you going to keep making those regular losses???
"In real estate circles this is called “Positive Cash Flow” but I like to call it a Money Machine"
In investor circles it's not called "Money Machine", it's called "Over Capitalised", and seen as a Bad Thing (tm) as you're getting less than optimum yields on your capital.
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