The 5 basics of property investment

Amy Hamilton Chadwick
The 5 basics of property investment

Freelance journalist Amy Hamilton Chadwick has done her homework on what you need to know before entering the property investment game. Here’s what she found out.

 

When you want to invest, buying property is enormously appealing. There’s something reassuring about bricks and mortar that the sharemarket simply can’t match. But buying a rental property is not always the easy money-making scheme it often appears. Before you start shopping for property, you need to do your homework.

Here are 5 things you need to know before you buy your first rental property:

 

You need to understand the numbers

Do you know the net yield of the rental property you’re looking at? If the answer is no, step away from Realestate.co.nz and start teaching yourself how to be a property investor.

To build a profitable portfolio, you need to understand the language and numbers of the industry. Before you can even narrow down your online search, you need to know your buying criteria so you can choose a property that ‘stacks up’ – one where the cashflow, equity, and opportunities to add value fit with your strategy.

There’s one thing successful investors have in common: a mastery of spreadsheets and an ability – innate or learned – to rapidly calculate the vital statistics of any potential purchase. If that sounds daunting, it doesn’t need to be.

The good news is that you can find out all the basic facts about property investment for free or very cheaply, using sources such as:

 

You need to have a strategy

An investment strategy is a surprisingly complex beast. It dictates what you buy, where you buy, how you buy, when you buy, and what you do with your properties once you’ve bought them (add a minor dwelling, renovate, or subdivide for example). Your strategy will help you know how to structure your investments, which can be extremely important in the long term: will you buy in a trust, a look-through company, in your own name, or in a partnership?

“You need a strategy. You shouldn’t buy property just because you talked to a guy at a barbeque who made $170,000 on a do-up in Manurewa,” says property investor and developer David Whitburn, author of Invest and Prosper with Property. “People buy because they have a fear of missing out; it’s one of the things driving up prices in Auckland.”

Rather than using a strategy, many investors fall into the trap of buying on emotion, rather than finding a property which will help them grow their money. They fall in love with a house and pay too much, or renovate to their own standards.

David Whitburn quote

Whitburn says he often sees new investors fall for character villas, leaving them saddled with vast maintenance costs. A utilitarian brick-and-tile unit has the possibility to provide far better returns, even though you might not have a burning desire to live in it yourself.

Without a strategy, you'll need to be extremely lucky not to buy at least one lemon. With a good strategy, you can, to a certain extent, make your own luck. For some investors, a strategy starts decades in the future: they work out how much money they'll need in retirement, calculating back from there to establish exactly how many properties they need.

 

You need to borrow wisely

It’s almost impossible to overstate the importance of borrowing for aspiring property investors. Because banks lend such a high proportion of a property’s value, the leveraging on property investment can be perceived as superior to other asset classes. This is one of its biggest selling points.

However, lending is also where many inexperienced landlords come unstuck. If you plan to own 5 or more rental properties, you need to have sufficient cashflow to allow you to continue borrowing – which necessitates careful buying from the outset. Lack of cashflow leaves many empire builders stalled at 3 or 4 properties.

When you run your numbers, you need to know how the bank will analyse your investments; it may bear little resemblance to your own analysis. Lenders scale your rent down by 25% in their calculations, assume 4 weeks’ vacancies and often stick to a 25-year principal-and-interest loan. A good relationship with a specialist mortgage adviser can help work with these constraints, and many investors use more than one lender to spread their borrowings.

Even if the bank will lend you enormous sums, you need to ensure your numbers agree with theirs. Naturally, you'll want to make the most of the bank’s money. But borrowing too much (over-gearing) can be disastrous; in the last recession massive leverage caused several high-profile investors to crash and burn as values tumbled and banks tightened their credit.

“Debt is not always your friend,” says Martin Hawes, financial adviser and author of Martin Hawes’ Investment Guide. “Gearing to buy something cuts both ways. Leverage is one of the things that makes property investment so appealing, but it magnifies the losses as well as the gains.”

 

You need to be passionate about rental property

There’s a myth that property is a fool proof, hands-off way to make money – an idea perpetuated by shows like The Block and Our First Home. (Whitburn notes how misleading the ‘returns’ are on these shows, citing the free labour, free marketing, no agency fees and hundreds of thousands of dollars’ worth of other freebies. Then there’s the contestants’ lost income, and their need to pay income tax and GST on these deals. It might be reality TV, but it’s not reality property trading.)

In real life, property investment is far from being passive income. It takes time and energy to organise the borrowing, buying and managing of your properties. Even with a property manager, you need to manager the manager, says Whitburn, to say nothing of ensuring you comply with the Residential Tenancies Act.

“Assess the time that it’s going to take to purchase the property and manage the property, even if you outsource part of it,” says Hawes. “Do you have the time, the inclination and the aptitude for that? It takes quite a lot of stickability and it’s not always a great deal of fun.”

 

You need to check your options

Property is almost everyone’s favourite asset class. But remember that you don’t have to buy a house and rent it out to make money from property. There are several other options open to you if you want to have a slice of the property market:

  • Buying shares in a listed property investment company, which has a low entry cost and is completely hands-off.

  • Commercial property, which has a high entry cost, but the returns can be rewarding.

  • Owning shares in a managed fund which specialises in commercial property or retirement villages (which usually operate a license to occupy).

  • Forming a syndicate or partnership to buy property.

Property has traditionally been a good way to build long-term wealth, but you shouldn’t ignore other types of investment, either. Talk to a financial adviser about whether residential rental properties are right for you.

 

Looking for a new home?

Westpac has handy tips, info and mortgage calculators to help:

 

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