Steven's investment property story

"If you want the tenant to look after the house, you have to look after them, and keep the house in good condition."

Steven and his wife have one investment property, which they bought in May 2006. “This was a straight investment option – a way of helping save for retirement,” says Steven.  “We’d had a rental some years ago which we sold – we rented out our family home when purchasing a larger house for a growing family as rental yield was high – but buying this property was a deliberate investment choice.” 

Choosing the property
Steven and his wife had a clear set of criteria when looking for a suitable rental property.

• Capital gain was important, so they wanted a property in or close to an established urban area where demand would be higher.
• They wanted to manage the property themselves so the house had to be near their own home.
• They wanted a good quality property that would be easy to rent and would also attract tenants who would look after the property.

They weren’t actively looking when they found their rental property.  They saw a ‘For Sale’ sign outside a house in the area that looked like it might meet their criteria, and knew the real estate agent who was advertising it from past experience.  “The agent was a major factor in us buying the house,” says Steven. “We trusted her and what she told us all panned out.  We had an independent valuation done and we also got a report from Quotable Value on the property’s sales history.  That showed it had doubled in value every 7 - 10 years, which gave us a lot of confidence in the area and the likelihood of achieving good capital gain.”

They had thought about buying a cheaper home in another area which may have offered higher yield (rental income as a percentage of the purchase price).  However, they preferred to buy in their local neighbourhood as they wanted to manage it themselves and felt more confident it would hold its value if the economic environment changed. 

The vendors were looking to move because of a job transfer and were willing to negotiate on price.  “We were prepared to keep looking until we got a property at the right price,” says Steven.  “You make money when you buy, not when you sell – especially if capital gain is the objective. I put together a spreadsheet showing the rate of return, factoring in interest costs, assumptions on capital gain and cashflow, and I’d recommend people do that.  Buying the house was actually quite an easy decision for us in the end, as the numbers stacked up.” 

Finding tenants
Steven put an ad in the newspaper initially, but with little effect.  He then advertised on TradeMe and was amazed at the result.  “We ended up having to choose between three people who really wanted the place.  I’d definitely advertise on www.trademe.co.nz again.”

All prospective tenants had to fill out an information sheet which Steven created.  It asked them for things like previous landlords who could provide a reference, pets, employer and so on. Choosing their tenant came down to a mixture of gut feel, plus references from previous landlords.  Steven says next time he’d consider doing a credit check as well. 

Managing the property
Steven and his wife manage the property themselves.  They feel the fee property management companies charge is significant, and they’re willing to commit the time required to do it themselves. “Finding and managing tenants does take time and effort though, which shouldn’t be underestimated,” Steven says.  “As our children are older now and we’re more established in our careers we’ve got more time, but we wouldn’t have got into it earlier because of that.”

Steven has a list of tradespeople he trusts and uses.  “You have to have people you can trust and you can’t let the tenant wait,” he says.  “If you want the tenant to look after the house you have to look after them, and keep the house in good condition.”

Finance and structure
Steven set up an LAQC (Loss Attributing Qualifying Company) for the investment property, and manages his own financial and tax affairs himself, using an accounting package.  The reason is not to save money on accountant’s fees, but because he says the more you know about your property investment and how it works, the more control you have.

They initially set the rent by talking to the agent and their own research about average rents in the area, and review it each year.  Steven offers the tenant a discount for prompt payment each month.

The investment is ‘negatively geared’ – which means it runs at a loss, allowing him to offset that loss against income tax.  Steven estimates the total annual cost of the property (mortgage and maintenance costs) are met as follows:

• ½ is met from rental payments
• ¼ is met by tax refunds
• The remaining ¼ is funded by Steven and his wife.

In terms of capital gain, Steven says they worked on the basis of a 3% capital gain each year.  The actual return in the first 18 months based on the current rateable value is 17%.

When they purchased the property they set up a home loan paying both interest and principal, as they wanted to build up their equity so they could ‘speed up the process’ and purchase another rental property.  They have now converted the loan to interest-only and would purchase new properties on an interest-only basis.

Lessons
Steven offers the following suggestions based on his experience of residential property investment.

• Consider doing a credit check on potential tenants.
• Inspect the property before taking possession - the previous owners of Steven’s property  took some of the chattels with them.
• Use TradeMe to advertise for tenants; it’s a very effective medium.
• Know what ‘good value’ is when negotiating on price – ask the real estate agent or get an independent valuation done.  You make money when you buy.
• Have good people around you – for example, a good agent, valuer, solicitor, tradespeople etc. and keep dealing with them.  Don’t worry too much about costs or fees – if they are doing a good job they’re well worth the money to you.
• Go for quality and have a long-term outlook.
• A tip on tax – you don’t have to wait until the end of the financial year to get the tax benefits from an investment property – you can benefit from a reduced personal tax rate simply by completing and returning an IR23BS form to the Inland Revenue – you can find the form on  their website www.ird.govt.nz.

Next steps
Steven and his wife plan to expand their portfolio, though they are not in a hurry. They will continue to look for properties in their local area.  Ideally, they’d like to find a property that could be subdivided and build another house on it, as that would be a more cost-efficient way to grow their portfolio of properties.  If they build their portfolio up to more than three properties they would look to use a good property management company, though they would invest considerable time in finding a good one.

While the property market goes through cycles, over time the trend in their area is that properties roughly double in value every 10 years. Their approach is a long-term, ‘buy and hold’ one and they will apply exactly the same selection criteria to new opportunities.