Articles - Graeme Fowler

[orion]

Good article Graeme, might publish that one too :-)

I have a client who wants to buy in Hawkes Bay, will introduce you in the new year (her request).

Cheers Nick

Thanks Nick, yes happy for you to publish it

[primal]

When we sell property and the profit we make, don't we need to pay capital gains tax.

[Nick G]

if the IRD rules that your intent at time of purchase was to sell for a profit - there are accountants on here who can give more details on how the IRD makes those judgements.

that's the loophole in nz tax law, in many other countries you're taxed on profit regardless of your intent.

[orion]

When we sell property and the profit we make, don't we need to pay capital gains tax.

There is no capital gains tax in NZ, but you may pay income tax.
What it's called doesn't really matter.
If you buy and sell and make a profit, then you pay tax, unless you hold it for 10 years or more.
If it's not an issue for you right now, then it is nothing for you to be concerned about.
If it is and you are not sure, talk to you accountant.

[Magusb]

Hi Graeme,

Thanks heaps for all the articles you have posted here. I've took my time to read it all, think and try to make my own mind up. So I wish this New Year you still feel motivated to provide guidance to us.

Mauricio.

[orion]

Hi Graeme,

Thanks heaps for all the articles you have posted here. I've took my time to read it all, think and try to make my own mind up. So I wish this New Year you still feel motivated to provide guidance to us.

Mauricio.

Thanks Magusb

[orion]

Property Investing and Loan To Value Ratios (LVR’s).

The LVR or loan to value ratio is a percentage that the banks use as one of the factors in determining whether they lend money to you, or not. They also take into consideration your personal income, rental income, other debts you may have, living costs and credit cards etc.

For the past few years, the LVR that most banks and lenders consider fairly standard is 80%. Recently this has been lowered to 70% for properties purchased in Auckland.
What this means is that if you’re buying a property for say $500,000 and the bank’s requirements is an LVR of 80%, then the bank will lend you 80% of the $500,000 which is $400,000. The other $100,000 will be in the form of savings or equity from your own home, or possibly other rental properties.
If buying the same property in Auckland with banks only willing to go to 70% LVR, they would lend you $350,000 and the other $150,000 would come from you.

Debt to Equity Ratio
This is often used by people thinking it means the same as LVR, but it is very different.
Debt to equity is a term more used in businesses to determine how much debt they have compared to equity in the business. To work out what the debt to equity ratio of a business is, you calculate total debt divided by total equity.
So, if a company had $15 million in debt and total shareholder equity of $10 million, the debt to equity ratio would be 1.5 times or 1.5 to one (1.5:1)
Using it for property is not that common although some commercial banks/lenders may use it as a tool along with using LVR.

What is a good LVR to have?
The banks are generally happy if your overall LVR is under 80% for residential property (70% in Auckland) until you get to a certain number of properties, or type of properties owned. The amount of properties can be different with each bank, and can also vary depending on the relationship you have with your bank, and sometimes if another bank wants your business.
Some banks will reduce your overall LVR down to 65% if you have say over 5 residential properties with them, others may have their limit at 10 properties and others may say it doesn’t matter how many properties you have, as long as you have a good steady income from a job or business.
Others may not be concerned about the number of properties you have, but the overall debt you have with them. Some will treat you as a commercial business (borrower) if you have over $1 million debt with them and some may say they will go up to $3 million of debt before you are treated as a commercial customer, and everything then goes to 65% LVR.
Often banks will be more cautious of investment properties you want to buy outside the area you live in. They may require a different LVR, or a registered valuation, and sometimes not lend to you at all. Also if the property you want to buy is under $100,000 some banks will be very wary of this and may limit you to a 60 – 65% LVR, or again not want to lend to you for these type of properties.
Most banks will also treat a block of 4 or more flats as commercial, and therefore ask you to put in 35% as a deposit (65% LVR).
N.B. All commercial properties are generally treated as 60 – 70% LVR with the most common being 65%, so again a 35% deposit would be paid (or equity from elsewhere) to purchase any commercial properties.
Only a few years ago, banks were lending 90% and in some cases 95% on residential properties as well as rental properties, in other words a 90 - 95% LVR.

So, as you can see there are a huge amount of variables in all of this, and people will often think if their LVR is 80% or just under, they will always be safe.
To me, that is not only wishful thinking, but also very risky.

My LVR is currently 57%, which means 43% of the properties I have are owned by me and 57% is still owed to the banks.
The banks I deal with are very happy with this and say that the overall position and foundation of my whole property portfolio is now the strongest and most solid it has ever been. One said it was one of the most solid on their books throughout the whole of New Zealand! I was at first rather pleased with that, but then thought, really?

To me, there is still way more risk there than I am comfortable with and I want to get my LVR down below 50% as soon as possible. Ideally this will happen within the next two years by selling off a few properties (ones that were bought as trades several years ago) and paying down debt further.
Eventually, the plan is to have my LVR at 0%, that is - no debt.

To me anything over 60% LVR if you have $5 million or more worth of properties has some risk. The higher your LVR is, obviously the higher the risk is.

This is what I would suggest as a guide for looking at your own LVR:-
Up to $1 million of property – 80% LVR
$1 million - $2 million - 70% LVR
$2 million - $5 million – 65% LVR
$5 million - $10 million – 60% LVR
$10 million - $15 million – 55% LVR
$15 million - $20 million – 50% LVR
Over $20 million – 40% or less LVR

What happens if the banks changes their rules?
This can happen at any time as we have already seen with Auckland properties now needing a 30% deposit as opposed to a 20% deposit for the rest of NZ. As mentioned there was a time not so long ago that banks were happy lending over 80% and in a lot of cases up to 95% on purchase price. Some 2nd tier lenders will still do this for those that want it or can meet their criteria. The interest rate is generally a few percent higher to cover their risk, and is not something I would recommend for any investors to use.

If the banks changed their rules again to say for example, you now had to have 40% equity (a 60% LVR) across your whole portfolio, what would you do if you were now geared at 80%? You’re only option would be to sell or come up with a large amount of cash from somewhere else. If a lot of people were in the same situation, property prices could fall drastically until people came into line with the new rule. Or if too many people were being forced to sell, the rules may eventually be eased once again.

To have a strategy of buying properties whenever prices go up, and always leveraging up to an 80% LVR, gets more and more dangerous the longer it continues.

Property is a long term investment, and not something you can get rich from over night. The higher your borrowings get up to, your LVR should keep coming down to safer levels as shown above.
Even though property is a long term investment, the rules and regulations can change very quickly. These can come from changes with the IRD rules, changes in government regulations for property, or changes in bank requirements such as debt servicing, LVRs, or even higher interest rates being charged on investment properties, as an example.

What could happen to make the banks call in your loans?
I heard about an investor in NZ many years ago that had all 99 properties they owned with one lender, and that particular lender went into receivership. The properties were quite highly geared around 80% or so and the investor could not refinance them in time with any of the other banks, and therefore all properties were sold at mortgagee auction, and he lost everything.

But could your bank call in all your loans? This is something that can happen to anyone at anytime. If you read the small print, a bank can ask for all their money back!
It is unlikely that a bank would do this without good reason. But there are many instances when they can ask you to reduce your exposure with them.

For example, they may think the properties you have mortgaged with them are now worth less when they reviewed your portfolio the previous time.
This has happened many times to even very successful investors I know. All of a sudden the bank reviews your property portfolio and it shows up that a new E-Value for one of your properties is less than what is was the last time they did it.
They could ask you to get new valuations, pay down some debt, or reduce the limit on any revolving credit accounts you have with them, to bring it back into line with their rules. If you are not able to do any of those things, they will ask you to sell your property or properties.

I’ve had times over the years when a bank has said to me that they were reducing the maximum limit on my revolving credit facility, because the values of some of the properties I had mortgaged with them had dropped. Even a small drop of 5 – 10% in value of your properties could have a significant effect on your overall position if you are highly geared.

What can happen to change your LVR?
When I started investing over 25 years ago, I had saved $25k and the property I bought as a rental was purchased for $128k. I also had to borrow another $10k to keep the bank happy, which was on interest only from a lawyer, just to make it work.
In theory, my LVR was 80%.
The two loans totaled $103,000 ($93k bank plus $10k lawyer) and the $25,000 deposit was from my savings ($103k/$128k = 80%).
At the time I purchased this rental property, the bank had asked for a registered valuation. So I paid for a valuation and it came back and said the property was worth $128,000.
So I say in theory, as I found out a little later on that the property was worth a lot less than the $128,000 I paid for it, more like $100,000. I eventually sold it for $98,000 several years later.
This means if it was only really worth $100,000 at the time I bought it, my LVR was actually around 100%!

In this case, my LVR wasn’t what I thought it was. If the bank had realised that as well, they could have asked for more money from me to bring my LVR back to a comfortable level, most likely they would have wanted around $20,000. At the time, it would have been impossible for me to do that as I was a mechanic on low wages and didn’t have any spare money, let alone $20,000.

Apart from not knowing what your property is really worth if you had to sell it again (false valuations), there are a few other more obvious things that can change your LVR.

These will reduce your LVR:-
Paying down debt on your loans
Selling a property from your portfolio (unless there’s more debt on it than you sell it for)
Values of your properties increasing

These will increase your LVR (and increase your risk):-
Borrowing to buy more properties
Borrowing money against property to live on, purchase vehicles, or buy other liabilities
Values of your properties decreasing

This may sound all rather scary to you, and potentially it can be very scary.
Or you might even think none of this will ever happen to you, and so you are in denial about the dangers of having high debts and a high LVR.

Others will hopefully realise that investing can be done with relatively low risk by using a bit of common sense and also plan for what could happen. This could be from changes in rules or policies, property prices remaining static for long periods, or properties going down in value - which does happen at times.

Don’t aim to get as close as you can to your banks’ limits or rules. These can change at any time and by attempting to go to another bank - you might find their rules and regulations are even more strict.
Any small changes in the banks’ policies, changes in law, your personal income, or any slight drops in property prices could affect you drastically - when it really doesn’t need to affect you, providing you are sensible and have good money habits.

Safe investing.

[James.wu]

Thanks again Graeme, these info is very useful for me. Personally I don't like risk, and your info enable me to evaluate my risk. Your info is like a missing piece of my investment puzzle. Thank you very much.

[Perry]

If the banks changed their rules again to say for example, you now had to have 40% equity (a 60% LVR) across your whole portfolio, what would you do if you were now geared at 80%? You’re only option would be to sell or come up with a large amount of cash from somewhere else. If a lot of people were in the same situation, property prices could fall drastically until people came into line with the new rule. Or if too many people were being forced to sell, the rules may eventually be eased once again.

Have you seen someone suffer this? As in, the banks change the rules and then pressure existing
borrowers on their present portfolio to comply, rather than apply the rules to new borrowers/ings?

[Nick G]

It happens all the time with cross currency loans on property.

[Amber34]

personal mortgage vs rental mortgage

Hi Graeme
I have enjoyed reading all of your information in this forum.
I was hoping for your advice. I’m a newbie. I’m 34.
My husband and I currently have one investment property in NZ (purchase price 367,000, loan 250,000 17 years left on P&I, registered valuation 440,000). We do not need to top up currently.
We are currently overseas saving $ and would like to build our own home soon in NZ. We will have quite good equity in this build (house value at a guess would be 670,000, loan 325,000).
I would like to know your advice on killing our personal mortgage first using equity from our rental versus keeping equity in our rental and taking longer to pay off our own home mortgage. I calculated we could pay our personal mortgage in 5 years only if we used all of the equity in our rental and put it on a 100% loan interest-only. Then we would plan to attack the rental mortgage. Is there a benefit, apart from a tax benefit, of doing it this way, as opposed to keeping the equity in our rental and taking longer to pay our personal mortgage? We would definitely pay a lot less interest on our personal mortgage if we attacked that first.

At which point would it be worth considering a second investment property? Only once our personal mortgage is paid?

Please let me know if this is not the place to get such specific advice. I am new to this forum, but am really enjoying learning about property investment.

Thanks so much.

Amber

[Nick G]

Interest on personal property is not tax defuctable but it is on a rental so your strategy works, its just a case of reshuffling the same amount of debt.

Definately pay down the rental too after (or use an offset account to cease paying interest and maintain flexibility) because getting 1/3 of the interest you pay back is not a long term sustainable strategy:-)

[Perry]

A simple withdrawal of equity from the rental [business]
to fund a PPOR would not be tax deductible. It has to be
done in a different way, to achieve deductibility. Others
will doubtless offer possible scenarios.

[Nick G]

I stand corrected. Interested to see how it would be done.

[Perry]

It is the reason for the money being withdrawn from the business that's critical, Nick.
If it's taken out for personal reasons, the interest on the loan needed to cover the
equity withdrawal is not tax deductible.

In some ways it's the mirror opposite of withdrawing money from the equity in one's
PPOR, by way of a mortgage, (or the like) to use the funds to start a business of
some sort. I.e. despite the money being withdrawn from a private source (one's
home) the interest is deductible because of what the dosh is being used for.

The nouveau dark line* test may have some influence, but that would depend on the
circumstances, I suspect.

---

* Usually comically referred to as bright line.