Interest only or plus principle mortgage; and opinion on Rotorua.

[Catboy]

Hi All,

I'm new to NZ property investment, although I've had 2 UK rentals previously, one of which I have just sold.

I've just signed a sales and purchase agreement for a tidy 3 bed in Rotorua. While I don't believe it's a complete bargain (I'm paying only 8k off asking price) it feels like a solid family home which should be easy to rent.

I've done the figures and it comes out to about 6.6% yield, which while not the greatest, I'm pretty happy with as this will be a long term investment.

My main dilemma is the strategy I am going to use going forward. I have read a few times that a good strategy is the whole "interest only mortgage" and buy a number of properties relatively quickly (using value-added equity to recycle deposits etc) then further down the line sell a couple and sink profit back into the interest only ones... Obviously this relies on growth, which medium to long term is probably going to happen...

The other is obviously to buy slower but pay interest and principle. My main question is what would the seasoned property investors out there choose to do if they wanted to build a solid portfolio that could support them financially in a decade or so?

My main goal is to eventually invest full time and use my portfolio as an income. Don't worry, I am not under any illusion that it is easy money and am happy to admit I've got a lot to learn!

Lastly, what is the current feeling about investing in Rotorua. Is it due for capital gains seen in other parts of NZ?

I've done some reading and talking and have a list of good/bad Rotorua suburbs (obviously it's not that black and white, but for the sake of argument it's a starting point for someone who doesn't know the area) these are:

Good:

GlenholmeHillcrest
Springfield
Lynmore
Fairy Springs,
Sunny brook
Ngongotaha - ok
Pukehangi - ok

Not so good:

Fordlands
Turner Drive
Leslie Avenue
Western Heights

What is your opinion on the above? As mentioned I don't know how accurate the above list is but please feel free to add/correct me if nec.

Lastly, I've done lots of searching on the forum already for this info!

Thanks in advance.

[Nick G]

My thoughts in no particular order (disclosure we are property finding agency that operates in Rotorua, I've seen hundreds of properties, marketed hundreds more, bought and sold a few and hold one currently).

1. Rotorua is a funny market and there are some not good so good streets in "good areas" and absolutely fine street in bad areas. Go for a drive around and you'll understand.

2. Western Heights is huge and you can't really label it good or bad as a whole.

3. Do your net yield research. Rates are very high in Rotorua for starters, I think at your gross yield you might be CF negative. Rates are 2.5K or so in 'vegas, PM fees are slightly higher too so after maintenance and insurance gets added and interest rates go back up to 6 or 7 how does your property look?

4. Good property management is critical. Right now every PM looks good but hold a property through a downturn there and you'll see who really earns their stripes. Ask your PM to cast their eye over your property. Remember that nice gardens need to be maintained.

5. A 6.6% yield is low for a Rotorua "cheapie" rental so I guess you've either gone for a nice home or need to do some more research on prices. I've only ever marketed one property in Rotorua for under 7 and it's a really nice family home. Normally we've been 8-10%+ although in the current market 9% is very good.

6. Personally if I were to buy a 6.6% yield property in Rotorua I would be looking for a property with scope to improve and get the yield up in to the 8's but that's just me.

7. Rotorua is going through capital gains right now just like the rest of NZ but you don't want that to be your strategy. Personally I would try to find a property there that "washes its own face" - ie pays itself off with a P&I loan. I call it the "free house strategy". Buy the nicest one of those you can find and pay a proper deposit. You also want to be absolutely sure that it will rent easily.

8. Your strategy of relying on growth is a risky one. A lot of investors in the last boom did that, re-leveraging based on paper profits only to se the banks call in their loans when the crash came. Crashes always come and you want to have a rock solid foundation to be able to a) hold your properties and b) buy more.

9. Run your numbers on the following all happening at once at some point - interest rates go up to 7, rents drop 10% and pool of tenants gets tight due to employment issues, costs keep going up (they always do), 3 months vacancy (for whatever reason), you need to sink a lot of money in to fix a major issue with the property, your partner is pregnant and you just lost your job. Now imagine that when holding 10 properties and the bank calls you and says you need to sell 4 to meet your equity and servicing rules which are tighter in a downturn. Since noone is buying you have to meet the market and lose money on each sale. Poof, portfolio gone and you probably still owe money. This is exactly what happened during the last downturn to a lot of investors who leveraged and bought up large on the logic that growth would keep coming and it stopped overnight.

[Catboy]

Thanks Nick,

I really appreciate the in-depth answer- lots to think about! I'll post another response once I crunch the numbers etc.

[Catboy]

Other opinions appreciated also

[Kirwee]

Hi Catboy,
6.6% yield is very low as Nick says.
May I suggest that you read the "Sticky" articles by Graeme Fowler (Orion) at the top of this forums main page.
There's a wealth of information (pun intended) in these and they will provide answers to your question(s) as well as helping you to safeguard your assets.
Regards, Brian

[Damap]

We have a block of units in Ngongotaha. Had experienced very flat rents and declining values but this year rents have moved considerably.

[Catboy]

Thanks Damap, that's interesting... seems like cashflow is king in Vegas?

[Nick G]

Historically gains do come but they come in a rush whereas in the bigger cities is more constant but more expensive. So you want reasonable cashflow to keep the asset ticking along until the gains inevitably come.

[Catboy]

After reading replies on this and similar topics I'd be much more inclined to stay away from Interest Only (even partial) and stick with P&I on the whole property now. It feels like a more secure, fluctuation-resilient and sensible strategy to go with P&I while still aiming for positive cashflow.

[AlFa]

As for me you shouldn't even bother looking at properties outside Auckland if they're not positive on 20y PI loan. My yield in Rotorua is 10% gross and this provides small positive cashflow. So anything less and you're negative.

[Catboy]

Thanks AlFa, can you please elaborate on this statement "My yield in Rotorua is 10% gross and this provides small positive cashflow. So anything less and you're negative."

Negative in what respect exactly?

[AlFa]

Negative = You'll have to pay for the property from your pocket.

[Catboy]

Yes I get the concept but how do you know that anything less than 10% going to be negative?

[Nick G]

The lower the purchase price the higher the GY needs to be because your fixed costs like rates, maintenance budget and insurance don't get much cheaper. Just plug whatever the numbers are into the calculator tool and you'll be sweet.

[AlFa]

According to real world numbers of course. Will give you example:
PP - $180000
Finder's fee - $10000
Deposit - $10000
Loan - $170000 at 4.25%

Rates - $2200
Insurance - $660
Management - $1700
Interest, pa - $7200
Total tax deductible expenses - $11800

Rent, pa (52 weeks) - $17600

Cashflow = (Rent - PI - Expenses) - $300pa
Gross yield - 9.3%
Nett yield - 6.9%

So as you can see I have no allowance for repairs or tax and with 9.3% gross it's already on the edge. Hence I'm telling you 10% should be your target