Making the numbers work

[Bob Kane]

For example, one place is for sale by an investor at $420K. It's only 3 bedroom and in a rough pocket of a generally good area.
Even with a 20% deposit, interest only payments are still approx $365 a week on a floating rate. Add in rates at approx $50/week and you're already above the $400/week I estimate you might be lucky to rent it out for. That doesn't even consider maintenance!
Ie, that would be tying up $84K of my money as a deposit and by the time you factored in insurance, maintenance etc then you'd still be cashflow negative. Thanks to the Trademe property app, I can see they've only made about a 3% captial gain per year for the time they've held, so you wouldn't really do it for that either! This doesn't make a lot of sense to me!

Is this simply a bad investment that shouldn't be considered, or is this just the way it is these days? What are others looking for, is there a better way to make the numbers work? I have seen what you can claim as expenses to help your cause on the IRD website.
Sapio

This is a good question that will cause a lot of heart palpitations amongst some of the readers here on PT when I answer it.
Property in NZ seems to double in value every 7-10 years.
(yeah - I can hear the heartbeats already)
Lets be conservative and stick with every 10 years.
Now let's say you have a negative geared property - and let's be brutal - say you have to pay $200 pw to prop it up. That a $10k loss every year.
Why would you buy such a property - how can you make money when you lose $10k pa?

Now, get ready for some fireworks.
Let's say you bought the property for $100,000.
What happens over 10 years?
After 10 years you have lost (10 x $10,000) $100,000
And the value is now $200,000 - so you gained $100k and lost $100k so you've come out even.
As an aside - it would be quite hard to lose $200pw on a $100k property so maybe this example is a bit unrealistic. Never-the-less, you break even.

Repeat this calculation for a $300,000 property and losing $200pw:
Over 10 years - you lose $100,000
The property doubles in value and is now $600,000 - a gain of $300k.
Deduct the $100k loss and you end up with a gain of $200k.
Here we have a useless investment that is negative geared for 10 years - and we make a gain of $200k.
Ahh, you might be saying.
But property doesn't always double in value every 10 years.
Well, you might be surprised if you look back over the figures.

[Sapio]

This is a good question that will cause a lot of heart palpitations amongst some of the readers here on PT when I answer it.
Property in NZ seems to double in value every 7-10 years.
(yeah - I can hear the heartbeats already)
Lets be conservative and stick with every 10 years.
Now let's say you have a negative geared property - and let's be brutal - say you have to pay $200 pw to prop it up. That a $10k loss every year.
Why would you buy such a property - how can you make money when you lose $10k pa?

Now, get ready for some fireworks.
Let's say you bought the property for $100,000.
What happens over 10 years?
After 10 years you have lost (10 x $10,000) $100,000
And the value is now $200,000 - so you gained $100k and lost $100k so you've come out even.
As an aside - it would be quite hard to lose $200pw on a $100k property so maybe this example is a bit unrealistic. Never-the-less, you break even.

Repeat this calculation for a $300,000 property and losing $200pw:
Over 10 years - you lose $100,000
The property doubles in value and is now $600,000 - a gain of $300k.
Deduct the $100k loss and you end up with a gain of $200k.
Here we have a useless investment that is negative geared for 10 years - and we make a gain of $200k.
Ahh, you might be saying.
But property doesn't always double in value every 10 years.
Well, you might be surprised if you look back over the figures.

While this place obviously might not be representative of NZ's housing stock, it has only gone up 28% on the original asking price in 9 years. They've since dropped that price. The price they paid when they bought doesn't seem unreasonable. In this scenario you'd still be well out of pocket!

[TAG]

If you really think the rent is low review in 6 months rather than a year (unless it is fixed term of course).

Thanks for that, Wayne. We weren't too sure what would be ok - would it be too soon in six months? Right now the market in Chch for tenancies is a bit fluid because of the crazy post - eq rents settling down a bit - so will definitely be keeping an eye on this.

[Sapio]

Are you limiting your search to Christchurch?

DBTH, I personally have been so far because it's what I know. It makes the whole process a lot easier as you can view the properties easily if that's where you live, you have all your contacts and networks in the area etc.

For someone looking for their very important first rental, isn't buying in a different city or potentially island a little risky?

You're quite happy to buy unseen? What process do you have to avoid buying lemons?

Cheers,
Sapio

[Bob Kane]

While this place obviously might not be representative of NZ's housing stock, it has only gone up 28% on the original asking price in 9 years. They've since dropped that price. The price they paid when they bought doesn't seem unreasonable. In this scenario you'd still be well out of pocket!

If I've read your figures correctly:
- this property would run at a loss of about $100pw?
- it gains in value about 3% pa = $12k?
12k - 5k = $7k gain.
Is this gain too small for you?

[Sapio]

If I've read your figures correctly:
- this property would run at a loss of about $100pw?
- it gains in value about 3% pa = $12k?
12k - 5k = $7k gain.
Is this gain too small for you?

Is it your property Bob?

That rent was an absolute best case, by the time you factored in all the expenses, some vacancy etc, I think it'd be closer to zero return. That's also on interest only which leaves no margin for error or things going wrong. Then there's the opportunity cost of having a 20% deposit tied up! I don't think the risk return reward is there personally. But thanks for pointing out the different way to look at it. I've changed my search to 'less desirable' suburbs and seem to be getting closer to making the numbers work!

[Bob Kane]

Is it your property Bob?

That rent was an absolute best case, by the time you factored in all the expenses, some vacancy etc, I think it'd be closer to zero return. That's also on interest only which leaves no margin for error or things going wrong. Then there's the opportunity cost of having a 20% deposit tied up! I don't think the risk return reward is there personally. But thanks for pointing out the different way to look at it. I've changed my search to 'less desirable' suburbs and seem to be getting closer to making the numbers work!

LOL
Good luck!

[Don't believe the Hype]

DBTH, I personally have been so far because it's what I know. It makes the whole process a lot easier as you can view the properties easily if that's where you live, you have all your contacts and networks in the area etc.

For someone looking for their very important first rental, isn't buying in a different city or potentially island a little risky?

You're quite happy to buy unseen? What process do you have to avoid buying lemons?

Cheers,
Sapio

If you are going to own in an area away from where you live there are a few things i would suggest:

1) Don't do it if you're going to stop at 1 property - you need to have scale in the area to make investing outside your local area worthwhile

2) The MOST IMPORTANT person is your property manager - Find a boutique manager (i.e. not one of the big agencies) who lives in the area you're buying. The problem with major/chain PM companies is the quality of service goes up & down as staff turn over. If you go with a smaller (owner operator) you will be a bigger part of their overall business so more likely to get good service. They will know the streets to buy in and the ones to stay away from, with a bit of luck (my best PM does this) they are hands on and do some of their own maintenance work which will mean when they 'inspect' a property on your behalf they will have a feeling for what needs to be done to get a property to a tenantable state. You may have to pay your PM an hourly rate to inspect properties for you but when they realise that you're buying and they'll get the management of the property i find they're happy to help out.

3) Become a local expert - this might require a trip or 2 to the location but will mean you don't have to go each time you find a property on line that you may want to buy. You should use this trip to get a feel for the area, meet property managers so you can pick one and meet some of the local building inspectors. Outline your plans and what you will want/expect from them as you build your portfolio. Spend as much time as you can online understanding recent sales and what they will rent for. understand the demographic of the area so you know what is desireable for that local community... forget the rot people spout about don't buy a place you wouldn't live in yourself... different people have different expectations of what home is. Meet their expectations - NOT YOURS.

4) Understand costs of fixing things - carpet, internal paint, hot water systems, new roof, replacement weatherboards, wiring - these costs don't vary much location to location (ex the Auckland up-charge) - as you become more aware of what might be wrong with a place and what the risks are and which items are high cost to replace you will understand where to look to find the ISSUES that will need to be fixed. For me issues that need to be fixed are actually great to find. I know i can replace/fix something for a certain price... i can negotiate 2x that of the sale price of the house as it's more trouble than it is worth in most cases for the vendor.

To avoid lemons - broadly covered in point 4 but you need to set your offer price to ensure you're covered for the RISK that you're taking... this comes down to how you negotiate the deal... remember NEGOTIATION is everything. If you understand motivations of the vendor and what is most important to them you will be able to cover yourself for most risks. But in reality you will get stung from time to time with a new SURPRISE - take the pill (cost) and learn from it... it strengthens your point 3 above! Just don't over extend yourself financially that you can't cover these surprises that pop up time to time.

The first few sight unseen purchases are a leap of faith... but they get easier. The reality is you follow the same process when purchasing however the 'viewing' step is not done by you.

Hope this helps.

[Nick G]

2) The MOST IMPORTANT person is your property manager - Find a boutique manager (i.e. not one of the big agencies) who lives in the area you're buying. The problem with major/chain PM companies is the quality of service goes up & down as staff turn over. If you go with a smaller (owner operator) you will be a bigger part of their overall business so more likely to get good service. They will know the streets to buy in and the ones to stay away from, with a bit of luck (my best PM does this) they are hands on and do some of their own maintenance work which will mean when they 'inspect' a property on your behalf they will have a feeling for what needs to be done to get a property to a tenantable state. You may have to pay your PM an hourly rate to inspect properties for you but when they realise that you're buying and they'll get the management of the property i find they're happy to help out.

The MOST IMPORTANT person is your property manager
Absolutely true

Find a boutique manager
I used to subscribe to this however having fired one boutique manager after 2 stolen ovens and a $12K maintenance bill due to absolute neglect of the property (I was overseas) now I think differently.

I think now that you should ask around a bit, particulalry at the local PIA or other local investors and get a feel for things. The risk of a big agency is just what DBTH said, however if they're big it's often because they have good systems and know how to hire.

If you go small, make sure they have systems, ask to see a couple of their investor reports and quiz them on how they handle issues like late payments, maintenance or damage. That being said, if they can do some of the maintenance it is really nice because you'll save money and the person has more hands on involvement with your property.

I will add don't worry about PM fees. The difference a % means is a few hundred dollars. Compare that with a $12K repair bill. It just makes sense to find the best local operator and ask them to work with you.

[Sapio]

Update;

The property I kind of started this thread about failed to sell, was then listed as a rental and failed to get a tenant and then got relisted with a different agency by the same owner. It's in a bad pocket on the good side of town.

We attended an auction for a place for ourselves to live. It was eventually sold to investor who has listed it for rent. The yield is 4%. 4%!!! And that's with an optimistic rent they may not even achieve. Great area so I guess they're just going to hold for capital gain.

The situation in the good area of Christchurch where we're looking seems interesting at the moment. There are heaps of vacant rentals on the market with rents coming down, yet houses are still going crazy at auction with little sale supply. Is this the peak or just usual?

[Monsterbishi]

The situation in the good area of Christchurch where we're looking seems interesting at the moment. There are heaps of vacant rentals on the market with rents coming down, yet houses are still going crazy at auction with little sale supply. Is this the peak or just usual?

The market is indeed starting to normalise itself in Christchurch, until lately the market has been dominated by demand stemming from overall lack of supply - now that we're past that people are starting to look towards more traditional reasoning like school zones, size and proximity to town.

You are right though, auction prices are still ridiculous compared to other means - two bedroom places seem to be affected less but three bedroom places are still going for stupid money.