Make first home a rental and buy a second family home

[Jamrock]

Hi all

I have a question regarding buying a second home and possibly turning our current home into a rental. Here’s the scenario:

I own a 1 BED city apartment which I live in with my girlfriend. It’s valued at $600k with a mortgage of $200k.

My girlfriend is currently selling her UK home. Using bottom dollar assumptions, she aims to bring over NZ$235K. We earn a combined gross income of $210k pa

With plans to start a family, a 1 BED apartment is not ideal. I guess we have 2 options here;

1. Sell the 1BED apartment and combine our money to buy a bigger place
or

2. Keep the 1BED apartment as a rental and purchase a bigger place (The 75m2 apartment with car park rents out at $600pw)

There are some tax concerns as well as LVR and ownership structure considerations. Are we able to sell the apartment AFTER buying a bigger place or does that involve some tricky tax issues?

How do we arrange the mortgages if we decide to make the apartment a rental, either in our own names or a company?

[Anthonyacat]

First up you need to consider whether your current home makes a good rental. Super quick sums: $600pw x 50 weeks = $30k rent. Less $8k bodycorp and $2k rates gives $20k; a 3.3% net yield on $600k. Hard to say whether that's a good investment to you, but it's not one I'd buy.

You will be able to sell the apartment after buying a bigger place, as long as the banks think you can service both mortgages. A rent appraisal will help with that, and on a $210k income I don't see any issue, but I'm not a broker! There should be no significant tax issues at play there. Your existing mortgage will become deductible from the point it becomes a rental, and your new mortgage will be non-deductible private debt. There shouldn't be any LVR considerations here, as you're buying a new owner occupied property so can get 80% lending. Perhaps consider using a different bank (or a mortgage broker) to avoid the possibility of them asking you to bring the current apartment down to 65% LVR.

If you decide to keep the apartment as a rental, it's worth considering a restructure. Personal ownership may be the best option, but it's likely an LTC will make more sense, or possibly a trust, given intention to start a family. If you don't restructure, there's nothing you can do with the mortgages, as above your existing one becomes deductible, your new one isn't. If you do restructure there's the opportunity to make more of the debt tax deductible, but there is also the possibility that you won't be able to raise sufficient finance as the properties will need to be with the same lender, who will likely stick you with 65% LVR on the rental.

Hope this helps!

[Rosco]

Hi Jamrock,

A quite common restructure is for the 1 bedroom unit to become a rental, often by selling to an LTC, so that the LTC borrows $600,000, and all the interest on the $600,000 is tax deductible. A good mortgage broker and property accountant can help you with this, and you should be able to borrow 100% in the LTC, if you use one or two banks (two is often better as have your personal house with one and rental with another).

First I think you need to look at your long term strategy. Does your 1 bedroom unit help your long term aim?

With a 100% mortgage of $600,000, the 1 bedroom property is going to be quite cashflow negative. For me this isn't ideal and I would only do it if I had a 5 year strategy to turn it around. Often that would be to subdivide or add a minor dwelling, which I'm guessing you can't do. Maybe in your case, turn into a two bedroom unit could be an option? Otherwise you are really left with paying down debt, but realistically in the next 5 years you are likely to be still paying down debt on your personal house. So take some time and think this through. The other option you could consider is to buy a new personal home, sell the 1 bedroom unit and then buy a specific rental property where you can add value or is better cashflow.

Good Luck

Ross

[newbyvest85]

I own a 1 BED city apartment which I live in with my girlfriend. It’s valued at $600k with a mortgage of $200k.

Apart from the issues re mortgage structure etc., I also strongly recommend (coming from painful personal experience) seeking legal advice regarding the 1 bed city apartment, which you own.

Is there anything you can do, e.g. set up a Contracting Out Agreement, to ensure that the city apartment continues to be YOUR own property - as opposed to being a RELATIONSHIP PROPERTY? It depends on how long your relationship has been, if it is <3 years there may be scope for discussing that still.

One always hopes for the best in relationships (I do), but I nearly lose half of everything - had I not been saved by the 3 year rule.

[Anthonyacat]

Is there anything you can do, e.g. set up a Contracting Out Agreement, to ensure that the city apartment continues to be YOUR own property - as opposed to being a RELATIONSHIP PROPERTY? It depends on how long your relationship has been, if it is <3 years there may be scope for discussing that still.

Excellent advice to consider, but they're already living together in the property, so it's likely relationship property already if the other tests are met.