Choosing yeild over location?

[spurner]

I know of people recently who have purchased IP's in smaller towns for lower prices and higher yeilds, the reason seems to be that the prices are more affordable. Places like Tokoroa, Invercargill and small towns. The purchasers are based in major cities and their properties are scattered throughout the country.

Example http://www.trademe.co.nz/Trade-Me-Pr...n-56211252.htm $100k property, 9.4% return, rent $9360p.a. at 100% occupancy, less $7600 interest, $950 rates, $300 insurance, $1000 management, and you're already losing $500pa. Even if it gets an 11% return it's only making $1150pa(max) which wouldn't cover maintenance. One bad tenant or maintenance like painting the house would wipe out all positive cashflow for several years. Even at 100% occupancy with nil maintenance is it really worth it for $20pw? And that's not taking into account legal fees, accountancy, and your own time involved.

I used to own some leasehold properties in P.N. returning 20%+ gross. After 2 years of ownership, tenants, and maintenance the net result was that I'd broken even (without getting anything in return for all my time and work put into them).

Am I missing something, as it seems there is little control over the property from afar, and the high yeilds are very deceptive and positive cashflow is unobtainable unless you have good equity, in which case you could get positive cashflow in a major city instead.

It frustrates me to see people investing this way, when they would do so much better investing in a better location like Akl/Wlg/Chc.

Everyone knows yeild is important but do people place too much emphasis on it without thinking about the fundamentals of PI? Have people forgotten the golden rule "location, location, location"?

[xris]

It frustrates me to see people investing this way, when they would do so much better investing in a better location like Akl/Wlg/Chc.

Everyone knows yeild is important but do people place too much emphasis on it without thinking about the fundamentals of PI? Have people forgotten the golden rule "location, location, location"?

I agree. I sometimes feel that there is almost an obsession with positive cash-flow. By being so totally focussed on this people will overlook some glaringly obvious pitfalls when buying. One example might be, for example, buying in Hari Hari when you live in Napier. Just how much are you giving up by operating in this way? I believe these people will quickly realise that the initial $3,000 positive cash-flow they obtained pails into insignificance when compared to all the negatives they soon become aware of.

xris

[Monid]

Hi Spurner you have to be careful not to generalise too much from one case. I'd say generally where ever you buy its hard to find a property these days which stacks up from day one as a cashflow positive property, small town or otherwise.

I'm guessing people are still hitting the small towns because the yeilds are better than in the main centers, and the costs of entering the market much lower.

As long as people have thought through the costs, and checked out the likely growth or decline of the area, there is nothing wrong with a small town as a vehicle for investment.

The main problems there is is that people don't think through the possible costs or have a realistic expectation of growth so they pay far too much for what they get...

[RentMaster]

I agree Spurner. I stick to Auckland myself.

However one of the advantages of buying the lower priced places, is that if you buy a larger quantity, you are spreading the risk. Unless they are all in the same location of course.

Smaller locations also run the risk of one of the major employers closing down.

[Dean@Massiveaction]

I also agree Spurner but people who do their research in smaller markets can do very well. Because I am fundamentally afraid of risk I stick to Auckland unless there is something AMAZING about a small town deal. High yield wouldn't tempt me.

[spurner]

Success stories

Yes my mind is probably already closed to the idea of investing outside a major city.

Does anyone have any success stories from buying in these areas profitably? Getting positive cashflow in the bank on a regular basis?

Is it actually possible to make money on a $50k-$80k property in say Tokoroa, of which there are several just on TM. Even if you got the property for FREE, surely rates, insurance, management, maintenance, legals/accounts, and tenant trouble would cost you more than the $5k-$6k pa you could ever hope to receive in rent?

I can forsee that owners will walk away from these properties in the near future when faced with expensive maintenance and tenant hassles, and just leave the property to the council there (if this isn't happening already).

[Paul34]

Success

Hi

I have made money in the small towns and a huge advocate. I started in 2002 and entered Chch, then Hamilton, then Gisborne, then Wanganui, South Taranki, West coast, Paihatua (and picked up one in Queenstown).

The advantages of small towns for me are relatively obvious.
1) Yeild.
2) Tenant stability: I have had tenants that have stayed the entire term. Why? Because it is a house rather than a flat.
3) Resale: I would prefer a house in a small town over a flat in a city any day. I have owned flats and that is one headache when it comes to sale as you are dealing with investors.
4) Cap gains: The towns were last to go up. Look at the likes of these towns and they are still under valued. Now with the govts working for family packages the rents are also rising. Rent in Gisborne over the last three years has gone up 30%-50% coupled with huge capital gains.

Rememeber also it is what you buy not where. In a town you can buy a good house in a good location and really differentiate yourself in the tenant market which is much harder in the cities.

Now Tokoroa to me is a different story due to the over supply but some towns are just crying out for somewhere to rent.

When you are forced into negative cashflow in a falling market with an expensive mortage it is not a nice to be.

[xris]

Hello Paul34,

Christchurch a small town?

You say you have had success since you entered in 2002. Well, that is good, but with great respect, who has not had success since 2002? You have not the experienced a down market. When we get another one, those small towns (smaller perhaps than the ones you mention) will be the first to be hit. If you have bought well, maintained the place well and have a liveable property then you will probably be able to ride out the storm. But if not and you have to exit then you will be in trouble.

Spurner – yes.

West Coast last year:

Bought a dump for $30,000 – onsold for $55,000. I took a calculated gamble that one of the many eager investors desperate to buy cheap would, and I was right. I would not have done it if the market had been flat, or even normal. The risk of being stuck with it would have been too great. My risk in a major centre would have been less, but still not insignificant.

xris

[Paul34]

Flow

Sorry I didn't make myself clear:
Chch-Hamilton 2002
Gisborne: 2003
Wanganui: 2004
South tarnaki, west coast, Pahiatua: 2005

[NZGEMS]

well i had better jump on the band wagon here, I have bought successfuly in the small towns. I have very few hassles with tenants and of course have rental managers in all towns too. I cant see the problem with them, and it is only in the last couple of years I have really purchsed much there as where I live in Hamilton the houses which pay their way are pretty scarse now, I do not suggest people put in no money, as it appears spurner has done his sums on. I tell them I would suggest a 20% deposit, if you do borrow it all and have a hiccup you could be in trouble, but the houses in the larger towns are certainly going to cost you money if you are borrowning 100% I dont like putting money in if i can help it, (which sounds great from someone who has several "lifestyle" properties) another name for negative cashflow but they are houses we use ourselves at times to holiday in.

my rules are the numbers have to work. and this to me means:

I only buy houses which would pay their way with virtually 100% borrowing, or houses with a good amount of equity so i could onsell for a profit quickly if I chose to.

NOTE i say would pay their way with 100% borrowing it doesnt mean I DO BORROW 100%, one thing you do have to watch with those cheaper houses though is the insurance and rates are often the same as a $300k house where you may have only paid $80k so you do need more cashflow to pay for it. if you can pick up a house for $300k renting for $600pw you are way better off than a house of $80k renting at $160,

but I am certainly in favour of those small towns I just dont want hundreds in any one town. I spread myself around the different towns.

Everyone has different rules to their investing and what works for some will scare others off. trading can be risky too if you look at it that way you could be caught with a sudden drop in the market and have several houses you have purchased with the intention of onselling and suddenly the market has dropped and you could be left with them, that is a risk too, with my ones i buy if i cant sell them again i certainly have a plan b to just rent them out. I usually put in a deposit too even though it is 100% funded, i am selling all the time as well as buying so have money coming in from sales to put a deposit on the next one with.

And which small towns do I invest in????

Rotorua, Kawerau, Te Kuiti, Huntly, Invercargill, Gore, Mataura, at present that is it but have had others and will in the future too and also have houses in some of the larger towns. I still get out looking at times, going South again at the end of the month.

Have permanent hold houses in most of those towns too so I am not planning to bail right out of them at any time soon.

Robyn

[SuperDad]

Hi Spurner,

I just wanted to jump in here. In reading different threads on this forum, I have noticed that people use the term "CF+" in two ways: pre- and post-tax. You seem to be using "CF+" to mean "pre-tax CF+".

In another thread, xris suggested that we consider adopting a standardised usage of the term "valuation". I would like to make a similar suggestion with respect to the notion of positive cashflow - perhaps we could at least qualify whether we mean pre- or post-tax. Further, we need to be aware of whether we are using the term "pre-tax CF+" before or after costs. "Pre-tax CF+ before costs" would simply mean that the rental income covers the interest on money borrowed. This is not very useful, as there are other fixed costs associated with property. Therefore, I submit that by "pre-tax CF+" we mean "pre-tax CF+ after costs".

Looking at the example you provided, its obvious that you are using the term in respect to the pre-tax cashflow, but only after some costs. The example again was:

$100k property, 9.4% return, rent $9360p.a. at 100% occupancy, less $7600 interest, $950 rates, $300 insurance, $1000 management, and you're already losing $500pa. Even if it gets an 11% return it's only making $1150pa(max) which wouldn't cover maintenance. One bad tenant or maintenance like painting the house would wipe out all positive cashflow for several years. Even at 100% occupancy with nil maintenance is it really worth it for $20pw? And that's not taking into account legal fees, accountancy, and your own time involved.

How do the figures stack up once you take into account the tax refund?

Why haven't you budgeted maintenance into your costs? In my spreadsheet I calculate maintenance at 7% of annual rental income. (I know others use different methods of calculating this figure.) Why do the figures without taking into account maintenance when all houses need maintenance? You're only skewing the figures by doing this. Similarly, why haven't you taken into account legal fees and valuers fees associated with purchase? The costs will make a big difference to your first year's cashflow.

I put all of these costs into my spreadsheet and, suprise suprise, I haven't found any properties that are pre-tax cashflow positive in year one. This raises another issue: perhaps we should be careful to differentiate between "CF+ from day one" and "CF+ from second year", both pre- and post-tax? Why would this be useful - because one-off costs make a big difference to the first year's cashflow. As we are only running cashflow analyses on buy-and-holds, which we will be keeping for longer than one year, why not look to the second-year cashflow projections to give us a better idea of whether a property will pay its way? Of course, we could always omit the one-off costs from our first-year analysis, but this does not reflect the true costs of ownership in year one.

To summarise. I think that the following are useful notions:

1. Pre-tax CF+ from day one after costs.
2. Pre-tax CF+ from year two after costs.
3. Post-tax CF+ from day one.
4. Post-tax CF+ from year two.

Is this all a useless excercise in splitting hairs? Obviously I don't think so. Why? Because I have often found that others are not clear when using these notions. Both newbies and fanatics alike could benefit from some conceptual clarification in this area, not least for the purpose of allowing clearer communication with each other.

One last thought: Spurner, does your investing strategy require pre-tax positive cashflow (from day one or from year two)? Can you meet your investment goal/s with post-tax CF+, or even post-tax CF neutral? This is one issue I am trying to sort out for myself. If it turns out that you can get away with post-tax CF+ (and I think true pre-tax CF+ places will be very hard to find once you factor in all of the true costs), then you'll start to find more deals that stack up. Some might say that you're finding more deals because you're lowering the bar. I say that there's nothing wrong in a strategy that involves lowering the bar if your goal/s will be effectively served by that strategy.

Happy hunting,

Paul.

[Volatile]

Hi Spurner,

I put all of these costs into my spreadsheet and, suprise suprise, I haven't found any properties that are pre-tax cashflow positive in year one. T

Paul.

This is the same issue i am finding! I can not yet find any properties where the numbers stack up with 100% finance. Then alot will not stack up with a $50,000 deposit.

[McDuck]

I think that “location location location” still applies.

[NZGEMS]

Yes location location location does apply, but it depends where you define location as. For me it anything the numbers work, but dont get me wrong, I would not want just these cheaper properties (and I know some do) I like a mix of the nice, middle of the road and a few cheapies.

I keep mostly middle of the road because at the end of the day if things get tough people have to live somewhere and there will always be renters and so there will always be a demand for good average houses. The demand in the lower bracket will be there to a certain extend and some of my properties in these cheaper towns will fall into that middle of the road bracket, I do avoid the real rough areas though even though they are even cheaper in many cases, you are more likely to have propblems with them.

so it all depends in your world the meaning you put on location location location. I know I certainly like my property portfolio as a whole to put money in my pocket so I go for a mix with some really nice stuff, mostly middle of the road and a little of the what would cosidered the junky stuff.

Robyn

[cantthinkofanickname]

I to have properties in smaller towns my last one 1 month ago has these figures
Rent = 180
Occupancy rate '2 Weeks' = 96.15%
Solution = $86535.00
Asking price = $119,000
bought $90,000
Closing costs:
Deposit 0 % = $0.00
Legal fees = $800
Stamp duty = $0
Mortgage app fees = $0
Mortgage insurance = $0
Valuation fees = $500
Other borrowing costs = $0
Clean up costs = $0
Inspection costs = $0
Other costs = $4500 reno
Total closing costs = $5800.00

Mortgage details:
Loan P&I = $90000.00
Interest rate = 7.5%
Term = 25 Years
Weekly mortgage repayments = $129.81
Total repayments for life of loan = $168750.00

Annual costs:
Management fees 0 % = $0.00
Letting & advertising = $0
Body corp fees = $0
Rates = $950
Utility rates & fees = $0
Insurance = $350
Miscalanious costs = $0
Land tax = $0
Maintenance 10 % = $899.86
Other ownership costs = $0
Total annual costs = $2199.86

Summary:
Total annual rent = $8998.60
Total annual mortgage = $6750.00
Total annual costs = $2199.86
Total annual cashflow = $48.74
Total funded costs = $5800.00
Risk free return = $232.00 bank interest rate of 4%.
Annual Cash On Cash Return = 0.84 %
Cashflow Positive Weekly = $0.94
this property is under rented at this time and should be 200 pw but i had 2 others empty so just wanted this sorted fast hence cheap rent
the good part of this deal is now happening, reg valuation after renos $128,000. LVR will be 75 % AND I HAVE MY $$$$ BACK Paper profit $33,200 Of course capital gain is not going to happen much here but since i dont have any cash in the deal who cares i will be out in a fortnight trying to find another .I believe in another two years this propertywill be putting $1,500pa pre tax in my pocket as it is a long term buy & hold

graham