As a result Kiwis often view residential property investment with rose coloured glasses (all good) , but like any investment class, it has its good and bad points.
Residential property investment returns are a combination of the rent (yield) and capital gain. Rent commonly equals about 3% to 4% of the capital value;
A $350,000 house might rent out for $400 pw or $20,800 pa
Less rates, insurance, perhaps 3-4 weeks vacant pa. , & maintenance, say $12,000 pa = 3.4% rental
3.4% on its own is not enough, so the investor clearly needs capital gain as well
3.4% plus a capital gain of say 5% pa = 8.4%
On that basis it starts to stack up, but capital gain is of course not guaranteed.
Horses for courses
A 30-year-old investor will probably borrow a lot of money and use the rent, plus perhaps some of his/her surplus income, to pay off the mortgage. He/she will not be wanting income but will be seeking long-term capital gains.
A 60-year-old investor will be looking to invest for income by age 65 to 68. He/she will be planning to have no mortgage on the property by his/her retirement age, so that he/she can use the rent as retirement income.
The problem for the 65-year-old is the 3.4% income (before tax). It is about 1% less than you can get from a bank, about 2% less than you can get from quality bonds, and 3% to 5% less then you can get from listed property trusts. In addition the 65-year-old investor cannot use any capital gain as income until he/ she sells the investment property.
Unless you have a lot of money, you will probably only be able to afford one rental house and so it will be difficult to get any sort of diversification. The main problem with lack of diversification is tenants – can you get one ? Or if you get a bad tenant who is often in arrears, you will have no/poor income but you still have to pay rates, insurance etc. If a tenant damages the property, again the investor has to pay and hence no income for a while.
If you can afford more than one house, remember geographical diversification. Imagine if you had all your money in rental houses in Christchurch, or Te Puke where most of the orchards have been destroyed by the PSA virus (hence low tenant demand).
If you are going to have more than one rental house, it would be better to have them scattered around different cities in NZ e.g. Auckland, Hamilton, Tauranga and Wellington.
Liquidity or access to money
Everyone needs liquidity or access to cash as emergencies do arise. Most property is illiquid in that you usually cannot get cash out of it until you sell it. Consequently you should normally hold some cash handy for emergencies.
If that all sounds too hard, or just not you, you can invest in commercial property in NZ by buying shares in the well-known listed property trusts (LPT’s) via the NZ share market. The income is more like 7% to 8% too. See article no 2 from last week.
Residential property investment is very popular, but has low yields, and is not without risk. Perhaps it is better for younger people growing their capital, but not quite so good for people getting close to retirement. Then it may be better to have a diversified portfolio of bonds, property and shares.