Investment is all about making the figures work. And in times of economic stress, it’s even more important to be sure you are on the right track when it comes to the sums. If an investor is not working out their risk and return, cash flow and long-term gains, they could slip into loss territory quite easily. We explore the vital numbers for property investors, and whether that tempting new opportunity may just push you over the edge of affordability.

Mortgage Stress

Research and ratings company Canstar ran data for New Zealand Property Investor magazine on how much income investors need to earn to pay a mortgage on a new rental property; and how much weekly rent they will need to get to stay in positive cash flow territory. The data shows Bay of Plenty and Auckland investment mortgage holders need to have gross household income of $44,527 and $41,368 respectively above the average income to be able to service their debt without slipping into mortgage stress (generally defined as over 30 per cent of household income). This is without taking into account the main family home (that might be mortgaged), nor outgoings as they can vary hugely across households. However, it’s a different story in Southland where the average house price is low enough to allow average-earning investors a decent buffer against mortgage stress.

Canstar New Zealand general manager Jose George says the company’s research shows being in mortgage stress is likely to be common. “This is worrying. Mortgage stress is the point at which households struggle to pay bills, and general wellbeing, including mental health, can suffer.”

Do Your Research

Kiwi Mortgages principal adviser Rakesh Bansal says investors need to regularly scrutinise their lending because of changing legislation, and in terms of how much they can borrow and what tax vehicle will suit them for tax efficiency.

“After the government upped trust tax many investors will review their investment portfolios even though they cannot do anything about the rise. Combined with tax deductibility and changes to the Residential Tenancies Act, holding investment properties is going to be expensive.”

He says the mindset of the two property investor types – investing for retirement or building a portfolio – is quite different. A young couple in their 30s doing well will invest even if they have to initially make up a small loss. It is a temporary pain they can afford as they will take a long-term capital view.

“The most important numbers are equity and whether their income is high enough to buy more properties. For people investing for retirement, they generally only want one property and to get the mortgage paid off as quickly as possible.”

However, he says many first time investors are putting off entering the market because lending is tight, interest rates are rising, banks’ appetite for lending is limiting and repayments are increasing.

“People have started calculating this in their own minds, which I didn’t see a year ago. The first thing they always want to know is what their repayments will be to calculate whether they fit into their household budgets.”

Look Ahead

iFindProperty owner and operations manager Nick Gentle says there are two numbers that are important when considering a purchase: final cash flow and equity gain. “I look for immediate equity gain as it helps growth and then I always look for yield.”

He says savvy investors set goals before starting to look at buying and then measure properties to those goals. “If you want to buy to develop and sell, then you want to make a profit. If an investor wants to buy something to hold and rent, then they want a rental income. If you buy something and you don’t mind if it makes a small loss for a while, then you work out what the rental is, how much of a loss you can stand and how quickly you can get rid of the loss.”

About 85 per cent of investors are “mum and dad” landlords with one property, who have been able to buy because they had enough equity in the family home. Gentle says they tend to think in terms of rent – does the rent cover the mortgage and what else can I buy. “The numbers they run are very different to a professional investor who is trying to build a portfolio and thinks in terms of cash flow, equity, LVRs and other things.”

He says many investors who bought recently will have to sell when the interest deductibility drops to a quarter next year and then comes off completely the year after. This will cause a rapidly shrinking pool of properties and because of that social housing and new builds will no longer really be a factor as rentals for a couple of years, so rents will increase which will help those investors out.

It’s a good plan to set goals before you look at buying and measure properties to match your goals.

Matter Of Interest

Gentle says for a long time the book on mortgages was interest only – paying down the mortgage on the house twice as fast because it was tax deductible debt. If he was buying a property now where there was room to add one or two bedrooms, Gentle would opt for a five-year interest-only term because cash flow will be low for a while.

However, he says investors need to factor in that a 25-year loan will drop to a 20-year principal and interest mortgage when the interest-only period ends. “At some point they will have to redo their whole mortgage and there is no guarantee the bank will accept this or will let an investor make bigger payments.”

If an investor wants two houses in 30 years and then sells one to retire, Gentle says he would have a principal and interest mortgage, as it would guarantee the debt being paid off in 30 years. He would just adjust his lifestyle in the meantime.

Doing The Sums

“Any investor who didn’t do any numbers on their property over the past 18 months will more than likely have poor rental yields because the phasing out of mortgage interest tax deductibility will have hit them first and now they will be struggling with high interest rates,”

Gentle says investors need to remember it is a 20-year long-haul game. “The message is that good and bad times come and go.”

He concedes it is a lot easier to be in residential property investment for the long haul if an investor has a well-set-up portfolio, as he has, but “if they are bleeding money every year they can’t do it”.

Running the numbers regularly, he says, makes it easier for investors to work through different scenarios when times are tight as they are now.

Factor In The Hard Times

Ryan Weir is director of management experts Property Scouts. He says that when working out the sums for a potential property, it’s important to not only look at numbers from the rosy period when the rental is fully tenanted. Investors also need to consider the not-so-good times, when interest rates, maintenance, insurance and rates are rising and there are gaps in tenancies.

He says it is prudent to run the numbers as a stress test. “Take a darker approach to the projections you have and run the numbers with higher maintenance costs than expected and programme in some extra vacancy, which are the big costs not many people think about.”

Even investors without mortgages should run the numbers to see if they are commanding a good return. The four figures he says investors should be keeping their eye on are market rents, average tenancy tenure, maintenance costs and a quick change in numbers through legislative control – see the table left for the details.

It’s important to run the numbers for good and bad times – consider tenancy gaps, increases in mortgage rates and other costs.

The big four

Rents: Can only be changed once a year. Weir says it’s not “bash out any old rental rate increase to be in line with inflation”. It has to be in line with market rent and average rent rises are about 4 per cent. Seasonality is also a factor in rents. In Auckland, for example, Weir says his company tends to see rents differ in the winter.

“A property can be rented in February at $800 a week and then if it is re-let in winter the landlord can expect a $64-a-week cut. This is a $3,328 loss just because of seasonality.”

He says it is more of a city fringe/Auckland central issue. Dunedin, Wellington and a part of Christchurch also have some seasonality in rents.

Rent income numbers can also change quickly through vacancy between tenancies. If, for example, a Mangawhai house is rented for $600 a week, but a five-week vacancy occurs between tenancies, that means a $3,000 hole in the bank account while there are still regular expenses such as rates, insurance and mortgage payments to meet. Weir says having the rental empty for five weeks is the same as having that property rented for a year at $540 a week. “That is the effect of vacancy.”

Tenure: If the tenure on a rental is lower than 18 months, Weir says it could be a sign there is something wrong with the property that needs to be uncovered and fixed.

Maintenance costs: These should be looked at on a 12-month rolling average. If there are constant or high maintenance costs they are the quickest way to eat away at returns.

“Often landlords just go along and pay the maintenance bills, but they need to stop and take a look at what maintenance costs are and decide if the property is costing far too much to hold.”

Legislative control: This can also change numbers quickly, says Weir. “I will never forget the moment I was watching a Jacinda Ardern stand-up news conference and she mentioned mortgage interest deductibility was going to be phased out. I could not believe what I was hearing.”

He says this alone, without other changes aimed at landlords, has had a huge impact. “An investor with a $650,000 mortgage is going to be worse off by potentially $200 a week when the changes are fully phased in unless they have bought a new build.”

Bank changes also have a massive effect when credit tightens up, says Weir, not a topic many people think about. Any changes often stop investors from borrowing against their rentals to make improvements and growing their portfolios.

Weir says in this environment it is best for investors to hang on to what they already have and optimise returns.