With big goals like owning an investment property, it’s crucial to preplan and set clear goals with your partner and/or family. What is it you’re looking to achieve by owning an investment property? When do you want to be in a position to buy your first investment property? Once you’ve clearly mapped out what your goals are you’ll be able to work that down to a budget and then have a much more determinate path for getting there.

If you’ve only just recently purchased your first home, you might need to spend some time saving the pennies and paying off a good chunk of your existing mortgage to build up equity in your current home.

The reason why it’s important and valuable to pay off your existing mortgage is that you can actually use your equity as a deposit to purchase a property. This effectively means you’re able to achieve 100% finance.

Yes, that’s right, absolutely no cash. Just the 30% deposit in equity typically required to buy an investment property (note the higher deposit value required here).

An Example to Illustrate

Let’s put this all into context; imagine that you bought a property 5 years ago for $500K on a 20% deposit (so you paid $100K cash, and took on a $400K mortgage). At this point, you have only the 100K cash in equity.

Now imagine over those 5 years you’ve paid off $100K of the loan and the value of your house increases to $900K. So your current equity is equal to: (900K house value – 300K mortgage = 600K in equity).

With this 600K in equity, the bank requires that you keep 20% of the total current property value invested in your current house. In this case, you will need to keep $180K equity in the house ($900K * 20% = $180K). This leaves you with $420K ($600K equity – $180K required = $420K) to use as the 30% deposit for your first investment property. We can then do a simple calculation to figure out the total budget we are currently working with:

Available investment equity / Required Investment Deposit % = max budget including bank loan

$420,000/30% = $1,400,000

It’s important to note that the bank doesn’t just look at your current equity position here but also your servicing ability. If your income isn’t reliable enough to pay off this new mortgage it doesn’t matter how much equity you have as the bank will see you as an insecure debtor. So it’s ideal to do this when you’re settled in a secure job and have been for some time.

If you’re asking yourself whether your income is high enough, a mortgage broker could be a great person to talk to.

What’s the catch?

Although it might sound ideal, there are always caveats to this ‘no cash down’ trick.

• The debt on this new property is essentially 100% and you have increased your overall leverage which exposes you to greater risk. This is an appropriately scary prospect so it’s a good idea to usually purchase a property at a price well below your max budget value. Doing the proper research here and making sure you have a cash-flow positive property is also crucial to help mitigate the real risk you’re exposed to. 
• On the positive side, property investment debt is generally favourably viewed as a type of debt by bankers and financial advisors alike as it is an asset class which will likely return both reliable income and also appreciate in value.

One of the keys to making money with your property investment is to never be put in a position where you are forced to sell. Despite the common public sentiment, property is by no means a risk-free asset and property values do not always increase over time. So it’s important that you have full control over when you sell and aren’t forced to sell in a down market should the time come. Property also entails odd, unexpected costs when things go a bit haywire or require maintenance eg. leaks in the roof.

With these unexpected events, it’s crucial that you have an emergency ‘cash reservoir’ that you can dip into to ride out the bad times. A good rule-of-thumb here is having 3-6 months’ worth of living expenses saved in an accessible account, earning a reasonable interest rate.

Okay, so you’ve built up your equity! Now’s the time to make sure you tick the rest of the boxes for finance approval. At this stage, it’s best to talk to a mortgage broker as they’ll be able to advise you which banks are ideal for investment finance.

You may have done this already, but if you haven’t, it’s time to define what criteria you want your investment property to meet.

It’s important to note that your investment decisions are entirely yours to make, but I personally think that it’s imperative you put a being cash-flow positive at the top of your list here. All this means is making sure that the property is actually leaving you with a profit each week after all costs such as interest, management fees and taxes have all been paid.

Although this seems to be common-sense, it’s actually more common in the market today for investors to hold negative cashflow properties. They do this because they speculate that the capital gains generated from holding their properties will offset the losses made each week. This is exactly why I’d urge you not to go down this path. Speculative gains are exactly that, and you’re more or less rolling the dice on your future financial freedom while taking a hit today. 

If you’re confused as to what costs you’ll need to account for when projecting cash flows and rental income needed, I’ve outlined the majority of costs you’ll need to consider below:

Typical Costs

• Mortgage interest expense
• Maintenance costs – a good rule-of-thumb here is to project for 0.5% of the property value annually
• Council rates – you can work this out here
• Insurance costs
• Property management fees (if you’re using a management company) – this is usually 7-8% of the weekly rent.

With interest rates currently around 4%, you’d probably be looking to buy a property with a yield of around 8.5%+ to cover all costs and provide you with some passive income.

With the crux of the financials out of the way, here are some other property-level factors I’d put on my list:

• Location, location, location: 8% yields are hard to find so you’ll need to look far and wide here. However, you’ll want to keep your investment located in a town that has a solid ‘micro-economy’ and won’t be severely impacted if a major employer leaves town.
• Single-storey, simple layout: Generally, the simpler the layout, the lower the maintenance costs. Single-storey weatherboard buildings are your friend here.
• Non-plaster clad: If you aren’t familiar with the leaky building issue with plaster-clad buildings, it might be good to familiarise yourself. Rule of thumb is to not touch plaster-clad buildings, period. Even if it’s new or the inspection returns nothing worrying, it’ll suffer from the significant stigma surrounding plaster buildings which will impact the capital gains to be realised.
• Above Sea Level: The oceans are rising so you want to keep away from them. Sea mist also significantly increases the rate your property will corrode, meaning more maintenance. Ideally, you want to be at a bare minimum of 5-6 metres above Sea Level. The My Elevation App is perfect for checking this.

Additional factors

• Multi-income: It’s great if you can find an investment that is divided into two units that are separately rentable. Why? You’re lowering the likelihood of a high vacancy cost if a tenant leaves as it’s highly unlikely you’ll have both separate tenants vacate at the same time.

There are a few key parties you’ll need in this journey as outlined below. Make sure you do your research here and find someone that has a good reputation and is suited to your budget.

• Mortgage Broker– I’m personally a big advocate for utilising a mortgage broker when arranging finance. They’ll be able to ensure you get the best deal available to you from the bank.
• Lawyer– You’ll need a lawyer for the deal part of this process. Specifically, to create the relevant documentation and make sure the transfer of ownership is done correctly. Your lawyer will also be able to advise you which clauses to put into your offer on the property.
• Accountant– They’ll be able to advise you on different financial and ownership structures and also give you advice on how you could ‘tax optimise’ your investment.
• Property Manager– Although private management is becoming increasingly popular, I would advise against it if you’ve got a pretty full-on lifestyle or want this to be a purely passive investment.
• A Good Real Estate Agent– A Real Estate Agent that really understands your goals and their market is invaluable. They can offer you tacit market knowledge and help you both find the best property and selling price for when you exit an investment. As a Real Estate Agent that has operated in the West Auckland area for the last 12+ years, I’d love to be able to sit down and discuss how we could apply some of our strategies to do just that for you. 

Once you’ve found the right people, make sure you consult them before putting an offer in on a property. Specifically, let them know your plans and ask for advice on issues like the best ownership structure and how to optimise for tax.

Now the exciting part! Get your digital binoculars out and start searching through Trademe using filters matched to your exact criteria. Using the keyword “yield” in your search may help separate the investments from the ‘family homes’.

HOT TIP: Like most Real Estate Agents, I tend to load new listings on a Monday or Tuesday. So if you’re looking to have your finger on the pulse, Monday and Tuesday evenings are your friend.

Once you’ve found a promising property, you’ll need to gauge the rent. You can do this by asking for a rental appraisal or current rental (if it is currently an investment property) from the listing Real Estate Agent. If this isn’t available you can also look at the median rental rates for the surrounding area here and via Trademe’s rental section for that area.

Once you’ve assessed a realistic rental figure, you’ll need to calculate the net yield. This is the same as yield but uses profit/net income (money left after all expenses aside from tax are paid) rather than gross rental income.

Hot tip: If this is already an investment property for the current owner and is returning a satisfactory yield, it’s a good idea to dig a little deeper to try and unearth why the current owner is selling a perfectly good investment. It may be as simple as they’ve found better investment opportunities, or there may be a nasty expense on the horizon.

Even if the property is in another part of the country, I always recommend going to visit the property in person before putting an offer in. After all, this is a major investment that you’ll likely hold for many years, so the travel costs and time lost inspecting are negligible in the grand scheme of things.

Once you’ve done all the research, financials and spoken to your lawyer and other appropriate parties, you can instruct your lawyer to close the deal for you!

HOT TIP: When submitting your offer, it’s a good idea to have “Your Name and/or nominee” on the offer. The “and/or nominee” part will allow you the flexibility to change the ownership entity later if need be.

It’s completely normal and appropriate to feel overwhelmed with this. But if you’re looking for some of the financial freedoms property investment can provide, just start with baby steps.

Just starting can often make the whole process less daunting. And if you’re too busy to do the searching yourself, let me know your requirements by contacting me and I can keep you up to date with opportunities in the West Auckland market that are suited to your criteria!