Homeownership is the dream and goal of 99% of New Zealanders. Once achieved, homeowners often to turn to buying their first investment property.
For your first home, the ideal deposit is 20% (here’s an article we wrote on a deposit for your first home). But the requirements for investment is in the middle of changing. Over the past 10 years, the amount required to purchase an investment property has been as much as 40% of the purchase price. But during the Covid-19 lockdown, the Reserve Bank of NZ removed the LVR funding restrictions (for a minimum of 12 months).
The minimum deposit for an investment property in 2020 is 20%
I have spoken to people who believe although they need to save cash to purchase a property. If you already own your own home, you can use the equity in that home as the deposit for your new investment property. Typically, you can borrow up to 80% of your own home.
Here’s an example:
Let’s say you own a home worth $600,000 with a mortgage of $380,000. You can borrow a further $100,000 on this home (up to 80% of $600,000 which is $480,000). You can then use this $100,000 as a deposit on your new investment property which would buy you up to $500,000 of new properties at 80% lending (if your income allows it).
So that’s the deposit side of things taken care of. What about income?
The calculation for the required income to purchase a new investment property is complicated. It depends a lot on how many children you have, how much debt you have, sometimes even how many cars you have. But there is a quick and easy formula we use to see if you are in the ballpark.
To calculate the maximum you can borrow: 5x your income and 10x your rental income.
In the example above, the total mortgage would be $880,000 (current mortgage of $380,000 + new mortgage of $500,000). Let’s say you earn $140,000 and the new rental will earn $20,000 per annum (here’s an article we wrote on Gross Yield). We can calculate the approximate affordable mortgage as:
$140,000 x 5 = $700,000
$20,000 x 10 = $200,000
Total estimate mortgage affordable: $900,000
Unless you have a high amount of secondary debt or other significant expenses, you could feel comfortable that your income is enough to afford an investment property.
Most people start by measuring the Gross Yield on a property (here’s an article on a 2 seconds formula for calculating yield). This is the return on the property before expenses are taken out and provides a good benchmark assuming no unusual expenses.
Yields can vary throughout the country. It is reasonably common to see yields of 5% in Wellington and Christchurch but closer to 3% in Auckland, where the houses are more expensive and capital growth tends to be higher.
Ultimately, you are chasing higher yield if your priority is to look for a cashflow positive property. Find out what yield you need to get a positive cashflow and aim for an area where this yield is typical.
You may have noticed that, for the investment property to pay for itself on the bank’s affordability calculator, it would need a 10% return. This is extremely high in New Zealand. Properties usually return between 3%-6% depending on what you are purchasing. This is typically why most New Zealanders only end up purchasing 1 or 2 properties; they simply run out of income. The actual costs are much less with interest rates currently around mid 2% but the banks must calculate if a property owner can afford interest rates at a much higher rate.
Some things to bear in mind. Rentals do increase over time. So if you can’t afford a second or third investment property at the moment keep working on increasing your income; either through increasing rents or getting a pay rise.
Once you have your eye on a property add up your current mortgage and the new mortgage required to purchase the investment property. Now, multiply your current income by 5 and your total rental by 10. If this number is greater than the future mortgage, it’s worth looking into getting a pre-approval.
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