Our childhoods have betrayed us. Property investment is not as easy as rolling a four to land on Mayfair, paying ￡400 then sitting back to wait for someone to land on your square. But don’t sweep the play pieces onto the carpet and stomp off for a Milo yet. Instead read on to find out if you’re placed to get on the board.
From 1 May 2021, the minimum deposit for an investment property is 40% with an exemption for new-build properties. Over the past 10 years, the amount required to purchase investment property has been as much as 40% of the purchase price and as low as 20%. For the rest of this article, calculations will be assuming you need 40% deposit as per the rules at time of posting.
When looking to purchase an investment property, it’s best to first look at how much deposit you can pull together before finding out whether your income will support the mortgage. This is because the deposit required is relatively easy to calculate whereas the income calculation takes into account a number of factors.
It’s a common misconception that you will need cash for the deposit on an investment property. In fact, you can use the equity in your own home as the deposit for a new investment property. If you have enough, you can fund the entire deposit using that equity. Typically, you can borrow up to 80% of your own home, so if you have paid off 50% of your mortgage you have 30% of equity you could put towards a deposit on a rental property.
Let’s say you own a home worth $1,000,000 with a mortgage of $500,000. You can borrow a further $300,000 against this home (taking your mortgage up to 80% of $1,000,000 which is $800,000). You can then use this $300,000 as a deposit on your new investment property. This would buy you up to $750,000 of new properties at 60% lending (if your income allows it).
If you have savings you could use a mix of cash and equity to increase the amount you can borrow (assuming your income stacks up), or use your cash to reduce the amount you are borrowing against your home.
If you don’t know the value of your home, you can use tools such as OneRoof’s Valuation page. As a general rule use a slightly lower number than the valuation provided to allow for market fluctuations while you apply for your mortgage.
Using equity for a deposit is simple if you are applying to the same bank that has your home’s mortgage. It is all done in a single application; you just apply for the full amount of money needed for the new property, with your current house given as security. But if you decide to go through a different bank for your investment property there will be two applications; in the example above you’ll do an application for the $300,000 equity at your current bank and another for $450,000 at the second bank.
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. Here’s an article we wrote on exactly how a bank calculates if you can afford an investment property.
But there is a quick and easy formula we use to see if you are in the ballpark. To estimate the maximum you could borrow: add 5x your income to 7x your rental income.
In the example above, the total mortgage would be $1,250,000 (current home mortgage of $800,000 + new investment property mortgage of $450,000). Let’s say your household earns a combined income of $220,000 and the new rental is estimated to earn $30,000 per annum. We can calculate the approximate affordable mortgage as:
$220,000 x 5 = $1,100,000
$30,000 x 7 = $210,000
Total estimate mortgage affordable: $1,310,000
So 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.
If the income example we have used is higher than your own income, don’t be put off. Whether the numbers work is a combination of your equity/cash for deposit, income, cost of rental property and projected rental income.
Yields can vary throughout the country. It is reasonably common to see yields of 4-5% in Wellington and Christchurch but closer to 3-4% in Auckland, where the houses are more expensive and capital growth tends to be higher.
Ultimately, you are chasing a 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.
In doing your research you may have noticed that, for the investment property to pay for itself on the bank’s affordability calculator, it would need a 14.2% 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, especially with interest rates currently around 5% but the banks must ensure a property owner can afford interest rates at a much higher rate.
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. The 2021 changes to investment property tax rules mean your tax costs will be higher than previously. Make sure you take these costs into account when deciding to purchase an investment property.
Once you have your eye on a property:
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