The Income Hurdle – Why Most Kiwi Investors Only Own a Single Investment Property

Date Published: 28 July 2021

For many of us, the game Monopoly informs our earliest understanding of how investment property works. And so we are given to believe that it’s fairly straightforward to grow from a single investment property to many as your first and subsequent properties appreciate and rents come in. However 77% of kiwi investors own just one investment property. Why is this? 

The income hurdle

There are of course many reasons why someone would have just one investment property. Properties can be a logistical and administrative hassle and a drain on your time, especially if you are managing the property yourself. Not everyone wants to be a property mogul, and there are a number of pitfalls for those that do give it a go.

But there is a major common barrier to investors growing beyond a single investment property. Most investors don’t have enough income to meet the bank’s servicing criteria for another mortgage. You may have more than enough money for a deposit and the income to support any shortfall in profits from an additional property. But the banks stress test your income on the assumption that rates may increase drastically. This massively affects how much you can borrow.

The income hurdle explained in an example:

Say you have a household income of $145,000 and an extra $30,000 per year from your current investment property. If you owe $1 million on a 30-year-mortgage for both your own home and your investment property, you will pay approximately $25,000 in interest and about the same in principal payments – for the first year at least. This comes to a rough total of $47,000 per year in mortgage payments. Quite a lot, but manageable given your income.

However, the bank will calculate your affordability at an interest rate of around 6.5%. Additionally, they will typically calculate the mortgage on your investment property over 25 years rather than 30. That increases the calculated payments by almost $30,000 per year – a significant amount! The bank also scales the rental property income by 75% to allow for vacancies and other costs such as maintenance and insurance. They do this both on your current investment properties and any property you are applying to purchase. This means over $6000 less calculated income. 

The bank will then look at your credit card limit – not your credit card balance. They’ll calculate your income using the assumption that you will max out your credit card limit and be paying 3% of the credit card limit each month. 

We should note, all of this is done to protect you from getting into a financial situation you cannot afford due to changes in interest rates etc so it is not a bad thing. But you can see how many people who feel financially comfortable in buying a further investment property get turned down by the banks.

So how do you jump the income hurdle?

Deal with your debt

The first thing within your control is to understand how much your secondary debt affects what you can borrow. As stated above, your credit card limit, not your balance is what the bank takes into account. A credit card with a $10,000 limit reduces your borrowing ability by $46,000! The same goes for overdrafts. So reduce or cancel your credit cards and overdrafts wherever possible.

If you’re paying down any other kind of debt, the bank will calculate as if you are making those payments in perpetuity, so if you can pay off a debt entirely then do so. For the same reason avoid hire-purchases and other small debts. If you’re coming to the end of student loan payments, it may be worthwhile paying it off faster

Make the numbers stack up

This means: look for properties with a positive cash flow. This means a property that brings in more income than it costs. It can also pay to go for a cheaper property that you can add value to by renovating, thereby increasing its capital value. Buying your own home is often an emotional choice but when it comes to investment properties you should focus solely on the numbers, they’ll either stack up or they won’t. 

Maximise your earnings

Now this one is a bit scary: ask for a payrise! This is a suggestion you may find daunting, but even a small increase in salary makes a difference. A $2.50 per hour raise will allow you to borrow approximately $50,000 more!

And if you already own a rental property it may be appropriate to review the rent to see if it’s in line with the current market. 

Finally, make a budget and stick to it. This will help you pay down your existing mortgage faster and allow you to borrow more to invest in the future – as well as getting you into a better financial position generally.

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