Invest in property - Home loans

When you invest in residential property you're buying a physical asset. Unlike other investment types, such as unit trusts or shares, the security of this bricks-and-mortar investment can provide some comfort and security to investors.

New Zealand offers several tax benefits for investing in residential property. For example, expenses you incur to generate your rental income may be tax deductible.

Rental income is the money your tenant pays you to use your residential property investment.

Two measures are commonly used to compare investment properties or calculate the returns from rental income:

• Gross rental yield: The rental income received relative to the value of your investment property. It can be a useful way of comparing different investment properties or your actual investment results with your goals.
• Rental return on investment: The rental income received relative to the equity in your investment property or the amount you've invested in the property. The amount of your investment is distinct from the value of the investment property as it represents the amount of your deposit. The remaining value of the investment property is the amount you would need to have borrowed to buy it.

When calculating your rental return on investment, it's important to factor in the costs associated with the borrowing required to buy the investment property, along with the other expenses incurred from maintaining and managing it.

How rental income can contribute to your loan repayments

One of the benefits of investing in property is that you can use your rental income to make, or at least contribute to, the repayments on your residential investment loan.

If your financing costs and other investment property-related expenses are greater than your rental income, you may find yourself in a "negative gearing" situation. While this has risks, it can also have advantages.

Capital gains are the second form of income for property investors.

You achieve capital gains when the value of your residential investment property increases compared with its original purchase price or value. This is why it's important to try to buy properties below their market value.

As property values tend to increase over time, returns from capital gains may take longer to achieve than rental income returns. You should consider the increase in your property's value in relation to the time you've owned the property and your original investment in it.

As an investor, you may aim to buy properties that can provide both types of investment return. Different properties will provide different levels of capital gain and rental income. It will be up to you to decide on your investment goals and the most suitable properties.

Negative gearing is the potential tax advantage of residential property investment.

It refers to the period, generally during the initial years of owning the property, when expenses are higher than rental income – for example, because of initial up-front expenses such as repairs and legal fees and because, generally, you pay more interest during the initial years of a standard principal and interest-reducing loan. Once you start making headway on repaying the principal, you pay less interest.

An interest-only loan increases the tax-deductible expenses associated with residential investment property over time because you're not repaying any principal. So an interest-only residential investment loan may be a good choice when following a negative gearing strategy.

"Leverage" is one factor that can accelerate your investment return. It's about buying rental property using borrowed money instead of paying the full purchase price with your own money. The more you borrow, the more you're said to be "leveraged". If your property goes up in value, the more you're leveraged, the higher the return on the actual money you've invested.

Equity is the difference between a property's value and the amount of outstanding loan used to buy it. If you sold your property and repaid your loan, your equity would be the amount left over.

Your equity in a property increases or decreases with rises and falls in your lending and property value. Equity is built up:

• by a reduction in the total loan
• by an increase in the property's value.

If your current property is valued at $300,000 and your current home loan stands at $100,000, the equity in your current property is $200,000. If you'd like to buy an investment property worth $160,000, you may be able to use the equity for the purchase and we may not need to take security over the investment property.

If the purchase price of the investment property exceeds your equity, you'll still be able to apply for a home loan but we'll need to take security over both your home and the investment property.

You can use the equity in another property to partly secure a residential property investment. To buy a property, you'll need a deposit of at least 20% of the property's purchase price or registered valuation.

You can use the equity you've built up in your own home to go towards your purchase.

Buying an investment property is much easier when you have your loan pre-approved. It shows real estate agents and vendors that you're serious about buying, it can speed up the loan documentation process and it enables you to bid at auctions.

With an ANZ pre-approved home loan certificate, you'll have our conditional approval to borrow up to a certain amount. The certificate will be valid for 120 days from the date of issue and have some specific terms and conditions.

There are different residential property types, for example, there are no lawns or gardens to maintain with an apartment and the tenants may be quite different from those living in a house.

We may lend different amounts of money depending on the property type.

Residential property

• Houses
• Town houses
• Apartments.

Commercial property

• Offices
• Factories
• Retail.

When you're inspecting a property you need to think like an investor. Look for opportunities to add value and cut costs and pay careful attention to the maintenance the property requires. Ask questions about the surrounding neighbourhood and the property's history.

If you find a property you think is suitable, research it in detail, including thorough document searches that your lawyer can do on your behalf. These documents include:

• a land information memorandum report
• a property file
• the local district plan as it applies to the property.

As you're arranging finance, you'll be able to analyse the property from an investment perspective. You can also make some assumptions about likely capital gain to determine your average annual return on investment.

It is a good idea to do a detailed analysis of all of the properties you visit. If there are two that are suitable, you can decide which is the better investment and focus on it.

The property market is made up of many smaller markets defined by particular areas or types of property. You need to:

• decide on your geographic area
• identify some properties
• conduct a basic "rental income return on investment" analysis.

There are many ways to find properties that match your criteria, such as through newspapers, real estate publications, agents' lists and web sites. Aim for a reasonable list of properties that, at first glance, appear to fit your criteria. If you're looking in a city, your list may contain 30 or 40 properties. If you're looking in a small town you may only have five or six properties.

To do a basic cash flow analysis, you'll need to know:

• the assumed annual costs of managing and maintaining the property
• the property's assumed purchase price
• the income you expect to generate from renting the property
• the approximate annual cost of the loan you'll need to buy the property.

The first three points are reasonably straightforward. To determine the annual cost of the loan you'll need, you can use our loan repayment calculator.

Your property investment team is one of your greatest assets as you grow your property portfolio.

Think about your investment team in the same way you'd consider any other team. You're the selector and coach - your aim is to select the best players who can work together to get the job done.

Your team will include permanent players and players you keep on the reserve bench for when they're needed. Research your team carefully before you start investing to save time and money in the long run.

The permanent players in your team will include:

• your ANZ home loan specialist
• your accountant
• your lawyer.

Your team might also contain the following reserves:

• real estate agents
• registered valuers
• property managers
• tradespeople.

Your ANZ home loan specialist will help you finance your residential investment properties. They can help you to choose the ANZ Residential Investment Loan that will best suit you and your investment goals and, as your financial requirements change, help you arrange any changes you require.

The ownership structure you choose for your residential property investments will depend on your own circumstances and goals. Things to consider include:

• flexibility over time
• simplicity – a complex ownership structure isn't always necessary
• the ability to introduce other participants
• the growth of your property investment portfolio
• taxation
• the ability to exit.

Your accountant and lawyer will help you to decide on the best structure for you.

It's important to buy property in a location where you expect higher than average capital gains (for reasons such as a good local economy, an increasing population or a low land supply for new development), unless you are after yield.

To make money through property purchases you need to buy wisely and choose a property:

• in a location with potential for improvement
• that provides a high yield
• that can be bought at a reduced price
• that has the potential for improvements that increase its value.

The best way to increase the property's value (and your income) is to increase the rent, by adding features tenants desire and are willing to pay for. Examples are a garage or carport, an extra bedroom (adding to the building, reorganising existing rooms or adding a sleepout), carpet, fence, security alarm and whiteware. Just making the place clean and tidy can give you a price advantage over other rental properties.

Improvements are best considered (and budgeted for) before you buy the property. When adding value, make sure the extra cost will achieve a high return on your investment.

Goal-setting is important in most aspects of life and it's true of property investment. Without a clear direction you'll find it difficult to co-ordinate your efforts in establishing an investment that matches your lifestyle, financial and life situation, skills and aspirations.

To begin with, ask yourself why you're investing in property. Is it to generate an income, is it to build wealth, is it a form of savings for retirement or is it a combination of all these?

• Do you have an investment period in mind? For example, you may want to retire in 20 years' time and provide a retirement income through property.
• What value of property do you want or need over this time? To answer this, consider the income you want from property.
• What type of property will you buy to meet your goal? Five two-bedroom flats or three three-bedroom houses or something else?

Write your goals down so they are quantifiable within a timeframe. Remember, it's all about equity and cash flow, not necessarily the number of properties you own.

• Don't offer the property to the first acceptable tenant unless it's a tight rental market. First and foremost they must be good tenants.
• Don't tell people the property is taken until the successful applicant has signed a tenancy agreement. They may be presented with another offer and change their mind.
• Remember you can't discriminate against tenants on the basis of race, gender, age, religion, marital status or whether they have children – and that tenancy agreements with people under 18 must be ratified by Tenancy Services before the tenancy starts.

• Get the bond payment straight away so you have two weeks' notice should your tenant change their mind before moving in.
• Lodge the bond with the Tenancy Services' Bond Centre within 23 working days.
• Arrange for the rent to be direct credited to your bank account.
• If you have a group-flatting situation, insist the tenants make just one rental payment to your bank account rather than pay individually.
• Just before, or as the tenant physically takes possession of the property, go around together and inspect the property. Note any damage or imperfections on a property inspection form, which both parties should sign.
• Take photographs or a video of the property at the beginning of the tenancy for the best record of its condition. Use the date function of the video.
• Give the tenant a tenancy information letter or booklet. Include useful information such as your contact details, what you expect from them as a tenant and what they can expect from you as a landlord, which day is rubbish day, contact details for an emergency plumber or builder, and how to operate appliances such as dishwashers.
• Write a welcome letter after you've received the first rental payment. State that you've received the payment and assure them the system is working. This also shows you're on the ball.

• When conducting inspections, look for items that need repair as well as checking how the tenant is keeping the property.
• Keep a close eye on rent payments, especially in the first three months. Check rents have been paid the day they should have been. (Telephone and Internet banking facilities help.)

• Don't accept the bond as the last rent payment. This is your security if you find a problem with the tenancy or property. If you allow the tenant to use the bond as their last rent payment, you've given away your security.
• Write a letter to the tenant, thanking them for being a good tenant and confirming the date they are leaving, the condition you want the place left in and when the property inspection will take place.
• Conduct a property inspection together once all the tenant's property has been removed.
• Release the bond money when you've checked everything.
• Give the tenant a written reference and ask them for one on your performance as a landlord. In a tight rental market, you can use this to help secure new tenants.

Consider large renovations if you can show they make good financial sense. For example, adding a bedroom could result in rental income higher than the cost of borrowing the extra money to do the addition. Remember to discuss major renovations or building ideas with your property investment team.

Most alterations require a building permit, which your lawyer can help with, and you'll need your accountant to ensure that all costs are tax deductible (capital expenses are not tax deductible). You'll also need the support of your ANZ consultant to arrange the finance. Lending criteria, terms and conditions and fees will apply.

Improving your property should result in a higher valuation, so arrange for a new valuation once you've completed any major work. It should show an increase in the property's value, so an increase in your equity. You can then borrow more money against the new equity to put towards buying another property.

Your goal should be to bring your property to a point where it's running to its optimum capacity - that is, it's generating the greatest amount of rental income and/or capital gains possible, while costing you the least amount of money each year to maintain.

Fixed rate home loans can help you to manage debt and offer some insurance against interest rate rises, but you should always allow for higher interest rate payments.

If your cash flow situation is so poor that a 1% or 2% interest rate increase would force you to sell the property, think carefully before committing to it. When considering a property purchase, do an interest rate risk analysis. For example, the extra cost of a two percentage point rise in interest rates (say from 7% to 9%) on a $200,000 home loan is $4,000 a year. Could you absorb this cost or would you be forced to sell?

You need to be prepared for the property market going up and down. If you've owned a property for only a few years, you may need to ride out the downturns.

When you buy a rental property, make sure it's in an area with a better than average potential to increase in value, over the next few years at least. Base your decision on factors such as economics, lifestyle and demographics.

As with damage to your property, your best defence is good tenant selection and active property management. Keep a close eye on rent payments – if they're missed, contact your tenant immediately. If you can't resolve the matter directly with your tenant, the Tenancy Tribunal may be able to mediate a resolution.

Are there demographic changes happening? Consider factors such as the aging population, population movements (south/north drift) and changing lifestyles, as they can all affect your investment over time. When planning your investment strategy, consider these changes and their effects in 10, 20 or even 30 years' time.

If you lost your primary income source, how would that affect your property investments? If the potential consequences are high, you may like to consider income protection insurance.

The ownership structure you choose for your residential property investment will depend on your own circumstances and goals. Things to consider include:

• flexibility over time
• simplicity – a complex ownership structure isn't always necessary
• the ability to introduce other participants
• the growth of your property investment portfolio
• taxation
• the ability to exit.

There are a number of advantages to setting up your property investment as a company or trust.

• It enables you to separate your business activities from your personal interests – so your personal assets can be protected if anything happens to your business.
• You may benefit from tax advantages. The current company tax rate is lower than the top individual tax rate.
• It makes it easier to treat your residential investment property like a business.

There are a number of company structures to choose from, including a Loss Attributing Qualifying Company (LAQC) which, unlike some other structures, allows you to offset any losses against your personal income tax.

Structuring your property and other investments is an important part of an overall financial plan. Your accountant and lawyer will help you to decide on the best structure.

Before rushing out with your successful investment formula and buying more properties, it's important to remember that the more properties you have, the more organised you have to be.

Be organised from the beginning. For residential investment property, this means keeping careful records of all the money you spend on your property and all your correspondence with your property investment team and tenants. Set up a good filing system so you can quickly and easily find receipts for your accountants, lease agreements for your lawyer and bank statements for discussion with your ANZ home loan specialist.

Investing in residential property can be a rewarding experience if you're committed to learning about the process and have a good team to back you up. You can begin building your team straight away by discussing your position with an ANZ home loan specialist.

You may already have enough equity in your home to start investing in residential investment property. ANZ lending criteria will apply.