Investors have been seriously impacted by reduced returns on their properties as costs rise, tax deductions fall, compliance requirements increase, effective P/E ratios rise and now capital gains diminish as a result of lower likely house price growth and the imposition of a high capital gains tax on short-held property.

In light of the many changes over the past year many investors are on pause. They have pulled back from buying while they assess the effect of the changes and, in particular, the Government removing their ability to offset their mortgage interest expenses against their rental income.

For Nick Gentle from iFindProperty the vexing new tax deductibility rules being phased in over four years for existing properties is going to mean, when they are fully introduced, he has to find another $50,000 a year.

While his portfolio can withstand it, to pay the extra tax he would need to generate $80,000 of other income a year and just putting rents up is not going to cover it.

Gentle is one of the fortunate investors who had a strategy of being cashflow positive from day one and has not relied on capital gains as many investors have.

He says while the extra tax is just a cost of doing business it has rattled many investors, who have paused their business.

“Now would be a good time for investors to clarify their investment goals, look at their approach, the effectiveness of it and why they are doing it. Even better would be setting a date for achieving those goals because it gives urgency and forces investors to think about how they will get to there,” says Gentle.

“If there is no clarity around goals and dates, investors tend to buy anything and miss out on a lot of opportunities. If an investor is not looking after their own goals they are looking after somebody else’s.”

He says the way to get through the looming bite from the extra tax is to look at cash strategies as an approach rather than wealth strategies.

Gentle suggests buying a house, renovating it and then selling it to use the capital for further cash strategies or to buy a better cashflow property.

Alternatively sell an existing property to reduce debt or sell to free up capital and use it elsewhere for better cashflow, such as buying an existing block of flats where cashflow is spread over several units or acquiring a small commercial property.

Off-The-Plan

Another strategy is to buy new builds off-the-plan, which have been popular for a while for several reasons. They are helping to increase housing stock and tax deductibility still exists on them. The finer details of this policy, such as how long they will remain new builds so tax deductibility can be used, won’t be known until late September/early October.

Property Apprentice investment coach Debbie Roberts says investors should be aware of the risks attached to new builds. “They have lower rental returns than existing properties and for a low income investor buying new properties is not the right strategy.” Because of the high demand for new builds, Roberts says developers are not moving on price as they don’t have to. Some have sold down developments for the next two years already.

For example, Williams Corporation, one of the country’s biggest builders and developers, can sell a 15-unit townhouse development off the plans in a week and has 68 building projects on its books. It’s biggest frustration is the exorbitant rise in building costs.

Gentle also lists other strategies such as doing the odd trade and infill development, where one house can be knocked down and two built, with only one requiring a 40% deposit and the other a 20% deposit.

Locking in interest rates is also important for investors. Gentle locked his in at 2.99% for five years. It was hedging against interest rates rising to 4%, he says, but he reckons all investors should be pursuing an aggressive interest rate strategy.

Paying Debt

For Roberts one of the best strategies is paying down mortgages on properties to free up cashflow. This could include trading properties.

She says it is important investors focus more on cashflow from their properties rather than capital gains in light of the tax deductibility change.

“Investors should not be relying on capital gains but unfortunately for many new investors it is their main focus. They will hit a lending ceiling when house price growth cools as it has already started to do.

“Without house prices soaring as they have done in the past two years and interest rates expected to rise within the next year, investors who have used equity in their house to borrow 100% for an investment property will have tapped out their lending facility.”

Roberts says they would have been better off looking at other longterm options. Sometimes she will recommend buying shares instead of property, depending on a client’s goals, timeframe for achieving them, income and risk appetite.

“By far, the majority of new investors should not be buying new builds and jumping into the market without the full picture, says Roberts. Property is a longterm investment and investors need to be strategic with the types of property they are buying. Avoid small towns with shrinking populations and do research on any area to buy or trade in.”

Roberts says it is still worth buying existing houses and investors can create their own capital gains by renovating and getting a better rental return, instead of buying a new build and getting lower returns.

Investor Pool Shrinking

An enthusiast for new builds is Property Ventures' Mark Honeybone.

“They are becoming a popular investor product now the Government has made big changes to tenancy laws, introduced the Healthy Homes legislation and removed mortgage interest tax deductibility.

“Even old school investors are buying new builds off-the-plan, although not enough are coming to the market.” His company has just signed up a 200-unit townhouse development at Māngere Bridge with prices at about $785,000 in the first stage and expect to have them sold within a week. “There is a lot of interest in that price range from investors across the board.”

He says many smaller investors are steering away from existing property, although traders are still around. The bigger investors with portfolios of about 50 properties are still active but they can afford to be as they are mainly long-term holders and may only have 30-40% debt against their portfolio.” Honeybone says the only way to beat the tax changes is to diversify, pay down debt as quickly as possible and look carefully at existing property compared to new builds.

“Investors should spend the next three years paying down mortgages as fast as possible to free up cashflow to buy more properties. It is never going to be cheaper than now to pay debt down. It has never been as good and will never be as good again. Low interest rates are allowing investors to get ahead.”

One strategy he has seen is investors buying two new builds, renting them and committing to paying down as much as they can of the mortgage debt over the next three years.

“The ASB’s 1.75% interest rate for new builds has come on to the market at the right time. Some people can even qualify for 90% lending.”

Honeybone says the biggest issue for any property buyer is the Government has made it difficult for new residential development by putting a brake on immigration which is limiting labour availability while also attempting to shut the door on older stock as an investment. “It has created a massive problem that is going to bite hard in the next couple of years. All it will lead to is more motels being required for homeless people.”

Out Of The Box

There are opportunities for investors that may seem a little out of the box, but can actually make sense in the current climate. Investing in show-homes is one option that investors may not be aware of. Show homes are often built in new or up and coming areas as a means by which to sell a building company’s homes. Cavalier Homes offer this as an option for investors, and there are a number of benefits. These include a guarantee of quality, good maintenance of an attractive garden, and a guaranteed tenant who will look after the home until it's time to sell.

Duplexes are another option for new investors or those with larger sections. If your area is zoned for duplexes it may be worth considering building a home that you can live in, with one next door that can be a rental. There are many benefits of building new: reduced LVR requirements, the possibility of continued interest write-offs (although this is still to be established) which may well add appeal.

Maximise Your Land Use

The opening up of residential land for subdivision and the addition of minor dwellings offers investors new opportunities to maximise the potential of their land.

Councils around the country are becoming aware of the importance of opening up land in order to allow for much-needed intensification: Auckland’s Unitary Plan is a great example.

Kevin Smith from Keith Hay Homes says that his company has noticed a large uptick in interest in new builds from investors post Covid-19, as people are barred from spending their money overseas.

“We are seeing ‘mum and dad’ investors increasingly interested in ways of maximising the potential of their properties.”

He says they have extended their basic range, and this is proving popular with investors.

There are a range of options for those looking to add value to their property, depending on the size of the land. The most basic option is the addition of a minor dwelling, which is generally under 65m2. Depending on the rules for your area, minor dwellings do not require the land to be subdivided, but there will be other requirements that will need to be met.

If you have a larger land parcel, subdivision could be a good option. Smith says that subdivision generally costs between $120,000 and $150,000 (which includes the groundwork needed). Relocatable or prefabricated homes can cost anything from $100,000 to $300,000.

With the new rules around interest deductibility and the extension of the bright-line test, new builds are likely to become an increasingly popular option. And if you already have the space in your (or one of your rental’s) backyard, it could be a cost-effective strategy for savvy investors.