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Yield Vs Capital Growth

A strong market rebound is underway but it’s important for investors to focus on yield and not buy based on capital growth expectations. Veteran commercial property investor Jeff Brill explains why – and how to do it.

By: Jeff Brill

1 March 2020

There’s been a host of policy changes and restrictions applied to residential property investment in recent years.

These include the reduction of chattel depreciation, the extension of the brightline test, looming changes to tenancy law that will better suit tenants, the foreign buyer ban and new rules around the ringfencing of rental losses.

Taken as a whole, it feels like the Government does not want investors to create their own nest eggs for when they retire. And it certainly throws up additional barriers to those who do want to invest in property.

But, even without these newly introduced obstacles, finding high yielding residential properties is a struggle for investors these days.

Basically, unless you find a particularly good deal, you are looking at gross returns of around 3-5% in the bigger cities and only slightly more in the smaller towns.

However, before turning away from property altogether my advice for investors would be to look further into the property investment spectrum and see what else is on offer.

That’s because there is a whole range of possibilities. To name just a few: there’s off-the-plan apartments; commercial property; and overseas resort apartments.

Off-The-Plan Options

First up, let’s take a look at off-the-plan apartments. There’s actually a lot of property investment companies out there selling off-the-plan and promising big capital gains by the time the development is built. But, to me, this brings back memories of the infamous

Blue Chip organisation which caused a financial headache to many investors following New Zealand’s last property boom.

So when this type of investment is being investigated, the investor must be careful not to be drawn in by punters telling them that if they put 10% down now for a property on the plan selling for $400,000, they will make a possible $100,000 or more profit when the building is built in two years’ time.

None of us can accurately predict the market cycle as there are many variables which affect it – and many of them are outside of New Zealand’s control. This reality dictates that you should always make sure an investment is cash flow positive before you sign on the dotted line.

The worst case scenario is that the built apartment is valued for less than the original contract price. If it was cash flow positive, then it’s still not going to bleed you dry until you find another accompanying positive income property to balance out your accounts.

My point here is that it is all about yield. International speaker, author, and entrepreneur Brad Sugars talks about a concept called a “wealth wheel”.

Essentially this concept means that you would purchase several relatively cheap positive cash flow properties to bring up the servicing in order to buy more and then purchase a more expensive negatively geared beauty in a good area.

A good example of this would be a portfolio with four properties in Manurewa and one in Takapuna. The idea is that the positive cash flow properties would cover the negative cash flow property and the net dollar gain would be zero. This “wealth wheel” would then be rolled away and then you would do it again, creating many “wealth wheels” and growing your portfolio.

It is important to note here that capital growth does not come into the equation. Instead it’s all about a focus on yield.

When looking at commercial property it’s a good idea to put an offer in with a due diligence clause attached. Once the vendor agrees, the investor can then speak to the tenant about their wants and needs, such as a new roller door.

‘It’s possible to buy commercial property for the same price as residential, with a similar deposit, have a higher yield and easily create much-needed extra value’

Commercial Attractions

I’ve already talked about the swathe of recent government interventions into the property market. However, it has been solely in the residential arena: none of those restrictions apply to commercial property.

Further, in commercial the achievable yields are in the five to eight per cent range as opposed to the three to five per cent range that you will typically see in residential.

Some investors may tell you that you will require a 50% deposit to purchase a commercial property. In fact, this is no longer true. According to Everbright Finance general manager Francine Kwok, commercial property can now be purchased with a 30% deposit - the very same amount that you will need for a residential investment house in Auckland.

There is a host of other attractive features that come with commercial property. You can take back the building and chattel depreciation; there have been no changes in the Property Law Act to aid tenants; and there’s no foreign buyer ban, hence you can sell it to whoever you want.

So why is there not a rush towards commercial property investment? A major reason is that many property investors, who have primarily operated in the residential field, don’t really know what they are doing when it comes to commercial.

In my book, The Sophisticated Property Investor, I discuss the seven ways it is possible to profit from residential real estate without using the property wave. Well, the property wave is used even less in commercial property and there are a number of ways you can increase the value of your purchase even before you go unconditional.

Here’s an example… An investor might see a commercial property that ticks all the boxes and stacks up financially so they can afford to buy it with some cash left over.

The idea is to always put an offer on such a property with a due diligence clause attached. Once the vendor agrees, the investor can then ring the tenant and ask to have a meeting to chat about their wants and needs.

Normally, the tenants are only too happy to comply. And, at that point, the investor should sit down and listen. The tenant may want a second roller door, a new driveway, more floor space and a myriad of other things. The investor should write this wish list down and make another appointment to see them shortly. That gives the investor a bit of time to gather costs for the items on the tenant’s wish list.

In this example, let’s say that the current rent is $30,000, the cap rate is seven per cent and the value of the property is $428,751. The investor should then meet the tenant again and bring up the first item on the list: the roller door.

They should mention that if the rent was increased by $1,000 per annum to make it a total rental of $31,000 per annum then the roller door would happen at the investor’s expense.

If the tenant agrees to this, it would probably cost around $4,000 to purchase and install the roller door.

With the increase in rent that has been negotiated, the value of the property is now $442,857. That means the investor spent $4,000 and increased the capital value by $14,286 using the formula V = I/R.

At this point, the investor has only covered the first item on the list - next
is the driveway. Working through this process can lead to decent value increases right off-the bat. If you can negotiate a longer lease, the risk for a buyer will drop and so too will the cap rate. This, in turn, means an even higher value.

Given all these features, commercial property is certainly an option worth considering. Just think - it’s possible to buy commercial property for the same price as residential, with a similar deposit, have a higher yield and easily create much needed extra value.

Greater Understanding

Despite the obvious attractions of commercial, these calculations and examples might seem complicated to many.

So investors interested in finding out more about the workings of commercial property, and other high yielding property investment options, can attend one of Jeff Brill’s upcoming free seminars. Brill says attendees will leave the seminars understanding everything they need to know to make a smart commercial investment.

For more information on the seminars go to facebook.com/ sophisticated property investment. Jeff Brill’s book, The Sophisticated Property Investor, is available from all major booksellers throughout New Zealand.


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