They say the only constant is change, and that definitely applies to the world of real estate.
There are many ways you could face the question on whether you should sell or rent out your current home. Maybe you’re buying a new family home without the financial need to sell, maybe two households are combining, maybe you are relocating to another city/country or perhaps you’ve just inherited a gorgeous property that you would like to live in.
It’s therefore important to decide what you’re going to do with the property you won’t be living in: Do you want to rent or sell your current home?
Reasons why you would RENT out your current home?
- The move is temporary: If you plan to return at some point in the future, renting out your home might be the way to go. Consider what’s called the breakeven horizon, which is a calculation that helps you decide whether it makes more sense to rent or buy, based on how long you plan to live somewhere.
- Home values are increasing: If you can expect the value of the home to increase soon, leasing your home could help you take advantage of that appreciation before you sell. But is Auckland (especially Remuera and the Eastern Bays like Kohimarama, Glendowie, St Heliers, Orakei and Mission Bay) in such a seller market? If not, do you have a crystal ball that can predict when it would be?
- You can’t afford to sell: If you’re underwater on the mortgage (i.e. you owe the bank more than the house is worth), it probably doesn’t make sense to sell if you can afford to service the mortgage. Turning your second home into a rental can buy you some time to gain equity – this is why time is your best friend in real estate.
- There’s a strong rental market: If the rent you would earn can cover more than the cost of the mortgage (and ideally include property management fees, rates, fixed water charges, insurance and other maintenance fees), it might make smart financial sense to rent your home. Property managers are reporting a slowdown in rental demand (could be a seasonal thing of course) for higher-end properties. Want to know how much your property should rent out for? Check out the most accurate market rent data for free.
- There are tax benefits in residential property investment: It USED TO be the case. But do note that negative gearing for residential property investment has now been abolished in New Zealand – from 1 April 2019 any losses derived from residential land will not be able to be offset against other sources of income (for example salaries or wages). In short, you can no longer claim a tax refund on any losses made in residential investment, subject to certain exceptions. This area of tax law is extremely complex so I would suggest seeking tax and legal advice. In Auckland where there are many such ‘negatively-geared’ property investments, you can bet there are landlords who are seriously reconsidering their positions, especially when the prospects of capital gains in the near-term are uncertain. And the property-related expenses are ongoing, tangible and certain.
- You would be on the hook for taxes: Depending on how long you’ve owned the home and how long you’ve personally occupied it (or your intentions when you first bought it), you may be liable for taxes under the brightline test if you sell now. Renting can give you time to make a selling plan that minimizes tax implications. Once again, seek legal and tax advice.
Reasons why you would SELL your current home
- The move is permanent: If you’re relocating to a new city or country, it may make the most sense to sell the home. It can be really challenging to manage a rental property from afar, especially if you don’t have plans to return to the area. Managing property managers can be a skill in itself, and the luck of a draw.
- You have equity tied up in the home: Often, homeowners need to sell their existing home to afford the down payment on a new home, especially if you are upgrading. There’s of course talk of RBNZ easing LVR requirements in the very near future – but for those interested in upgrading, it can still be a seriously significant chunk of cash.
- You’re not interested in being a landlord: Overseeing a rental property can be stressful and time consuming, and if the rent you’d be able to charge wouldn’t cover both your mortgage and property management costs, it might make sense to sell instead of becoming a DIY property manager. Given the current climate where there are new regulations coming in all the time (including insulation standards etc), it may cost quite a bit to get your owner-occupied property up to rental standard.
- Your house requires lots of repairs: Regardless of whether you rent or sell your home, you’ll want to address issues with your home’s major systems, like the roof, water heater, insulation and electrical panels etc. Without such repairs to make it liveable, you may struggle to find tenants whereas buyers may be more willing to overlook such issues and buy a ‘do-up’ so that they can make that home their own. Why not give others a chance then?
- You cannot comfortably service the mortgages on both properties if you are buying another: If you will face financial strain (eat instant noodles every day!) should the rental property take a long while to rent out when you are owning the second new property, then you should seriously reconsider the decision to rent the first one out. As mentioned, don’t simply assume that the rental market is hot and tenants will be begging to rent your property because there’s a shortage of accommodation. What Auckland certainly lacks is a shortage of affordable accommodation. Does your property fit that description? If not, it may take a longer while to rent out.
- Better investments elsewhere: You’ve got better use for the sale proceeds. A 3-month bucket-list trip of a lifetime? Commercial property where tenants pay all the outgoings? Rare art? That new Lamborghini? How about the increasing popularity of forestry? (Not investment advice, obviously.)
- Time to cash in on the gains: You’ve owned your home for ages. Like forever. The property market has gone up several times (just look at the median sale price chart below for the Eastern Bays/Remuera) and it’s time to retire. Sure, you are no longer in the frenzied years of 2014 to 2016. But you can’t survive on capital gains (I know there are reverse mortgages!) so you really need to sell to cash up and buy that dream retirement home at Omaha or the Bay of Islands….and go sailing/fishing every day.
What should you really think about?
The test, in my opinion, is this: Will your current home make a good rental?
Many people keep their current homes as rentals for emotional reasons. But it’s important to take the emotions out of the equation.
Some key questions to consider:
1) Is your existing house a good rental?
- Is there high tenant demand in the area that can afford to pay the rent you are requiring? Remember: the tenant does not care about the mortgage you are paying. Rent is driven by demand/supply factors.
- Will you be able to attract a good tenant?
- Is the property low maintenance and has no issues complying with any future regulations around insulation/healthy homes etc?
- Is there an opportunity to add value in the future? For example, subdivide or add a minor dwelling?
2) What is the cash flow?
As a starting point, I would work out the Gross Yield: take 50 weeks’ of rent divided by the property value (talk to me on this!) *100.
For example, $500 per week * 50 = $25,000 divided by value of $500,000 = 5% Gross Yield.
The Gross Yield gives an indication of the cash flow:
- 5% or under is going to be quite negative cash flow based on 100% mortgage. Remember that there is ringfencing in place so you cannot claim tax refunds on such losses.
- Between 5% and 7% is still likely to be negative cash flow, but a smaller, more manageable amount.
- Aim for at least 7% or better which should be break even or be positive cash flow. This can be difficult to ‘buy’ in Auckland. Is your current property like that?
After this, consider the Net Yield. This is basically the net annual rental income (i.e. gross income minus the full expenses such as rates, insurance and maintenance) divided by the property value *100.
3) Consider what happens if interest rates go up?
We are in a record-low interest rate environment today, but there is no guarantee this will last forever. If interest rates go up to around 7%, can you still cope with the negative cash flow?
Will you be forced to sell then? Remember that in such an environment, you will not be the only one looking to exit the residential property investment market. And that would mean you may looking at significant competition and lower prices for your rental property.
4) Do you want to gamble that the property will go up more than the cash loss?
This is basically the bet you make on most Auckland properties with low gross yield, especially in the Eastern Bays/Remuera area.
The Auckland market has essentially flat-lined for the past 3 years after some spectacular gains. Is past performance indicative of future gains?
5) Or do you have a plan to change the cash flow?
- Is there room to add a minor dwelling to increase rent? Or do short term rentals to get a higher yield?
- Subdivide long term and sell section, or build second rental on section? The Unitary Plan opens up lots of opportunities but you’ve certainly got competition. There are quite a few mum-and-dad investors around.
- Will you have any inheritance coming that can reduce the rental debt?
The truth is that many family homes in Kohimarama, St Heliers, Orakei, Glendowie, Mission Bay or Remuera do not make good rentals from a ‘yield’ perspective. The rental yields in these areas are extremely low and are usually cashflow negative (after all expenses etc are considered) unless you have owned it for a long time. In leaner times, such homes can be difficult to rent out for a great price and there are few tenants willing to pay the high amounts for a rental. Even if you’ve owned it for a long time, you need to consider the alternative yield that could have been obtained if you re-invested the gains elsewhere.
If you are still keen to remain in the residential property investment game, you may consider that it is better to sell the existing personal house and buy a specific rental, with far better cash flow or better long term options.
Finally, if you think your personal home will still make a good rental, then make sure you got the right tax structure set up. Speak to a specialist property tax accountant (happy to recommend).
Still confused or unsure about what to do next?
Come and have a chat with me. I’ll walk you through both options, explain to you the current market conditions and work on the best plan with you after thoroughly understanding your personal circumstances. I’ll also give you an accurate (not inflated) appraisal of your property so you know how to proceed.
If you finally decide to sell or rent, at least it’s a well-informed decision.
Found this post useful and have more questions?
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