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).