How do I calculate the return on a rental property?

Property remains as one of the most common forms of investment in New Zealand. However, not all properties are made equal. This is why when it comes to choosing which properties to invest in, one of the best ways to start is figuring out your investment strategy.

Choosing your investment strategy

Before choosing a property, it's important to first clarify your preferred investment strategy: buy and hold or buy and flip.

Buy and hold

For buy-and-hold investors, their goal is to hold the property on a long-term basis so they can benefit from its value potentially increasing in the future. As they hold the property, the buy-and-hold investor will also receive a secondary cash flow through its rental yield.

Rental yield is the amount of rental income a property investor can get in relation to the price of the rental property. This is calculated by the annual rental income of the rental property divided by its purchase price.

To explain rental yield in better detail, consider the following properties:

Property 1

Location: Dunedin

Price: $700,000

Rent: $505/week

Rental Yield: 0.0375

Property 2

Location: Auckland

Price: $1,400,000

Rent: $780/week

Rental Yield: 0.0289

As shown above, it is entirely possible for a lower-priced property to have a higher rental yield than a more expensive property. Therefore, when assessing a property's earning potential from a yield perspective, casting a wider net that also covers less popular locations can go a long way towards securing real property gems.

Buy and hold is the more common and accessible strategy of the two and is recommended for investors who:

• Are new to property investing
• Want to keep their full-time job
• Have other important time-consuming commitments, like raising a family

Buy and flip commonly called trading

Succeeding with the buy and flip strategy largely depends on previous investing experience, a good amount of DIY knowledge, and having a keen eye for renovation opportunities. Unlike the first strategy, the buy and flip investor's goal is to maximise the amount of profit he or she can make when eventually selling the property for a higher price. This price increase usually happens when the property's value goes up over time, or through efficient and well-planned renovations. The profit gained from selling a property at a higher price is more commonly known as capital gains.

To explain capital gains in better detail, consider the following properties:

Property 1

Location: Auckland

Price: $1,000,000

Property 2

Location: Auckland

Price: $1,400,000

If all houses in Auckland were to increase in value by 10%, selling Property 2 would result in higher capital gains ($140,000) as compared to Property 1 ($100,000).

While the profits that can be reaped from properties that have been successfully bought and flipped are more immediate and arguably more gratifying, it is also the more time-consuming and difficult strategy of the two. Given this, the buy and flip strategy is typically used by short term investors or traders who:

• Have the time, connections, and expertise they need to scout, renovate, and sell properties consistently
• Prefer turning the equity they gain into cash quickly
  

Rental yield VS capital gains

As a general rule, more expensive properties have a higher earning potential when it comes to capital gains. On the other hand, more affordable properties tend to have a higher earning potential when it comes to rental yield. Therefore, in addition to the investor's preferred investment strategy, the desirability of a property also depends on his or her property investment goals. These goals typically boil down to either a more consistent cash flow through rental yield, or significant but inconsistent profits through capital gains.

Assembling your property investment team

When it comes to property investment, it pays to forego the Kiwi "do-it-yourself" mentality. Purchasing a property is usually the biggest financial commitment the average person makes. When the stakes are this high, stumbling through the process to figure out things on your own can lead to serious financial consequences.

An effective property investment team is typically comprised of the following:

Financial Advisor

Financial advisors (previously known as mortgage brokers) act as your representative when it comes to setting up the best mortgage structure based on your financial situation. Apart from their experience in setting up mortgages, it is also their responsibility to stay on top of the latest rates from all the major banks and financial institutions, as well as any upcoming changes to lending criteria.

They also help review and process your loan application to make sure it has all the required identification, documentation, notes, and signatures. Remember that each bank has its own set of requirements when it comes to getting a loan approved. Without the help of a financial advisor, getting a loan application across the line can quickly become a frustrating and time consuming process.

Financial advisor’s focused on mortgages typically don't charge a fee because they are compensated by the banks.

Insurance adviser

Similar to a financial advisor, an insurance adviser acts as your representative when it comes to choosing the best insurance products based on your current situation and goals. The wording that goes into explaining what insurance products cover and do can be quite confusing. This is why it is the responsibility of the insurance adviser to have a comprehensive understanding of the different nuances that separate each insurance product. 

Not all insurance products are created equal. Without getting the proper guidance from a competent insurance adviser, you may end up signing yourself up to a limited and restrictive insurance policy that you won't be able to rely on when emergencies do happen.

Apart from their thorough understanding of the various insurance products currently in the market, insurance advisers can also look after your insurance claims. They can make sure that your claims are processed in a fair and timely manner.

Insurance advisers, like financial advisors, are paid via commission by insurance companies and typically don't charge a fee.

Solicitor

Solicitors help ensure your interests are looked after from a legal perspective. They typically review important documentation used in purchasing of a property, such as the sale and purchase agreement and the Land Information Memorandum.

Having a solicitor by your side helps ensure you have a thorough understanding of the legal implications of the documents you are signing and submitting. Agreeing to certain clauses without understanding what they mean can quickly lead to serious problems down the line.

Solicitors typically charge a fee for their service.

Property accountant

A good property accountant is as important as your solicitor.

Ensuring you set up your correct structures and file correct tax returns will save you sleepless nights.

Many property investors pay more tax and fees than they need to, by simply not getting the right advise at the right time, thinking they can do it themselves, mainly because of their limited knowledge regarding entities such as family trusts and companies. A competent property accountant can save you time by filing your tax returns, ensuring that the numbers you are submitting to the IRD are correct, and checking if you are paying the correct amount of tax.

Property accountants, like solicitors, typically charge a fee for their service.

Property manager

Once you manage to jump through all the hoops required to finally own an investment property, the next step is managing it in a profitable and time-efficient manner. A property manager's responsibility is to ensure that the property is regularly inspected, potential tenants are vetted thoroughly, tenant issues are addressed promptly, and rent is paid regularly.

Property managers typically charge for their services by taking a percentage out of your property's rental income.

Property adviser/Buyers agent

Based on your investing goals and financial situation, property advisers provide you with a personalised list of potential investment opportunities. Their advice ensures that the properties you end up choosing to grow your portfolio have a good return on investment potential and will have a higher likelihood of helping you achieve your property investment goals.

Property advisers typically charge a fee for their services.

Start building your property investment team

Sue and her team have decades of experience in helping Kiwi property investors prosper in the ever-changing New Zealand property market. Whether you are looking to get your first investment property or are looking to grow your investment portfolio, helping you achieve your investment goals is our priority.