Well, what a month eh! There’s certainly been a bit going on and some changes in the wind, so well and truly time for an update!
This is a fairly long one, so I suggest going and making your hot beverage of choice or pouring yourself a glass of your favourite poison, before sitting down to read the rest.
As you will very likely know by now, towards the end of March 2021, the NZ Govt in their great wisdom announced some new policies in an attempt to ‘fix’ NZ’s housing crisis, where we have a shortage of housing supply compared to the demand for it, some of these policies have a direct impact on residential property investors.
The day that the Govt made their announcement and introduced these new rules to us all, we were invited to be a guest speaker on a live info webinar to share our thoughts on how we saw these rules impacting investors and our views on what options we have as investors to work with the new rules, and how our property investing may or may not change moving forward, so two days post-announcement we spoke on that live webinar, along with another couple of Property Investment specialist professionals.
Now a month on we’ve had the benefit of spending a lot of time working with many concerned property investors, looking at their situations and portfolios helping them determine the impact the rule changes will have on them. We have also spoken with a number of other clients that are serious or full-time investors whom collectively as a group employ a range of various property investment, trading and development strategies. We’ve been looking at what the impacts will be on each of their situations and helping them identify the best strategies to move forward with their future property dealings.
Over the last few weeks, we’ve also had many brainstorming sessions, looking at all the options to invest in property under the new rules, looking at all the various strategies available to us that some investors including ourselves have always employed at least one of these alongside buy and hold investing, which can aid our overall investment plan.
So all in all it’s been a very busy and insightful month, and I must say, as much as the rule changes are generally seen by many as a negative for property investors….. It’s also quite an exciting time, as where there is change there is opportunity….more on that soon….read on.
Ok so let’s look at the background
The crux of the NZ housing problem is a lack of supply over decades compared to the ever-growing demand from a rapidly increasing population, mainly due to a much looser immigration policy over the last couple of decades, only getting worse over the last year with many of the 1 million Kiwis living abroad pre-Covid getting the heck out of dodge with a flight to safety back to good ole NZ.
The Govt knows that addressing the real issue at hand, lack of supply, is a mammoth job, it takes a long time and it will be very expensive to open up new land for development and build new homes in the order of what’s needed to balance demand.
So whilst they have announced new initiatives with a view to increasing housing stock, it’s a long slow and expensive exercise, and if we look at other recent Govt housing projects we do have to wonder how successful they will actually be at delivering any results beyond a handful of new homes, heck there’s currently a big shortage of building materials and skilled labour for that matter to actually do the building on any sort of scale.
Instead of properly addressing the supply side of the equation, they have chosen to try and stem the demand somewhat, going after the low-hanging fruit – Property Investors.
The two new policies that impact directly on property investors are:
- The extension of the Brightline rule (tax on capital gain) from 5 to 10 years.
- Removing the ability to deduct mortgage interest on residential investment property in your annual tax returns.
As far as we’re concerned the Brightline extension isn’t that big of a deal, property is a long term game, and ten years isn’t that long in the bigger scheme of things, and you only pay the tax on sale, if you sell within 10 years of purchase.
The loss of interest deduction is of much greater concern to us, and should also be to you. The average person who uses residential property investment as a way to get ahead in life uses leverage to do so. Meaning they borrow money from the bank, in many cases secured against their own home, and use that borrowed money to help them buy a rental property.
If the right properties are purchased and structured correctly these properties can generate a surplus rental income overall ownership expenses giving a passive income, while also increasing in value over time, building one’s wealth and making the investor less reliant on the Govt’s National Superannuation system in due course.
So what’s the impact?
The loss of deductibility of interest is basically a tax on debt and the interest rate. And contrary to what I’ve seen other Property Investment Educators say in their presentations this week, it is certainly going to have a negative impact on many residential property investors cashflows. Let’s take a look at some examples:
So for every $500k of debt you have on residential investment property, at 3% interest, it will cost you an extra $5,000 in tax over and above what you would have normally paid. At 4% interest rate that will increase to $6,600 extra, at 5% that’ll be $8,250 extra, and at 6% it’ll cost you an extra $9,900. That’s for every $500k of residential investment property debt you have.
So if you had 3 investment properties, with total debt of 1.5M and interest rates were say 5%, it’d cost you $24,750 per year in extra tax than it did previously (this is 4 years down the track when you have lost the ability to deduct the full 100% of interest).
So for the average property that we deal with, let’s say a purchase price of $500k, 100% financed with an interest rate of 3% and returning 1-2% pretax cashflow surplus. So @1% or $5k pretax cashflow (PTCF), the investor would previously have had to pay tax on that $5k, so $1,650 tax, well now after 4 years when there’s no deductibility of interest, they’ll have to pay tax of around $6,650, making their pretax positive cashflow property now $1,650 pa negative cashflow.
If the property had a higher yield and returned 2% of surplus casflow, so $10k PTCF, they would have had to pay tax of $3,300 tax from their $10k PTCF, now once they cannot claim the interest they will have to pay tax of $8,300 from their pretax CF of $10k. This is assuming an interest rate of 3%, gets worse as the interest rate increases.
PTCF at 3% of PP, would be a CF surplus of $15k (about as good as deals normally get at purchase) Normal tax on that would have been $4,950, now moving forward the tax would be $9,950 from the $15k PTCF.
The higher your Debt level (LVR) the greater the impact on your cashflow, the lower your LVR the less it will reduce your cashflow.
With any existing residential investment properties, the only way to beat the loss of interest deduction policy is to have less debt or better yet, no debt, therefore no mortgage interest.
So what can you do with existing properties?
If you own properties that will be negative cashflow after tax due to the loss of interest deductibility, look at what options you may have to pay down the debt level to get the property to a point where it becomes positive for cashflow after tax. If you have multiple properties, you may look at selling off one or more if that will give you the ability to pay down debt on the properties you wish to keep. The peak of a market is always a great time to sell down any less desirable properties or higher maintenance properties you may have.
Remember, the loss of interest deduction is being phased in over 4 years, so you have a little bit of time to improve your position before you realise the full impact of it.
Look to employ some other type of property strategy to create lump sum profits that can be applied to paying down debt. Any kind of trading strategy, reno and flip, develop and sell, any strategy that results in making lump sum cash profits that can be used to reduce debt on the properties you currently hold.
Some investors including ourselves have always employed one or more of these other strategies alongside our more normal buy and hold investing, but the majority of residential property investors do not.
Moving forward under the new environment I see it as pretty much essential that all investors need to run at least one other strategy over and above their buy and hold rental investing which will complement the bigger picture.
Investing moving forward
Look to invest in such a way that the loss of interest deduction policy has a reduced effect on you, or even look to avoid it all together.
There are a number of ways of doing this, here’s a few below.
- Invest in residential property using lower levels of debt, or without using debt at all (may suit some people, but there’s reduced or no benefit of leverage)
- Invest in commercial property, where you can still deduct mortgage interest
- Invest in otherwise residential property, classed as commercial by the nature of the lease and use of the property. (Waiting on Govt to add further details around their new policy before this one gets the green light).
- Buy brand new residential property, which the Govt has indicated will be exempt from loss of interest deduction (no details as for what period have been released as yet). Not all brand new property is ideal as an investment property. Good due diligence is key.
- Build brand new properties, to your spec and structured in such a way as to give maximum rental yield for the build cost, and also thinking about your exit strategy once the interest deductibility period comes to an end (assuming it will be a set number of years, details yet to be).
Of course, if you choose to employ more of a trading, spec build and sell or other development strategies, these things are not affected by the loss of interest deduction and are business as usual.
Over the years we have seen various clients who were either trading, spec home builders and/or doing some land subdivision, roll trading/development profits into property assets that they hold longer-term without debt, this model will work really well under the new rules moving forward. Any strategy that combines the creation of lump sum profits and holding property assets over the longer term will be very beneficial.
Over the last few weeks, we have spent plenty of time brainstorming various ideas and strategies to make the most of the new rules moving forward both with existing portfolios and future investments.
We have interviewed a number of our past and present property investing clients and colleagues, looking at the impact the loss of interest deductibility will have on them and their property portfolios. Our clients have generally done things differently compared to the average property investor and structured their portfolios and property purchases in such a way that they see a stronger yield and higher positive cashflow surplus than the average property investor outside of our network.
Thus the extra tax they will incur once the deductibility of interest tappers off can be paid from actual surplus cashflow. Whereas many other residential investors that haven’t invested in the way that we promote and teach will now be faced with paying tax on an investment that hasn’t actually generated a cashflow surplus at all, many will already be making a pretax cashflow loss and now under the new rules, they will have to find even more money from their own pocket to pay out tax!
Many of these negative cashflow investors will simply no longer be able to afford to continue owning their rental properties unless they implement one of these other property strategies we spoke of above, alongside their buy and hold investing.
Wherever there is change there is opportunity!
The more we look at this whole situation and the impacts the new rules will have, the more opportunities we see opening up due to it. It’s just a matter of you being able to identify what these opportunities are, what strategies you can use and how to position yourself to make the most of them.
We see these new policy changes as forcing our hand as investors to look wider, most of these other strategies we’re discussing here are not new and have been around forever but the majority of investors haven’t used them. I guess they wanted to keep things simple and didn’t see any great need to employ any other strategies beyond buy rent and hold.
Well, the old rules have changed guys and us investors must change too.
In this booming market of recent years, it’s been all too easy, there have been many people almost blindly buying anything and hoping the value will keep going up……and to date it has. No real strategy was required at all to get a certain level of success.
However ‘Buy and hope’ is not an investment strategy, and it only works in a rising market, once the market stops its incline which it will do, those buy and hope “investors” (really speculators) are left high and dry once the tide turns.
Without any real investment strategy up their selves, they are no longer able to invest and they generally exit the market.
We are seeing the tide turning already
We have been saying for a little while now that the huge growth our property market has seen in recent years is unsustainable, the upward cycle has gone on for far longer than it usually does. On top of that, the post covid surge in the market has been crazy taking our property values to even heftier heights. A crazy 28% growth in home values across NZ in the last 10 months alone!
Like any investor that has been around a while and invested through several property cycles, we knew it wouldn’t continue on upward forever, even though many others seem to think it would.
There always comes a point in any upward cycle where the market values reach levels that are just not feasible or affordable any further. This frenzy has been fueled by un-naturally low-interest rates, making the cost of money extremely cheap temporarily (that last word is key).
Money has been made artificially cheap, with the Govt and Reserve Bank dropping the OCR and therefore retail interest rates to extremely low levels that have never been seen before in this country, for the sole reason of keeping the economy going through the uncertain and most unusual times due to the Covid situation. Therefore many people who haven’t been able to afford to get onto the property ladder prior, suddenly have seen that they can now afford to get a mortgage and buy a home, even though the values of those homes are far higher than they were back when they couldn’t afford them.
Fast forward to today, there’s plenty of talk of interest rates likely to start moving upward, ASB has already increased its longer-term rates last week, whilst some short term rates have come down a bit with the banks trying to tempt people to fix short.
Since the Govt housing announcement and rule changes towards the end of March, the number of visitors to open homes has had a big drop. Tony Alexander saying just yesterday morning that real estate agencies have just reported a 78% decrease in buyer enquiry this month compared to last, and that includes first home buyers (FHB). Interestingly enough the new rules don’t affect FHB, so even they must be starting to think that values may well come back so they are sitting and waiting hoping to be able to buy in at a lower level than they can today. FOMO, Fear of missing out is now turning into FOOP, Fear of over paying.
In the last couple of weeks, we have seen an increase in the number of Real Estate agents reaching out to us, which is a big change from the last couple of years where the agents have had that much buyer enquiry that they haven’t needed to go looking for buyer interest. That in itself based on our experience over past property cycles is a big indicator of a change in market sentiment, and market sentiment makes a market.
This combined with the rules changing around interest deductibility and the impact that has on investor’s cashflow, it will be essential for property investors moving forward to have a thorough knowledge of various investment and/or trading/development strategies to be successful in the property game moving forward, the days of blindly buying anything and hoping the value keeps increasing are over.
We much prefer to invest in a counter-cyclic manor, buying when few others are rather than competing with the masses of frenzied buyers suffering FOMO. We see a huge number of opportunities unfolding from now on and have the strategies at the ready to implement to make the most of them, some of our clients have pivoted into these other strategies already and are getting some great results.
As the market continues to turn the opportunities presenting will only increase, those that have the knowledge and strategies to deal with them will be positioned well to benefit from the changing market ahead.
Want to know more?
To cover all of this in further detail and talk more about these other property strategies which will now hold an extremely valuable place in every investor’s toolbox we are presenting a brand new free training webinar, focusing on these other methods and strategies and how to implement them to invest successfully moving forward in the new environment.
There is something of value in this presentation for everyone, no matter your financial position, if you have been investing for a while and currently own rental properties and want to know the best options for you to move forward, or if you have been wanting to get into property but are yet to get started and are now wondering if you should or not and if property investment is still even feasible, then this webinar will give you those answers and explain the options you have.
We will even be talking about a trading strategy we’ve been using where you can buy and sell property making lump sum cash profits without actually needing to use your own funds or even get a mortgage, it’s a game-changer for many.
We will also be discussing another strategy that enables you to create an ongoing monthly passive income from property without the need to even own it.
So there really is something for everyone!
It’s not what you know but what you don’t know that holds you back, and you don’t know what you don’t know. So grab a spot on this webinar, learn something new, which could be that one thing that you run with and ends up a game-changer for you.
Secure your spot on this free training webinar by clicking the link or image below.
Webinar Event: The rules have changed, how do we change with them?
This is one Webinar you do not want to miss, we look forward to seeing you there!
Clint Taylor and Shane Allen