All investments, whether rental property or a share portfolio, should start with clarity around your objectives, risk profile and time frame.

Traditionally, residential rental property investment has been a relatively long term and low risk investment. Gross yields typically averaged 7-9%pa until the recent boom when they dropped to 3-5%pa. Low risk gearing is generally 80% or less of the purchase price and the property will be cash flow positive before tax if the rent received exceeds cash expenses including interest, rates, insurance, maintenance and property management fees.

Personally, we believe that rental property investment is a good strategic way to gain financial independence, although not a “get rich quick” strategy. Propery investment is relatively low risk, and the value and income yields are generally inflation proof. The income generated is also reliable and regular. These are all important considerations for a retirement plan.

But there are different ways to play the property investment game – rental investment can become short term and high risk if aggressively geared (you’ve borrowed lots of money to buy the property) and/or you plan to resell or “flick”.

If you are just starting out as a property investor then we suggest that you start with a simple investment to “cut your teeth on”. Some of our clients have ignored this advice and gone straight into more complicated property investment deals involving subdivision, building, renovations and so on and have been severely burned. So start simple and build up your knowledge and experience before tackling more sophisticated and complicated investment opportunities.

Start by examining your objectives. Are you investing for positive cash flow or capital gain? Beginning investors sometimes get hung up on the capital gain element of property investment. But remember, generally all properties get capital gain over the medium to long term of at least the rate of inflation. If you are a long term investor then look on the capital gain as “icing on the cake” rather than the cake itself. So if you are starting out it’s good to try to get a bargain (a property at a discount so you have immediate capital gain) but perhaps more important than ongoing capital gain is cash flow.

If the property is cash flow positive it will pay its own expenses and still put money in your pocket, or start to pay off the mortgage. Negative cash flow properties require you to put money in to keep going, so you need to ensure you do not over commit yourself. You can only have so many negative cash flow properties requiring you to put money in, but theoretically you could own an unlimited number of cash flow positive properties.

Set some investment rules to simplify your search. There are literally thousands of properties available to purchase and it is impossible to look at them all. Leverage your valuable time by limiting your search to:

• a particular type of property (for example, a 3 bedroom family home in a particular suburb close to shops, schools and public transport),
• a particular price range (based on your ability to borrow which a mortgage broker will be able to advise you), and 
• a minimum desired gross yield (so you need to know the approximate weekly rent that the type of property you are looking for is able to command. The NZ Property Investor magazine is a good source of information.)

Gross yield is calculated as the gross annual rental divided by the purchase price of the property. For example, if the rental income was say $450 a week the annual rental would be $23,400. If the purchase price was $390,000 then the gross yield (before expenses) is 6% ($23,400 dividend by $390,000). At this point don’t get bogged down in too much detailed analysis. A gross yield calculation is quick and easy and enables you to compare different properties.

Once you have found a property that meets your criteria you need to do due diligence. Find out the government valuation and maybe get a quotable value off the internet. Compare these values to the asking price. Find out the reason the vendor is selling – desperate vendors are much more negotiable on price. Look around the neighbourhood and talk to the neighbours. Think about the desirability of the property for prospective renters. It the garden high maintenance? Is the property handy to schools, shops and buses etc?  Is there outstanding maintenance work required? If so add the expected maintenance work on to the purchase price and recalculate the gross yield. Or alternatively, reduce your offer price by the cost of the outstanding maintenance work.

At this point you will probably do a detailed financial analysis of the property and it is a good idea to get a second opinion from your accountant to make sure your numbers are robust. StreetSMART provide a free property analysis spreadsheet on this web site, just click here.

At some point you will need a building inspection and probably a registered valuation. Do not rely on reports or valuations commissioned by the vendor. You will also need a lawyer to look over the sale and purchase agreement and check out legal title and LIM (Land Information Memorandum) report and so on. Don’t sign the agreement without having a professional check it first, even if you think it is conditional and you have a way out. Many beginners have been duped into signing a conditional agreement that they subsequently have been unable to get out of. The real estate agent is acting for the vendor (not you the purchaser) as their commission is paid by the vendor out of the sale price.

Remember, the property is not for you to live in – it’s a business transaction so you need to be able to look at the property dispassionately. If the numbers don’t stack up, or the due diligence fails, move on. Next please!

Unless you have taken advice or are an experienced investor, then if you do sign a sale and purchase agreement we suggest you put your own name as the “purchaser” and the words “or nominee”. This enables a deed of nomination to be executed prior to settlement to ensure the property is purchased in the correct legal entity. At this point it is a good idea to talk to a good property accountant like StreetSMART, if you haven’t already, and get some tax planning advice.

Tax breaks are usually quite an important part of the property purchase. Getting the initial structure and financing right will in large part determine the tax effectiveness of the investment in the medium to long term. In many cases a company or LAQC may be the best entity to purchase the property in. Your accountant should be able to advise about the best way to structure the company, including the number if shares, directorships and shareholding.

There are often one off opportunities to do some clever tax planning, for example possibly switching current non deductible (private) debt into tax deductible (investment or business) debt. But care needs to be taken as there is always an over riding requirement for there to be valid commercial justification for the transaction and structure. Mere minimizing tax is not valid commercial justification in the eyes of the IRD, and could even be treated as tax evasion which is a criminal offense.

Ask your accountant for advise as to whether you should get a chattel valuation done. This is different from a property valuation and is primarily used for tax purposes. If you have a chattels valuation you are often able to increase the amount of depreciation claimed on the property. This in turn provide a tax benefit.

Once the structure is agreed on and set up you probably should seek the services of a savvy mortgage broker if you haven’t already. A mortgage broker is paid by the bank so does not usually cost you anything. A mortgage broker will also be able to advise you of the best way to structure the mortgage and which bank is most likely to give you the best deal available at the time. Sometimes getting finance can be tricky, and in such situations a good mortgage broker is worth their weight in gold. A good mortgage broker can probably negotiate a reduction in mortgage application fees and may even be able to get you a rebate on legal costs.

And don’t forget to arrange insurance on the property to take effect from the day you settle. A small detail perhaps, but possibly with a disastrous outcome if the worst happened!

You also have to decide whether you will manage the property yourself or whether you will use a property management company. Many first time investors try to manage the property themselves but unless you know what you are doing that can be a mistake.

You will need a rental agreement, you should get a bond from the tenant and send the bond to the appropriate legal authority to hold, do a thorough check of the proposed tenant to make sure they have good references and credit history, undertake regular rental inspections and regularly review the rental charged to ensure it is market rate. Repairs need to be attended to quickly to retain tenant goodwill. And if the tenant gets behind with the rent you will need to follow this up straight away and try to collect the outstanding rent. If there are rent arrears problems or the tenant does a runner you may end up at a tenancy tribunal hearing. If a tenant moves out you will need to clean the property and advertise and select a replacement tenant as quickly as possible to minimise loss of rental income. Unless you are prepared to put the time and effort in you are probably better to use a reputable property manager. Indeed, tenant management is often the hardest part of being a property investor.

Once you have bought the property and have a tenant in place then you need to organize some record keeping for accounting and tax purposes. Once again ask your accountant about the best way to handle this and clarify the deductions you are able to claim.

Since most residential property investment is not subject to GST you will usually only be required to file annual income tax returns at the end of each financial year. However, you are able to file an IR23B if you are a salaried person, so that your employer reduces the amount of PAYE deducted from your pay. Otherwise, any tax implications as a result of owning the property will be calculated at the end of the tax year when your income tax returns are prepared.

A a word of warning here – although accounting for a rental property seems straight forward there are many often over-looked tax issues. There are definite advantages of having an experienced property accountant prepare the financial statements and income tax returns each year.

StreetSMART offer an obligation free first meeting to property investors. So why not give us a call and come in to talk about your strategy to become financially independent as well as your accounting and tax requirements. If you become a client of StreetSMART you will also be given (absolutely free) our hard copy detailed residential rental property investment guide which gives a lot of invaluable information for property investors.