Investing in residential property is a Kiwi favourite – climb the property ladder and own bigger, better, and more properties. Laugh yourself to sleep every night, as your properties go up and up in value, and as you collect more and more rent year after year from your poor tenants.
Despite the popularity of this asset class, I haven’t written much about property on Money King NZ so far. Property investment is not that easy compared with other asset classes like shares, and I am far from being an expert. But finally, here’s a beginner’s overview of the basics of purchasing a property, split into 5 sections:
- Section 1 – Key ingredients of buying residential property
- Section 2A – Buying as an owner-occupier
- Section 2B – Buying property vs Renting
- Section 3A – Buying as an investor
- Section 3B – Buying property vs shares
I won’t be going in depth into each topic, but rather I will cover the main things to know and the key pros and cons of buying residential property. However, throughout the article I will link to a few resources that are worth checking out to gain further insights into each topic.
1. Key ingredients of buying residential property
If you thought shares were complicated, think again. There are many more parts to purchasing property, and it’s certainly not as easy as going to a brokerage service and putting in an order for shares or an index fund. I would recommend having a look at Settled.org.nz as an easy to read beginner’s guide to the process of buying and selling a property.
But for this article here’s a super quick overview of the key ingredients:
Not many people can afford to buy a property outright, with New Zealand’s median property price being $629,000. You will most likely need a home loan to fund part of the purchase.
You’ll need to meet the lending criteria of the bank or lender providing your loan. First you will need your own money as a deposit, which is typically 20% of the property’s purchase price for an owner-occupied property, or 30% for an investment property – then the lender will fund the rest. It’s best to check with your bank or mortgage broker to see whether you qualify for lending, and if so, how much you can borrow.
There are different types and structures you can have for a home loan. At a very high level:
- Fixed loan – You pay a fixed amount of interest for a period between 6 months and 5 years, after which you must refix your loan at a new term and rate.
- Floating loan – You pay a variable interest rate (based on the market), typically higher than the fixed rates. In return you get more flexibility, like the ability to make additional payments on your loan at any time, or the ability to draw down funds from the loan.
You can split the financing of your home across multiple loans, as well as have different arrangements for paying interest such as an ordinary table loan, or an interest only loan.
You will need a lawyer or conveyancer to help you throughout the process of buying a property. This includes giving you advice on legal documentation such as the property’s Sale and Purchase Agreement, handling the settlement and title handover of the property, and helping coordinate the transaction of money between all parties.
Next you need a property to purchase! Like the sharemarket, the possibilities are endless – with different property types (e.g. houses, apartments, townhouses), locations, and sizes to meet your lifestyle or investment needs. Different properties have different ownership types:
- Freehold – The most common type of ownership where you own the land and any buildings on the land.
- Leasehold – Someone else owns the land, but leasehold ownership gives you exclusive use of the land and buildings for the term of the lease. You will usually pay ongoing ground rent for this.
- Unit title – You own a part of a building, such as an apartment or townhouse. This could either be freehold or leasehold ownership. You also become part of the building’s body corporate, and must pay body corporate levies to fund the building’s maintenance, insurance, and shared costs.
- Cross lease – You share the freehold ownership of a property with other owners, but also have a leasehold interest in a section of the property that you have exclusive use to (however, usually no ground rent is payable in this case). A common example of cross lease ownership is an undivided piece of land with two or more houses built on it, where each house has a different owner.
A property is a huge purchase, so it pays to conduct due diligence to enable you to make a well informed decision on the purchase. This might include a property inspection/builder’s report, a valuation, LIM report, as well as your own research.
There are a few methods in which a property is sold, and this should be made clear on a property’s marketing materials:
- Tender – This is where buyers submit confidential offers for the property before the tender’s closing date. An offer can have conditions attached (e.g. subject to financing and an acceptable property inspection report), and the seller will accept the best offer after the tender’s closing date.
- Deadline – Similar to a tender, however sellers can accept an offer at any time before the closing date.
- Negotiation – There is no end date to the sale, and buyers can submit offers to the seller for consideration at any time. Properties sold by negotiation are often listed with an asking price, which indicates an approximate price the seller is willing to consider.
- Auction – In auctions interested buyers publicly place bids on the property. The highest bidder becomes the unconditional purchaser of the property as long as the bid is above the property’s reserve price.
There are many ongoing costs to owning a residential property such as council rates, insurance, maintenance, body corporate levies, home loan interest, and furnishings.
2A. Buying as an owner-occupier
Very broadly, purchasers of residential property fall into two categories:
Our first type of residential property buyer is an owner-occupier. They buy a property with the intention of living there. Arguably an owner-occupied property is not an investment – Investments should make you money, but all an owner-occupied property does is cost you money through home loan interest, rates, insurance, and maintenance.
The value of the property can appreciate, which might give the illusion of it being an investment. But an increase in your home’s value from $500,000 to $600,000 doesn’t mean you made $100,000. Once you factor in your ongoing costs, chances are you haven’t made much profit after inflation. Instead an owner-occupied property should be considered as buying a lifestyle asset – like a car, it’s an asset which enables you to live the lifestyle you want, rather than an asset to make you money.
Your Money Blueprint – New Zealand house price increases are not what they seem
2B. Buying Property vs Renting
Given the choice of buying an owner-occupied property or renting, which one should you choose?
Reasons to buy
Having your own property gives you a place you can truly call home. There is no risk of being kicked out by your landlord, nor will you have to suffer from rapidly rising rents. It’s an asset that provides you and your family with security and stability, particularly a freehold property in which you no longer have to make loan repayments to the bank.
Owning your own property gives you the freedom to use it however you like. You can live in it, rent it to flatmates, have pets, and make renovations and improvements to the property. It’s a canvas to do whatever you want, only constrained by your land area, council regulations, or any body corporate rules.
There are a few government incentives for first home buyers who wish to be owner-occupiers (eligibility criteria apply, see links below):
- KiwiSaver first home withdrawal – Funds from your KiwiSaver account can be put towards a first home purchase. It’s one of the very few ways you can release your KiwiSaver money before you turn 65.
- First Home Grant – This is a grant of between $3,000 – $5,000 (or $6,000 – $10,000 for new builds) for first home buyers who meet the eligibility criteria.
- First Home Loan – A scheme which allows you to get a home loan with as little as 5% as a deposit.
Reasons to rent
You can still grow your wealth
There is nothing wrong with renting. As a renter you will most likely have more cash than a homeowner to go into other investments like shares and funds. These asset classes give you ownership of businesses and are perfectly acceptable ways to build your wealth. Think about the world’s richest people – they all got rich by owning shares in businesses, rather than investing in real estate.
You can move easily
Sick of your home, city, or want to take an overseas break for several months? As a renter, it’s much easier to pack up your things and move. As a homeowner, you have the burden of your biggest financial commitment to deal with before moving – it takes significantly more cost and effort, such as putting your home on the market, agent’s fees, and having to find a new home.
The burden is on the landlord
The landlord faces the burden of paying for rates, insurance, maintenance, and the upfront costs of meeting new regulations like the Healthy Homes Standards. However, this doesn’t stop landlords from increasing rents to cover these costs.
Your Money Blueprint – Should I buy a house now or wait?
3A. Buying as an investor
Our second type of residential property buyer is an investor. They purchase the property with the goal of making money. It’s harder to borrow money as an investor – You will need a higher deposit (typically 30%) to qualify for a loan. Although you can use the equity from an existing property that you own to contribute to that deposit.
A major difference between an owner-occupied property and investment property is cash flow. As you are not occupying the property, you are able to rent the property out to tenants, charging rent and generating income. It can be thought of as similar to earning dividends from a company, and different properties have different rental Yields. Related to the yield is gearing – a property can be negatively geared, where its outgoings (e.g. rates, financing costs, etc.) are greater than the rental income, or positively geared, where the rental income exceeds all outgoings.
A negatively geared property doesn’t make it bad, as investors can still benefit from capital gains, and is in fact very common. Speaking of capital gains, like shares, property investors typically enjoy tax free capital gains (as long as they hold the property for over 5 years), but they do have to pay income tax on rental income (minus expenses).
You don’t have to already own your own home to become a property investor. You can be a ‘rentvestor’, which involves renting your place of residence, but buying an investment property elsewhere (typically in a cheaper location).
RBNZ – LVR Restrictions at a glance
Canstar – What does positive and negative gearing mean?
Stuff.co.nz – ‘Rentvestors’ striving to keep their property dreams alive
3B. Investing in Property vs Shares
Like shares, property is an asset class best suited to long-term investment where you can ride out any turbulence in the market. What are the pros and cons of each?
Reasons to invest in property
Property is more tangible. It’s easy to see, feel, understand, and it’s something that everyone needs – a place to sleep, eat, and shower. Not something your Vanguard Index fund can provide! Property can also give you a sense of pride, and society and your own family often expects you to own property as a sign of success.
People often treat shares as just a ticker symbol on the market, and the sharemarket can feel like a casino at times. With shares and index funds, people often forget what they are. The fact that shares give you ownership of a business, is hidden by your ownership of these assets simply being your name on a share registry, rather than something physical.
Easier to leverage
Leverage is a key ingredient in a property investor’s tool kit. It can turn an average asset class into an outstanding one. It is much easier (and usually cheaper) to get lending for real estate as opposed to shares and index funds, making it possible to use a bank’s money to magnify your investment returns from property.
But the risks are often forgotten – leverage also magnifies investment losses. With an unleveraged investment, the most you can lose (in dollar terms) is the amount of dollars you put in. With leverage, you can lose more than your initial investment.
Every business day the sharemarkets are open and the value of your shares go up and down – sometimes for no reason at all. As the markets fluctuate, it is easier to be affected by, and trade based on emotions. Seeing a big 10-20% drop in the value of your shares may encourage investors to panic and sell off their investment at a loss.
With property, their change in value is mostly invisible. There is no ticker symbol for your property which indicates its value, nor does it have day-to-day fluctuations in its price . You don’t know for sure how much your property is worth until you sell it.
It forces you to save money
When you invest in property, you have to pay off your loan to prevent the bank from taking possession of the property. Part of your repayments goes towards building up equity in the house, resulting in your wealth gradually increasing over time.
With shares, no one is going to care if you buy a new phone or electric scooter, and miss your monthly deposit into your Sharesies account. Investment into shares requires more discipline to grow your wealth.
Reasons to invest in shares
Shares and index funds are more liquid too – It takes just a couple of business days to sell your investment and get cash out, as opposed to property, which could take months to complete a sale. This also makes shares suitable for beginner investors. You can exit any bad investment decisions easily, without suffering major losses in dollar terms, since you can dip your toe in with just some spare change.
You can’t sell down fractions of your property either. This tends to be more of a problem for retirees, where they have a lot of equity in a property, but a lack cash to cover bills and enjoy retired life. Although products like reverse mortgages can help with this.
However, I believe the ease of getting in and out can be a con for shares and index funds. It could result in investors not doing enough due diligence before investing, treating the markets like a casino or get rich quick scheme, or panic selling when volatility hits.
Low barrier to entry
You need a lot of money to get into real estate investing. For example, a 30% deposit on a $500k home is $150k – a huge financial committment. With shares and index funds, all you need is $50 to get started in the case of InvestNow, or $0.01 in the case of Sharesies – it’s an investment that’s accessible to almost anyone, even kids!
Easier to be diversified
Investing in property tends to concentrate your wealth on very few assets, in limited geographical locations. A natural disaster, weak housing market, or weak rental demand in your property’s area could severely dent your portfolio. It takes a significant amount of capital to spread a property portfolio across different properties and geographies.
With shares and index funds, a small amount of money can be diversified across many companies, across many countries. For example, just a small $50 investment into Smartshares’ Total World ETF gives you exposure to over 8,000 companies across 42 countries.
Requires less effort
Investing in shares requires a lot less effort. Dealing with lawyers, agents, banks, local councils, property managers, and accountants, are all time consuming overheads people seem to forget about when investing in property. And I’m sure most of us have heard about horror stories when dealing with tenants.
With shares index funds, all you need is to sign up with an online investment platform, deposit some money, place an investment order, and hold your investment. There are no ongoing expenses or maintenance for shareholders to take care of. Imaging buying shares in Air New Zealand and having all their management team and employees working to make money for you, year after year. And as The Happy Saver says “Not once have those investments phoned me at 10pm and asked me to come and unblock a toilet”
The Happy Saver – NO, I don’t want a rental property thank you
Passive Income NZ – Investing In Rental Properties: A Sure Thing
Kernel – Residential property is now a bad investment
Your Money Blueprint – Unlike Hansel and Gretel, you can’t eat your house
I think everything in investing is completely a personal choice, and there is no one size fits all answer to whether buying residential property is worth it. I do however think Kiwis overvalue property ownership, and undervalue shares – There is nothing wrong with being a renter, and choosing to own businesses over a home. Although I feel this mentality is improving with the introduction of easy to use investment platforms like Sharesies and InvestNow.
So always look at the pros and cons of each, look at the numbers surrounding the property you’re interested in, and see whether they fit your preferences, personal situation, lifestyle and investment objectives. And just because your friend, relative, or person featured on Stuff.co.nz/NZ Herald is investing a particular way, doesn’t mean it’s right for you. And remember nothing in investing is an either-or choice – it’s always possible to invest in both real estate AND shares.
Personally, I am interested in buying property sometime soon, but with the knowledge that it would be a lifestyle asset, rather than a true investment. However, I would never go all-in on becoming a property investor – the illiquidity, lack of diversity, and high effort required is unappealing to me, and for that reason I intend to keep any shares and index funds I buy in my portfolio forever, growing and generating increasing dividends over time.
The content of this article is based on my personal opinion and should not be considered financial advice. The information should never be used without first assessing your own personal and financial situation, and conducting your own research. You may wish to consult with an authorised financial adviser before making any investment decisions.