BUILDING UP WEALTH THROUGH INVESTING IN PROPERTY

        "Of all millionaires 90 per cent became so through owning Real Estate and a wise Young Man or Wage Earner should Invest his Money in Real Estate"

                         Andrew Carnegie (American Steel Tycoon)

The proportion of Pension Fund assets invested in Property has averaged around 10% but has been as low as 5% and as high as 20%.

We have typically recommended an exposure of around 10% but believe that, for aggressive investors saving for retirement or retired individuals requiring a high level of income coupled with a proven inflation proofing ability, a weighting of up to 20% of total assets in property is warranted- at the expense of bonds" 

                                ( Craig & Co.- "The Headliner" 6/8/96) 

DIFFERENCE BETWEEN DIRECT AND INDIRECT PROPERTY INVESTMENT

Direct Investment

You own it yourself.  

Indirect Investment

You don't own it yourself.

There are investment intermediaries

Examples are:

- managed funds

- mutual funds

- property shares

- syndicates

- superannuation schemes.

WHY INVEST IN REAL ESTATE?  

Self Use

The majority of real estate is purchased for self use, including residential, commercial and industrial properties.

 Estate Building

Many of the world's wealthiest people have large real estate holdings.   For most their home is the biggest investment they have that they can pass on to heirs.

Inflation Hedge

Property prices have historically risen ahead of inflation.  

Status

Real estate ownership gives a person status and a physical presence of wealth.   

Satisfaction   

Real estate is bricks and mortar, it can be seen and admired.    Investors  get satisfaction out of their own property, improvements they make and work they carry out around their section. 

Personal Control

Most investors enjoy the day to day decision making associated with managing ongoing investments.   This gives them a direct input into making the investment successful.

 Leverage    

Because of the bricks and mortar nature of property and the (historically) increase in value, lending institutions are more inclined to lend for investment on property than other investment types.    Loans may be secured against the real estate asset. 

Tax Shelter

Taxation authorities allow a deduction from income for depreciation on improvements and renovations and all other operating costs.    New Zealand has no Capital Gains Tax.   This acts as a strong incentive to invest in Real Estate.

MAIN TYPES OF PROPERTY INVESTMENT 

Residential

 Commercial:                     

-  Commercial Business District (CBD)

-  Wholesale

-   Industrial 

Retail 

Rural 

Recreational 

Tourist

FACTORS THAT AFFECT RETURNS OF PROPERTY INVESTMENT

Population Movements

These cause increases and decreases in demand which affects property prices

Location

- in bigger population centres

- standard of other properties in neighbourhood

- on a hill with a view, near beach

- close to places of work

- close to transportation links

- close to shops

- close to schools, public amenities

- close to public utilities

Management Input

- improvements made to properties by owner

- state of repair of properties

- seeking and looking after tenants

Market Trends and Economic Factors

- the different types of Property Investment all have economic cycles

- for example when there is a recession and high levels of unemployment consumer spending will be down and it is likely that there will be retail shop close downs

- the fortunes of rural property investment are very dependent on prices being realised overseas for farm produce- land prices will change accordingly

- industrial concerns which export are less profitable when our exchange rate strengthens.

- office rents and prices fluctuate according to the demand for financial services

Government Policy and Taxation Legislation

-  dependent on this investment in property types can be more or less profitable.

Local Body Action:

-  through their zoning responsibility they can change the land use and make investment in specific property types more or less profitable.  

TAX ADVANTAGES OF INVESTMENT PROPERTY 

***  can claim all costs incurred  

***  only rental earned is treated as assessable income 

***  capital gain is not treated as assessable income 

***  is there is a loss (i.e. expenses higher than assessable income) this can be deducted against other income earned by the taxpayer which will reduce the income tax liability.

AVERAGE ANNUAL CAPITAL GROWTH (1966-1995) 

 (Source- Valuation New Zealand)

WHY INVEST IN RENTED RESIDENTIAL PROPERTY?

***  it allows easy entry into the Investment Property owning field. 

***  it provides a service that is always in demand. 

***  it is the best security for lenders. 

***  it is easy to spread your risk over several properties with several points of income. 

***  it provides instant and consistent cash flow. 

***  it provides capital appreciation without capital gains tax. 

***  it protects the value of your hard earned dollars (hedge against inflation). 

***  it allows the Government to help you become wealthy. 

***  it provides an asset that is easily tradable. 

***  it is not time consuming. 

***  it provides a financially secure future which you control totally for your benefit.

GEARING TO INCREASE PROPERTY WEALTH

              Gearing  (or Leverage) occurs when investors  borrow money to finance property investment.

               Providing the return of rental plus capital gain is in excess of the cost of borrowed funds, gearing will result in an increase in the % return on the owner's contribution to the investment.

Positive Gearing

This occurs when the cost of borrowing (mortgage interest) is below the overall yield on the total capital invested (rent)

 Negative Gearing

This occurs when the cost of borrowing (mortgage interest) is above the overall yield on the total capital invested (rent).   Investors should be aware that the higher the level of borrowings the higher the risk that the investment will fail.

Example of Increased Returns on Investment through the use of Gearing

Purchase Price $100,000

Net Income -  Rent 8.5% $8,500,  Capital Gain 6% $6,000

Interest Rate on Borrowings 10%

Scenario 1- 100% equity, no mortgage

Scenario 2- mortgage 50%

Scenario 3- mortgage 70%

N.B.  Return on Owner's Investment =   Net Return to Investor                 

                                                                Owner's Investment

CASE STUDY- HOW TO BECOME A PROPERTY MILLIONAIRE 

The figures quoted are hypothetical and could be converted to similar situations.

Assumptions

- lending institutions have policy of lending maximum 80% value of security

- loans taken out are flat mortgage (i.e. just repay interest on the principle)

- interest on loans constant at 10%

- capital gain on property  value constant at 10%

Step 1

Mr Property Investor buys a house which represents good value, and in an area where property values will rise, for $100,000 by putting in $20,000  and borrowing $80,000 on a flat mortgage    He makes sure the income received from rents pays for the interest on the loans and other outgoings. 

Assuming 10% compound capital gain the property value will increase as follows:

Year 1-   $110,000

Year 2-   $121,000

Year 3-   $133,100

Year 4-   $146,410 

Year 5-   $161,051 

Also over the period rent increases have resulted in a surplus of cash flow, due to the fact that his interest on mortgage repayments do not increase. 

At the end of 5 years Mr Property Investor still owes $80,000 on the mortgage but his equity has risen from $20,000 to $81,051 ($161,051 less $80,000), in other words it has quadrupled.

Step 2

Now that he has had 5 years experience in property management he has built up the confidence to expand his portfolio. 

He buys 2 more properties, each worth $120,000, once again making sure they represent good value and in an area that will rise in value. 

His property values are now:

Property 1                   $161,051

Property 2                   $120,000

Property 3                   $120,000

                                   $401,051

He borrows the full purchase price of $240,000 to finance the purchase so his borrowings are now $320,000 on flat mortgage, still within the 80% bank criteria.                                          

Once again he budgets to ensure that the rental income received covers the interest payments and other outgoings.   In fact he is initially making a surplus and has now decided that he has sufficient exposure to the property market in his investment portfolio and will spend this in other areas.   With the increased rent over the ensuing years, and due to the fact that  interest payments are fixed, the surplus increases over time which  increases his return and enables him to live a comfortable life.  

Assuming 10% compound capital gain the property values rise as follows:

Year 1-   $441,156

Year 2-   $485,271

Year 3-   $533,799

Year 4-   $587,179

Year 5-   $645,897

Year 6-   $710,487

Year 7-   $781,535

Year 8-   $859,689

Year 9-   $945,658

Year 10-  $1,040,224

Year 11-  $1,144,246

Year 12-  $1,258,670

Year 13-  $1,384,537

 Step 3

He sells one of the properties and pays the $320,000 back to the lending institution. 

His Net Property Worth has therefore increased to $1,064,537  ($1,384,537 less $320,000) based purely on capital gain he has achieved. 

His actual return on the investment has in fact been much higher than that as he has been achieving cash flow surpluses in latter years. 

Thus,  in this example, he has converted a $20,000 investment of his own money to in excess of $1,000,000 in 18 years.    He could have in fact achieved this a lot quicker if he had borrowed to purchase more properties in Years 6- 18.

ADVANTAGES OF INDIRECT PROPERTY INVESTMENT 

              For those investor's who do not wish to encounter the possible problems of direct management of property Indirect Property Investment is an alternative. 

              Managed Funds are a type of Indirect Property Investment.   Their features are: 

***    management by experienced managers who have specialist knowledge. 

***   benefits of diversification due to the acquisition of stakes in a number of properties and/ or property companies. 

***   enables investors to partake in investments with a small monetary outlay in comparison to the larger outlay necessary for direct property investment.    

***   holdings are tradable quicker than direct investment i.e. more liquid. 

***   time and knowledge- an investor restrained by time and knowledge is able to choose a manager to act on his behalf. 

***   performance  information-  values are produced  regularly and prices available quickly. 

***   should be regarded as medium to long term investments and are particularly suitable for:

-  someone intensely interested in money making opportunities.

-  investors wanting to relieve themselves of the demands of managing their own investments.