Agony Aunt: Pitfalls in property

Dear Janine,

We are a couple with no children, mortgage free and wanting to know what we should put our money into for later. Should we buy a rental property or shares? What is the best place for our money? We are also interested in buying a house with our parents (with us owning a share and buying out the full share at a later date). We don't know the tax pitfalls or gains from this.

ANSWER:

Being mortgage free is the financial equivalent of having the wind in your hair and the world at your feet. You are in a brilliant position to crank up the savings machine.

Rental properties are one of the first things Kiwis tend to consider, and yes, they've done well for us in the past. They've roughly tripled over 20 years and doubled over 10 years. But don't get too fooled by the sugary returns of the past. Growth tends to be lumpy and if you pick that sweet spot where prices take off like a rocket, you're quids in. If you don't, it's a long hard grind and a lot of hassle. We bought our first flat in the early 1990s. In 2000, we had it valued only to find it had fallen $5000 in value (and the tenants had thrashed it). A tidy profit was made a few years later, but it's a reminder that you can go eight to 10 years in the property market and achieve little.

Right now property investors seem to be sitting on the sidelines. I think they know we're in for one of those eight to 10 year sideways patches where prices might creep up a little, but not by the standards required to be a great investment. Owner occupiers will keep buying and selling, but landlords probably won't add to their holdings. Things are out of synch still and my own gut reaction is there's no compelling reason to leap in (given there are other investment options). But you need to do your own numbers. Get on the calculators on sorted.co.nz.

To show you why it looks marginal to me, here's a back of the envelope example. You buy a rental for $350,000 and borrow the full amount. Two-year fixed rates are about 7.25 per cent per annum, but let's use 8.25 per cent to allow for fluctuations in the future. A 20-year mortgage has fortnightly repayments of $1375 - a smidgeon under $700 a week. Will you get that amount in rent? Heck no, you'll be lucky to get half (we'll ignore agents fees). It leaves you paying half the mortgage. Over 20 years, you and the tenants will have paid the bank a total of $715,000. When you tot up your own contribution of $350 a week, it's over $18,000 a year. Then you've got to allow for rates, insurance, maintenance and periods of no rent. We'll be kind and estimate $5000 a year (that's tight, as a few weeks lost rent will chew it up). You'll end up subsidising the rental by $23,000 a year from your own pocket. If you put that cash into a boring old term deposit and averaged 4.5 per cent net, you'd have squirreled away $725,000 after 20 years. This is an option that doesn't involve paint jobs or tenancy tribunals.

If you can get $725,000 from a bank account, then that becomes a benchmark for making a decision on the rental. If house prices triple over 20 years as they've done in the past, your $350,000 rental will be worth over a million and leave the bank account for dust. But we've had a world credit crunch of catastrophic proportions, so it's a big call to think that history will simply repeat. Right now, I think you'd be lucky to come out even, but it's a decision for you to weigh up.

If you choose riskier investments, there's a chance you could do even better. For perspective, over the last 20 years New Zealand shares have gone up 115 per cent and Aussie shares 443 per cent (in Aussie dollars). These numbers are from the MSCI Indices with net dividends reinvested. Don't forget international shares in the mix - they've gone up 178 per cent (in New Zealand dollars). I've not included dividends in that number as they tend to be low or wiped out by a fee. Our own sharemarket isn't flash, but a good broker will turn a better result than an index.

You mention tax pitfalls on property - yes there are many and everyone is waiting for the new rules to come out in the Budget, so hold fire. Depreciation rules look set to change, maybe ring-fencing of losses and closer monitoring of vehicles such as LAQCs. But the major bleating is coming from a proposal to tax property at a fixed percentage of the equity you have in it. For example, if the government decided to tax you on 5 per cent of your equity and you had paid off $200,000 of a rental, you'd pay tax on $10,000. That's $3300 for the year, if you are a 33 per cent taxpayer. I'm biased on this one and think they should do it. They already run a similar system for offshore shares. It evens out the landscape and won't apply to your own residential home.

If you go into this with your parents, sit down and discuss every eventuality. What do your parents get out of this? If it's parental-charity, is it fair on siblings and will it raise their hackles? What is the plan if you can't afford to buy them out? What if they die, who inherits their half? Square off these issues and the ride will be smoother. It is worth taking the time to sit down with an adviser.

Janine Starks is a financial commentator with expertise in banking, personal finance and funds management. Opinions in this column represent her personal views. They are general in nature and are not a recommendation, opinion or guidance to any individuals in relation to acquiring or disposing of a financial product. Readers should not rely on these opinions and should always seek specific independent financial advice appropriate to their own individual circumstances.