Returns from property
Property has two types of potential returns. One is from rent paid by tenants and the other is from the property increasing in value – called capital gain.
Property investments are not considered to be ‘liquid’ because we can’t withdraw our investment quickly. To get money out we need to sell the property or increase the mortgage. This may not be easy – and there can be extra costs such as valuation and real estate agent fees.
People buy investment properties to make a long-term profit as prices rise. In the short term there may be little or no profit from rent after expenses like mortgage, insurance, rates and maintenance are taken into account. And if we sell within 10 years of buying, we will also have to pay income tax on the sale. (This is called the 'bright-line property rule'.)
How to invest in property
It is usually harder to borrow money for a rental property than for our own home. Some lenders may have lower lending limits for investment properties. As with ordinary home loans, lenders will look at what we can afford to repay when we're borrowing for investment property.
Some lenders and mortgage brokers have particular expertise in lending for investment. See our guide to getting a mortgage for more.
Risks of investing in property
Property investment is often described as ‘safe as houses’. Yet there are risks, for example:
- A lender can ask us to repay the mortgage unexpectedly and we may not be able to sell, or sell for enough to cover the mortgage.
- If the investment property is mortgaged with the same bank as our own home, there is the risk that the bank could sell both properties if we run into difficulty with paying either mortgage.
- We might need, for some reason, to sell the property at a time when it has dropped in value, and be left still owing the lender money after the sale.
- Interest rates may increase, so the money we make from the property is reduced.
Paying off the mortgage as fast as we can reduces these risks.
How much work is involved?
Property investment usually involves more work than saving money in the bank or investing in shares and managed funds.
Most investors spend a lot of time looking for suitable properties to buy, finding and managing tenants, and arranging for maintenance work to be done.
A property manager can do some of this work in return for a percentage of the weekly rent. The manager will take on the tasks of finding tenants, collecting the rent and bond, and dealing with maintenance issues and tenant communications on our behalf.
Other ways to invest in property
As well as buying property directly, we can also invest in managed funds that buy and sell commercial property. These funds may own properties such as office buildings, factories and shopping centres directly, or they may own shares in other funds that own the property (known as property securities). Investors receive income if the managed fund makes a profit on rents it receives, or sells the buildings or shares at a profit.
We can also receive a capital gain if the fund price has risen by the time we sell.
Property funds give us the advantages of property ownership without having to find the property and do the hands-on management ourselves. They also make it possible for small investors to own a diversified portfolio of commercial property, which has a different cycle of ups and downs to residential property.
With KiwiSaver, many funds have commercial property as part of their investment mix.
Property syndicates are another way to invest in property, although these have a different legal structure to managed funds and can be riskier. The Financial Markets Authority website has more on these.