Is Property Investment Suicide? Part 1

We’ve all seen the affects real estate has had on our respective economy. With Western economies becoming increasingly reliant on real estate, its becoming all too true that the only thing left of value in this western world is the land that we own.

I recently revisited the idea of buying into real estate after rebutting and denying the effects real estate has had on our economy and its dominance in our everyday lives. In New Zealand especially it seems to be the only topic of discussion:

“Why are we so willing to give up our land?”

“Sell the milk not the cow!”

“Foreigners are stealing our land and our jobs”

“Housing prices and rent are on the rise AGAIN”

“McDonalds needs to bring back the McRibb” – ok that’s one of mine but still relevant… to my stomach.

Many people I’ve spoken to have had some kind of interaction with real estate from the millennial trying to buy their first house or a property guru making their 7th property investment. The number of interactions involving real estate is mind boggling. But you aren’t here to hear me rant about people. You’re here because you want to know what my title is all about.

What I am hoping to communicate to all of you is that property is a GREAT investment … for a small % of you. For the rest of you there are probably better investment opportunities that you should probably consider.

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What?

Some house keeping. I had to make some assumptions in my analysis for the below. I assumed that the mortgage rate and any alternative investments are the same, 6% per year and that everything is compounded yearly. I assumed rent was $470 per week (pretty high but its what I pay) and that the value of the property was $600k with a 20% down ($120k) – probably the price of the property I’m renting based on my recent searches on TradeMe.

Let’s get into it. There are a couple of types of people to consider:

The Home Maker

These are individuals that don’t see property as an investment vehicle but as the next stage in life. These individuals typically buy to live, only own one property and take out that 30 year mortgage to also allow them to enjoy life while also being able to pay for their home.

my-home-14

At the end of 30 years they’ve just paid $1.034M for your $600k home.

There’s no point doing a what if analysis for these people because they aren’t in it to invest they value the security of having a home if things turn for the worst and there’s nothing wrong with that.

The Property Newb

firsttimehome

Young professionals that hear something on the news or have went to a couple of seminars about property investing. Fresh to the game they have a vague idea of mortgages, interest capital gains and investing but nothing too in depth or any practical experience. They’ve rationalised that they want to invest and property seems simple enough. Buy, maybe rent or sell at a good time. Property newbs don’t have enough capital to own several properties so they typically put all their eggs into one property and might have also asked for parent consignment on the mortgage. They opt for a 30 year mortgage, perhaps even an interest only mortgage so they can maintain their quality of life while owning a piece of the action.

Scenario 1: The interest only mortgage payers

You’ve paid 20% down ($120k) and are only paying the interest portion. You are building 0 equity and lets assume you rent your property out ($470/week) to help with the interest payments. Your goal is to sell at a gain. Your mission, unbeknownst to you, will be to sell at a large enough gain to make all that interest back plus a little bit extra to say that you came out on top. Let’s take things one at a time – how much do I need to sell my property for to breakeven with my interest payments?

This is what you want:

Required gain on sale = ∑ of all interest payments

Let’s say you hold it for 2 years and then sell:

Your property needs to sell for $608,720. Easy!

No one to rent your interest only property?

Your property needs to sell for $657,600. Again, doable.

Here’s a graph of how much you need to sell your property for the longer you hold the property for no rental income.

Property 1

Obviously the longer you hold your property for the higher your property price will need to be to make up for all that money you shelled out in interest. Keep in mind that you still haven’t made any money just broke even.

Scenario 2: Fixed rate mortgages

Same numbers but you’ve opted to gain some ground on the bank and increase your share of the house. You will need to contribute more; the principal portion.

Let’s begin with the ability to rent your house to cover part of your mortgage payments and a sale at the end of 2 years.

Your property needs to sell for $608,012 if you have rental income and $669,180 if you don’t.

Property 2

Again, you haven’t made any money just broke even with your investment. The difference between interest only and fixed rate is the compounding principal payments you’ve been paying.

I’ve just painted a pretty rosy picture in favour of buying into this property debacle but as with all epic novels the Hero of the story is about to run into some trouble. Stay tuned for the next blog to find out what happens when we want to actually make money off our investment and when we pit property against other investment options available. I’ll also cover off our third type of investor the “Property Guru”.

What do you think about investing in property? Is it for everyone? Is it worth the hassle? Any good/bad stories? Let me know in the comments. Also, if you have any questions about the calculations or about other investment options available in NZ let me know. I’m always happy to help.

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