What’s all the noise about property

by Shawn O’Grady
3 Minute(s) to read

What’s all the noise about property

So you are asking why has property investing become the preferred choice over the more traditional form of savings, let’s look at the illustration below.

Bear in mind property investing should be regarded as long term investing. The assumptions used I’ve got from Q V, Interest.co.nz and Tenancy Services.

Savings

Let’s assume you have $250,000 that you want to invest. Suppose you were to deposit this in a bank account. Let’s also suppose it was your lucky day and you locked the money up at an interest rate of 4%.

INVESTMENT = $250,000

INTEREST EARNED = 4%

INCOME = $10,000

Now let’s assume you are on an income tax rate of 33.00%, this is the top tax rate for individuals in NZ.

TAX PAYABLE = $3,300

NET INCOME = $6,700

NET RETURN = 2.68%

Or, put another way … 4% less 33.0% tax = 2.68%

This isn’t the end of the story. Let’s now assume INFLATION to be running at 1.5%. Our net return after inflation is therefore only 1.2%.

That’s a 1.2% return after tax and inflation.

Property Investing

So let’s now look at how you’d fare if you took that same $250,000 and bought a property instead of putting it in the bank. Again, for the sake of comparison, we will make a few basic assumptions. Let’s assume the $250,000 property represents fair value in Stokes Valley. Let’s also assume this property returns a very conservative rental income of $325 a week. How do the figures now look?

INVESTMENT = $250,000

INCOME (Rent of $325 per week) = $ 16,900

Now let’s again assume you are on an income tax rate of 33.0%

TAX RATE (assume no deductions) = $ 5,577

NET INCOME = $ 11,323

Now we need to make another very conservative assumption, this time on the rate of capital growth Wellington is slowly growing at 1.6% (much lower then the average 3.

CAPITAL GROWTH (1.6%) = $ 4,000

TOTAL NET INCOME = $ 15,323

If we were to now look at our after tax return on equity, we get a respectable 6.13%.

If you own your own home outright, please reconsider your thinking, as it amounts to throwing your biggest asset away in the rubbish bin. The major advantage Real Estate has over other investment strategies is the ability to leverage a small amount of capital into a large investment.

Again, let’s see how the figures would pan out if you purchased the same $250,000 house, at fair value, but this time leveraged with 80% finance (Meaning cash down of only $50,000). Let’s assume you secured the loan at an average interest rate of 5.5%, and that, once again, you were to receive $325 a week in rent from a tenant.

DEPOSIT = $ 50,000

BORROW = $200,000

INTEREST PAID (5.5%) = $ 13,420

INCOME (Rent $325 per week) = $ 16,900

PRE-TAX Cashflow = $ 3,480

CAPITAL GROWTH (1.6%) = $ 4,000

NET TOTAL RETURN = $ 7,840

To calculate your after tax return on equity, you work this out on your capital invested, which in this case is your deposit.

AFTER TAX RETURN ON EQUITY = 15.68%

By Dennis O’Grady

HAVE WE GOT YOU THINKING?

Give us a call on (04) 563 6965 or email: dennis@taxman.co.nz or shawn@taxman.co.nz

Keep an eye out for October’s article!

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