Tony Brazier

www.braziers.co.nz

Tony Brazier

The Press - Tuesday 19 May 2009

Crunching the Numbers

Now that you’ve decided to invest in residential property, completed your homework, found and inspected the premises, then it’s time to crunch some numbers.

The question is, just how far do you go with analysis. Many buyers are just happy to know the gross return so that they can compare simply to other gross returns. Others expect Return on Equity figures. Yet others will insist upon including depreciation and tax rates to get a more precise picture. Then there are those semi professional landlords who wish to see a discounted cashflow and an Internal Rate of Return.

The truth is too many budding investors analyse themselves to a standstill. Keeping it simple is best. Having said this if you challenged most investors, and sadly some salespeople, to prepare a good financial reason as to why they should invest in property they’ll fall back to the old cliché, “You can’t beat bricks ‘n’ mortar”.

That wont cut it with the Gen X and Y investors coming on stream. They like facts.

Firstly the gross annual return (ie, weekly rent times 52 weeks) is often compared with deposit rates in the bank and can fall short when all outgoings like rates, insurance, vacancies, management and repairs are deducted to give the nett return. The bank deposit rate can indeed look better. However the bank deducts tax before the depositor has any chance to use the money, whereas the investor can deduct the cost of all of those expenses mentioned above and more. This is, in effect, more income created for the bottom line by being able to claim tax off the property’s and the owner’s other income. Hence the nett return increases.

Add to this the ability to claim depreciation on the building and the chattels, that the tax department offer as fair wear ‘n’ tear, and the tax deduction claimed against the income is even greater on an annual basis. (Our tax laws are amongst the fairest in the world and encourage NZ citizens to provide accommodation for others). Hence the nett return increase.

But it doesn’t stop here. Add to this the fact that over the decades the various types of residential investment properties have growth compounding by 9%-10%, (not right now admittedly,) then we need to also consider the benefits beyond the nett return annually and analyse how the money (cash) invested to buy the property has grown in value since bought.

For example if only $10,000 was invested in cash and the rest put up as security against one’s home, by the time the investment property value has grown by $10,000 more the investor has a return of 100% gross on his input. Hence the nett return on equity increases.

Ultimately the best way to see how your investment works is in hindsight. However projecting forward, say five years, with the growth rates, interest rates, depreciation rates and costs, then analysing it as if that had all happened, this can give us a way of determining how the actual cash we invested worked for us over time. The fewer dollars we put in the more each of those dollars works for us.

In this ‘machine’ the return on each dollar invested for us can be phenomenal over time.

Negative gearing is when you must contribute money annually to make the investment ‘machine’ work. This is not for the faint hearted and is not appropriate in a dropping market, however it is good for those paying lots of tax who can ‘top up’ the investment to enjoy the other benefits.

With all of the above ingredients to consider, investing is like creating a recipe to produce your own outcomes. Will I put in cash? Will I spend on renovations? What rent increase will I get? How does this affect the value? When can I revalue and buy again?

It is easy to see why some experienced investors place far more emphasis on the numbers the property creates than on passing the inspection which often is only done to see that the property actually exists, and can be better done by various professionals anyway.

At the end of the day property is a medium to long term investment. Currently we’ve had nine years forward, two years back. Now is the time to analyse, create your recipe, plan for worst case scenarios and look medium to long term. History tells the property investor, “We’ll be back.”