Archive for November, 2007
I want to add a little bit more to my previous blog on whether to go for capital growth or equity as your property investment strategy? Before I go on I will say that this is my opinion and the right strategy for you will depend on a number of things. Particularly early in your wealthdevelopment you are going to need good cashflow - if you don’t have this from your job or Business then you will need this from your properties.
Timewarp to 2002 – triggers to me starting investing
I had read Andrew King and Lisa Didson’s best-selling book The Complete Guide to Residential property Investment in New Zealand, and Dolf de Roos and Jan Somers’ book Building Wealth Through Investment Property. I went as a guest of a friend’s parent to a couple of APIA, listened to property investment accounting guru Mark Withers talk on tax savings from property investment, and since I was a young corporate solicitor in what was then the top law firm in New Zealand I was on the top tax rate. Some family and family friends were investing in property, I had helped my grandmother for years drive to collect rents from tenants and be her assistant property manager, so I knew it was time to invest myself. Having been to fund manager, sharebroker and property investment seminars the presenters were saying that only between 1 and 8% of people retire rich, most are dead or dead broke (and obviously statistics get a little bit distorted or mis-interpreted a fair bit to sell a story sometimes).
So I had enough positive affirmation to make the decision to buy property. I am delighted with all of the above that helped inspire to get me into property.
So I started looking in the property presses of Auckland, various papers, using websites and agents.
My $200,000 mistake (my case study)
Back in 2002 when I started my own direct property investing, I made a mistake. At the time I didn’t think so, but hindsight is a wonderful thing.
I had narrowed my selection down to two properties - one in the lower decile suburb of Manurewa and one in the exclusive subrub of Remuera:
1) a 3 bedroom house on just over 800sqm in Manurewa, to be auctioned with agent’s estimated price and vendor’s RV of ~$152K, rental appraisal $260/wk, owner occupied, that would benefit from a minor cosmetic renovation; or
2) a 2 bedroom unit in Remuera with less than 300sqm land, list price $250K sale by negotiation, rental appraisal $275/wk; owner occupied by an elderly couple in need a cosmetic renovation.
Options:
Manurewa house: After talking with the respective agents and attending the Manurewa house auction where I was the only non agent there, I made a bid at the auciton at the nice low price of $125K. This did not meet the vendor’s reserve so the auction was canned. The vendor’s reserve and requirement was in fact $140K as he needed to clear his Mortgage of $133K and play to relocate to Australia $6K and of course $1K legal fees. So $140K I was told would definately buy it. The property would cost $7K to renovate with professional assistance or $2.5K if I did it myself and with friends. The rental then would be $280/wk giving a 10% yield.
Remuera unit: I was told the vendor wasn’t very negotiable at all, the agent not revealing the vendors reasons to sell, apart from time to move on to a new place. They said $250K would buy it. The property would take $10K to renovate professionally or taking out the bits I could do $6K. The rental then would be $300 per week giving a 6% yield.
Which property would you choose?
Well I choose property 1 the Manurewa property - being very attracted to the yield. Cashflow is King right! I got myself a pre-tax positive property and thought I was very clever.
After my renovation the property was valued at a Massive $160K up from the $150K if I hadn’t touched it. In mid 2005 I still owned it and it was valued at just $175K.
Guess what the Remuera property was worth…
It sold two months after that registered date at $470,000. All it needed was paint, carpets and a new benchtop, so even if the asking (list) price was paid, $10K for renovating this small-medium sized unit, it still went up over $200,000. Allowing for the tax rebate this property was after-tax Cashflow positive.
Tired of my assigned property managers sadly hating their job managing South Auckland properties I had 7 property managers in this time, and rent arrears so I terminated their contract. I managed the property myself for a while and got bored of turning up to collect rent arrears and finding their 5 children aged from 2-9 years of age unattended. I asked the 9 year old where’s Mum, where’s Dad – I got told at the pub! Sadly after won of these big day’s out Jake the Muss put his fist through the mother face fracturing her skull. This didn’t help my rent arrears and I saw blood on the walls of my rapidly deteriorating home.
I rang Tenancy Services wanting to get an immediate eviction – but to no avail. They were not 3 weeks behind in rent! I had had enough and was pretty disappointed with project and managing it myself was rather stressful – so I changed my mind as I wanted to keep this property forever, and I sold it.
Look at my foregone equity – taking into account the nearly $150/wk after tax positive cashflow I made (interest rates were sub 7%), reno costs, but subtracting the lost rent and damage to the property that they couldn’t pay (they split up) I made less than $20K on this property. The Remuera property would have made more than $200K after allowing for the costs of reno and cashflow
So I cost myself $200,000 by going for the positive cashflow property.
Equity is King.
I now know what my Granny and parents know – that cashflow is nice, and is needed when you are starting out building a portfolio. But whenever you get a choice – choose equity.
Remember that when you have an equity portfolio you can choose to change to a cashflow portfolio (or even putting the money in the bank!), but try changing from a cashflow to equity portfolio straght away. You will not be able to do it as you will not have much equity and hit debt sevice walls with the bank straight away.
Conclusion
I conclude that not everything you are taught is right. Just because other investors do it does not make it right. Cashflow is very important and you must be able to meet your debt obligations. However once that is achieved then Equity is King.
Some readers may not like my message as I am directly seeking that they question their own cashflow strategy – however I want to say there are other strategies out there and I guess if I can help a couple of people reading this blog not blow many hundreds of thousands of dollars in lost equity as I did, my job is done.
As the sun shines we can look forward to a fantastic long kiwi summer. Lots of seminars have been on lately, including the Richmastery Property Academy, and the New Zealand Property Investors’ Federation Annual Conference (this year in Christchurch). These events have encouraged me to think even further about my investing strategies.
These were both magic events with a new line up of speakers to add further Interests rather than the same old people and content being rehashed, so that was good to see. It has been very busy time for me lately which has been exciting.
I took a 3 day weekend to recharge the batteries a little at the family bach on Waiheke Island it was sublime and is a truly special place for me to escape, relax and be in my element with my wife. I will show a couple of photos to give you all a taste of what gives me so much pleasure:
This was my view from our bedroom window at sunrise (I am sooo glad I got up early – but only because I was going on a kayaking excursion for half a day) – the northern coromandels and castle rock are shown here.
Here’s the jetty which provides an alternative form of access to this otherwise exclusive beach property.
Now for me showing off my new software package (ok it took me half a day to learn how to make this black and white when my brother in law can do this in 2 minutes – but at least I know now)!
And so as not to bore you too much more, here’s a view from the point – overlooking Rotoroa and Pakatoa Islands, Frenchman’s Cap and due east towards Coromandel township. Yup a truly special place for me to relax. A place like this gives you so much time.
So I did some thinking:
How important is cashflow? - Really?
I’ve been thinking a lot lately about my investment strategy and goal to have $500K secure passive residual income. I know I will do it – the question is when. I don’t want to wait until my parents live to 120 and die, my Generation X mentality wants it sooner than that. However I think I need to focus on capital now.
Then I got thinking as I like to visit my 89 year old grandmother who lives 7 minutes away from my home regularly. She has been through a lot living through the Great Depression in the early 1930s, WWII with its heavy restrictions on food and fuel, periods of high government intervention, high inflation and now to today’s modern economy. She is an investor, but is focussed on shares and managed funds, not property.
Background (can skip this part if pressed for time guys)
So a bit of background on her: she needs to pay costly rest home and pharamaceutical fees. She wants to live the good life and who can blame her for that so she is in a very nice rest home (Remuera Gardens). She likes to dress sharp and has an impressive shoe collection to rival my mum’s and Emelda Marcos , and she is a stylish dresser – pretty impressive for her age.
Just for the avoidance of doubt this is granny on the right hand side – my supermodel like wife Bridget is in pink.
It costs her around $60,000/year to live the lifestyle she chooses (of which a significant portion is for expensive market leading heart pills and top fees to cardiologists and her geriatrician to prolong her life and around 16 other pills for each day). For her cashflow is very important – without it she would have been dead, and not as happy. It would be frustrating for her to have to lower her living standards just because she is a bit older, so my grandfather (he’s not with us anymore) worked hard and granny seldom needs to dip into capital – basically only for operations that are out of reach for 99% of the population. Basically the Government has a policy of not paying for $150,000 operations on people in their late 80s (I think that is probably fair enough). Basically people simply die without access to a big stash of capital – so if you want to live longer you need capital too.
On talking to Granny she told me that she hasn’t worked since she gave birth to my uncle nearly 65 years ago! She got thinking too and we talked for hours about this over a sherry and shortbread . She came to the conclusion that she and Grandad never actually needed to work. Her father Sir George Sinclair was a seed merchant and this was eventually developed this into Yates, a leading NZ company.
In the Great Depression her family instead of having 12 servants cut it down to 8 as it was really tough times for Business back then. She had some nice inheritances (capital assets) in a large parcels of land in Auckland’s paradise that is Waiheke Island and other money. Her brother got a bit more and other Business Interests as wealth was traditionally passed down to males – with it being appropriate for females to marry men from moneyed families.
So by using my grandmother as a case study she is a millionaire now. She chooses financial assets like bonds, term investments, commercial paper, managed funds, shares from all around the world as her investments to pay for her lifestyle. She generally increases her capital every year through compounding of investments and the cashflow they provide gives her the $60,000 per annum she needs to live off. Oh better not foget that $13,200 or so dollars the government gives her as a taxable pension income - that is pretty special.
So whilst she didn’t have to save money she did – my grandfather was a top obstretician and gynaecologist – but worked for the government so it was harder to save in those days.
A new investment paradigm
So now that background is covered here’s the philosophy that I am starting to embrace now.
It is more important to have capital than cashflow. It is hard to come to this conclusion as other so called experts and market advisors in their seminars and books state “cashflow is king”. It is very important, but it isn’t king. “Capital is king” and will always be. Think about it – even if you are a below average investor and simply give $1,000,000 to a retail bank you will now earn around 7.5% or $75,000 per annum. Take income tax off this and you have around $50,000 to live off.
I have more than that 1 million dollars now, but consistently achieve compounding returns of over 30% on my money. Whilst I should probably set up my own managed fund, I will hold fire for now. But think if you want $100,000 pa to retire on, and assume a low Interest rate form a major retail bank or even safer government stock, you need just $2 million in equity. However I calculate that you would need around 20 average South Auckland properties to get this return. Then you get the admin that comes with it.
So what Granny and I think is the ultimate strategy is to have property, leveraged up in high capital growth areas. Leverage helps you get their faster (even though granny doesn’t believe in debt, I think it is important and not an issue as long as your capital growth exceeds your interest bill).
I will write more on this in future – I need to explain and cover off many more things for you to accurately see why – but this blog is jsut to get you thinking as I have been doing lately that you might not be employing the correct investment strategy for yourself.
Market thoughts
As for the market I have been talking to people in my network, parents and some in their network, heard from Tony Alexander BNZ Chief Economist at private client functions and ANZ Chief Economist Cameron Bagrie have all talked about the fact that take inflation out their is very little “real” growth in the property market at the moment and New Zealand has some economic challenges to look at.
Unemployment is actually only low because of the record number of people on sickness and other benefits to remove from this statistic and high number of government workplace enrolment schemes. But hey it is politics and when the current government likes to tell you how you must live you life in their system, they have to have some marketing points like “low unemployment”.
So the abovenamed people have me analysing the Treasury and Statistics New Zealand website Data a lot, and left me a little bit confused as to where we New Zealand is at. I am a numbers person mainly and have been wondering about the my portfolio, concerned a little bit about coming off hot sub 7% Interest rates and onto mid 9% rates – I have to admit it hurts a bit! Our productivity as a nation is poor. We need to remedy this – the quicker we do this the faster the prosperity for us all.
The thing is if you have enough capital, you can use debt as a buffer to live off. Michael Yardney discusses this concept in his book and although Granny has never had a loan, my parents have had them and still do for their investment portfolio and in times like this when Interest rates rsises mean hundreds of thousands more Interest costs per year, they simply soak it up through revolving credit accounts and sometimes revaluing a property up to allow them trips to Europe and other places they like visiting abroad.
So get thinking about yourself and the respective virtues of whether “Cashflow is king” or “Equity is king”. Granny doesn’t have much cashflow but she has a lot of equity – and if you could choose one to be strong in out of cashflow or equity which would it be?