My partner and I have our own home at the moment with a sizeable mortgage, and we're thinking of starting a property rental portfolio.
We've been told that it works best to have a few properties, rather than just one or two. Would you be so kind as to give us your opinion on building a property portfolio?
How's your risk tolerance? A move like this could make you either wealthy or bankrupt.
If things go well, you benefit from growth not only on your investment but also the money you've borrowed. More than a few people have retired young on the back of rental property. But they're the ones we tend to hear about. The losers don't talk about it.
There's skill in property investing, which comes from getting to know the market. There's also a lot of luck - something that some successful property investors won't admit. You could win or lose on property price trends, rent trends, luck in your timing of purchases and sales, availability and reliability of tenants, whether properties need unexpected maintenance and so on.
Buying several properties does spread your risk, especially if you buy different types of property: units as well as family homes; inner city, suburban and rural; and in different areas. While having a geographic spread makes it harder to watch over your properties, price slumps or tenant shortages don't necessarily happen in all markets at once.
You can also reduce risk by spreading your purchases over time, so you don't end up buying everything at a price peak.
One downside to buying several properties is that it takes considerable time and effort to keep everything well maintained and running smoothly. Some people make it their fulltime job. You can always hire someone to manage the properties, but that eats into your profits.
Another major downside is the big borrowing you'll have to do. Given your large mortgage, I'm assuming you won't have savings to use for deposits.
Mortgage adviser Karen Tatterson of Loan Market points out that, in most cases, to get a loan you need to have at least 20 per cent equity in your total property investments.
Let's say your current "sizeable" mortgage is $600,000 on an $800,000 home. Your $200,000 of equity is 25 per cent. You could perhaps borrow $200,000 for a second small property, bringing your total mortgages to $800,000 on properties worth $1 million. Your equity would then be 20 per cent. But that would probably be your borrowing limit.
If your mortgage is smaller than that, relative to the value of your home, you've got some leeway. But still, the more you borrow the more vulnerable you are.
For example, say you find yourself with properties totalling $3 million and mortgages totalling $2.4 million. If property prices fell by more than 20 per cent, your debt would be bigger than the property values.
That's sometimes called negative equity. And you only have to look around the world - or even a few decades back in New Zealand - to know that it can happen.
You can live with negative equity if everything goes well. Hopefully, after a while, property prices will recover. But I suggest you work through some bad possibilities.
For example, with large mortgages, it's likely the rent won't cover the expenses - including mortgage payments, rates, insurance and maintenance. So you'll have to contribute other money. Could you cope if one or even both of you lost your jobs - assuming you are both working? Or some tenants didn't pay rent for a period? Or you couldn't get satisfactory tenants for a period?
Then there are nightmare scenarios. What say you discovered a property was being used as a P lab and it had to be decontaminated - and even after that it was hard to let or sell? Or tenants trashed a property. Or a house turned out to be leaky and it cost hundreds of thousands to fix it?
In any of these situations, if you found yourselves forced to sell a property, you might have to accept a low price. Sometimes people end up with no property and still a debt to the bank.
Still like the idea of a property empire? If so, maybe you've got the guts to give this a go. You could well be writing to me in 10 or 20 years to say you're worth millions.
But I strongly suggest you get your home mortgage well down before you embark on this adventure.
I'm presently negotiating with my employer. Can it pay more than the minimum employer contribution amount into KiwiSaver? I contribute 8 per cent and would like it to up its contribution to 5 per cent.
Yes, an employer can pay any amount above the minimum 3 per cent of your pay into your KiwiSaver account. And anyone else can also contribute any amount. Good luck with the negotiations.
Legal title of assets
Being a novice investor, I decided to go to one of the better known and well recognised investment companies, Craigs Investment Partners. It has been very helpful and I'm pleased with the performance of my portfolio.
The shares are held on my behalf by a subsidiary of the investment company, which assumes legal title of my assets while I have "beneficial ownership". However, a friend asked a question which has left me wondering - who actually owns the shares, and what would happen if the investment company went bankrupt?
The subsidiary is regularly audited and has professional indemnity insurance. While this sounds good, I am very aware of the problems with finance companies in New Zealand and around the world where people were sure they had all the safeguards and were assured by their company that their investment and shares were safe.
So do I need to actually hold share certificates to prove that I own the shares? Do I actually own the shares? What would happen if the company and/or its subsidiary did go bankrupt? Are there any risks in such an arrangement?
Good questions, with less than simple answers, I'm afraid.
Asked who owns the shares in your situation, Stephen Jonas at Craigs Investment Partners replied: "The name on the share register is the nominee, for example Custodial Services Limited.
"The holding against the nominee is usually a pooled holding, so the holding may include shares of more than one client. However, the nominee holds the shares as a bare trustee, so the client is the beneficial owner and retains all ownership rights - for example, entitlement to dividends or distributions."
On to your next question: what would happen if the company or subsidiary went bankrupt?
"As the shares are held in trust by the nominee, they do not form part of the assets of the nominee," says Jonas. "If the nominee went bankrupt the shares are not available to repay any debts of the nominee. During a liquidation of the nominee, the shares would be transferred into the name of the individual clients who beneficially own the shares."
Sounds comforting. And Jonas adds that Craigs is regulated by the New Zealand stock exchange.
Furthermore, the Government is doing much more than it used to in this area. The Financial Markets Authority (FMA) notes that brokers are required to act with skill, care and diligence when handling client property. "We have been monitoring custodians and brokers and produced a guidance note to help the industry understand their obligations."
An FMA spokesperson adds that new regulations are about to come into effect in December. "These regulations mean that the custodians are regulated independently, over and above regulations governing brokers' obligations. These allow for additional controls for investors and additional reporting requirements to investors."
Still, he says, transferring shares in the event of liquidation would be a lengthy process, "quite onerous and potentially expensive". There would be no quick fix.
In the end, no investments come with absolute guarantees. If you're losing sleep over this, you could buy all the shares directly yourself, through Craigs. This is easy to do with New Zealand shares, but somewhat more complicated with international shares, says Jonas.
And the international complications don't end with the purchase. It's much easier, on an ongoing basis, to own international shares through a nominee account. "The nominee processes any corporate actions - for example, spinoffs - and receives and processes any distributions, such as dividends and bonus payments, on behalf of their clients," he says.
"The nominee service also simplifies the sale of shares, which can be particularly time-consuming and expensive for overseas shares." If the sale happens after you die, it can get quite messy.
Ultimately, though, it's your choice. Oh, and by the way, even if you own the shares directly, you'll no longer get paper certificates for New Zealand shares, and certificates are also being phased out in other countries. But it will be your name on the registries.
Lending to children
*Note: Inland Revenue has since acknowledged it made an error in its response to this Q&A. See next week's column.
I hate to say it but I think you are wrong in your last column, in the first Q&A about parents adding to their mortgage so they can lend to their student son.
Quote: "On the tax issue, an Inland Revenue spokesperson says, 'If someone lends money and charges interest, they will have an obligation to disclose the interest payable as taxable income.'
"This seems rather unfair when the lender is adding to their mortgage to make the loan, given that mortgage interest paid isn't deductible in this country - unlike some other countries. But it's the law."
I think it is deductible. There have been cases stating that the deductibility of interest is determined by the use to which the borrowed money is put.
If the parents on-lent at the same interest rate, then they may receive, say, $2000 interest in and pay $2000 interest out. Taxable profit . They may have to put in a tax return to show this.
Another reader made much the same point as you, but Inland Revenue doesn't agree.
"Interest on money borrowed in deriving assessable income is deductible under the general permission in section DA 1 of the income Tax Act," says a spokesperson. "But it is worth noting the private limitation in section DA(2) applies, and a deduction for interest incurred is denied, if the money is borrowed for private purposes."
What does that mean for average parents lending to their average student son? Because the parents have a personal relationship with the child - or for that matter a friend - any interest they pay if they borrow to lend to the child or friend would generally not be deductible, says the spokesperson.
She adds: "We recommend that a person should seek professional tax advice if they are unsure whether a deduction for expenditure is allowed in their circumstances. There can be many variables that affect the deductibility of interest and other expenses incurred."
• Mary Holm is a freelance journalist, member of the Financial Markets Authority board, director of the Banking Ombudsman Scheme, seminar presenter and bestselling author on personal finance. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary's advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to firstname.lastname@example.org or Money Column, Business Herald, PO Box 32, Auckland. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice.