Time to ask if you're the landlord type

By MARY HOLM

Q: I should shortly be receiving my share of an inheritance that is held in an account in England.

It amounts to $225,000, and I'm wondering how best this money could be used to provide for my retirement. I am 35 now and will retire at about 55.

The thought of buying maybe two or three houses and then renting them out, so that the mortgage can be paid for me, does sound like a good option. But I don't know whether this makes financial sense in the long term.

I at present rent my accommodation, and am not interested in buying to live in, as I believe that it is not financially clever at the moment.

I am not averse to investing the money in the sharemarket, but already do that on a monthly basis and so feel I could deal with something else.

Who knows, if houses are a workable option I could expand in the future and give up my present day job to manage and upkeep the properties.

Would this theory work in practice? I have not lived in New Zealand long enough to understand the trends and workable options here.

Any light on this matter?

A: One of the strongest arguments against investing in residential rental property doesn't apply in your case.

Most landlords also own their own home. By buying other houses, they are not spreading their risk.

You, though, already have money in shares and none in property. So investing in a house or two has its merits.

You should still watch, though, that you don't end up with lots more in property than shares.

That way, you reduce the advantages of diversification. It might seem hard to believe lately, but there are periods when shares perform much better then property.

Another point: don't get too carried away with the line that your tenants will pay your mortgage.

It sounds great. But there's nothing magic about borrowing to invest in property. If you borrow to invest in anything, you raise your potential returns but also your risk.

Usually, with rental property, all goes well. But just a few of years ago quite a few landlords found they couldn't cover mortgage payments when they had no tenants for several weeks, or even months.

They ended up selling into a weak market, sometimes for less than the purchase price. I heard of more than one who owed the bank more than their sale proceeds. They lost their deposit, and then some.

Even if that doesn't happen to you, and it probably won't, keep in mind that you benefit from borrowing to invest only to the extent that your return, including capital gain, is higher than the interest you're paying on the mortgage.

While landlords with mortgages often do pretty well over time, they might have done better simply by putting the money in a share fund. And there would be a lot fewer hassles.

Which brings me to another point. Being a landlord can be a lot of work. Do you enjoy maintenance? You can always pay others to do it, but that eats into your profits.

You talk of possibly giving up your job and running properties full time. That's fine, as long as your returns are higher than returns on alternative investments plus the wages or salary you would have made in other employment.

In the end, I think, it comes down to personality. Are you the landlord type?

I suggest you invest in one rental property, without too big a mortgage.

Perhaps put the rest in a one-year or two-year term deposit. By the time it matures, you'll have a better feel for whether rental properties suit you.

If they do, get a second property. But do keep up that share investment, too.

There now. Have I forestalled another load of pro-rental correspondence? This was fairly positive, wasn't it?

* * *

Q: Reading your response to the 45-year-old male who had consolidated his property and invested his nest egg in a diversified share portfolio, which had not performed well, I reflected on my own experience.

At 45, flush with capital from a couple of good years in business, I bought a commercial property from which to operate the business. I was fortunate to be able to subdivide and tenant the other half of the building.

The next year I began investing in residential property, as our house was nearly freehold. Not a lot of money was required, and the first two houses I brought rose in value quickly.

I entered the local and international share market quite late and rode the high-tech wave. At one point I had increased my investment by 80 per cent.

However, along with most other investors, I could not bail out quickly enough and lost 60 per cent of my original $50,000.

So over the last seven years I have had a more diversified portfolio than you are suggesting: business, commercial property, residential property and shares.

Business is hard and competitive but provides rent to pay off its own property, which in turn provides security for the business.

Because of high taxes and compliance costs it is hard to increase the value of the business, and it is very hard work.

Commercial property is the outstanding winner as an investment. Our building has risen from $700,000 to $1,200,000 in seven years and the original mortgage is considerably reduced.

Residential property requires little money, but the yield is less and managing delinquent tenants is a problem.

Rental properties do not tend to rise in value as much as your own house in a good location. Our house value has doubled and the rental houses have risen 50 per cent in value.

Shares! Don't touch them.

A: Your conclusions are based on what, exactly?

One person's short-term experience in a type of investment that everybody says should be long term. Plus a single business, a single commercial property, a single home and a few rental properties.

Sorry if I sound sarcastic. I appreciate your writing. And everybody's judgment is, of course, hugely influenced by what has happened to them.

But your sample is far too small to teach us anything.

Another person with a similar line-up of investments could well report that their business is easy and highly profitable; the value of their rental properties has risen much faster than their home; and their commercial property has been a real dog. I've heard of plenty of examples of all those things.

As for the shares, it sounds as if you're a Johnny Come Lately. There are many people who have been in shares for more than 10 or 15 years whose investments have grown nicely.

Also, now is a peculiarly tough time to judge the merits of international share investment. A longer-term perspective is fairer.

Another point: you talk about not bailing out quickly enough. Don't even think about that! Heaps of research shows that people who get in and out of the sharemarket usually do worse than those who get in and stay in, through thick and thin.

If you've still got those shares or share fund investments, I urge you to keep them. The 60 per cent loss is real only if you sell. Given time, I'm sure it will turn into a gain.

Getting back to conclusions about which investments are best, I'm sticking with unbiased research that looks at many investments over many periods.

That shows that fixed interest is low risk with low average returns; property is middle risk with middle average returns; and shares are higher risk with higher average returns.

And if you hold a mixture, you can reduce your risk without reducing your expected returns.

As you say, you've done pretty well on diversification. And that's great.

Ideally, I would like to see you with more in shares. But I don't like my chances!

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Q: On Saturday, October 19 you convey advice from Craig Macalister of KPMG which appears to say that real estate commission is a deductible expense for tax purposes, when selling a rental property.

Are you able to seek clarification from Craig?

IR 264, Rental Income, on page 9, seems to contradict his views pretty solidly.

A: What's this? I thought I said no more questions on rental property depreciation for a while, unless they are truly fascinating. I'm a bit worried about what fascinates you!

Still, you sound worried. And so does another reader who asked for "the IRD reference authorising this". He adds, "I have been unable to find this in the IRD internet page."

So we'll do just one more Q&A on the subject.

The photocopied page you sent me has a heading, "Expenses that you can't deduct for tax purposes". Under that, it says, "You can't, for tax purposes, deduct capital or private expenses from your rental income".

A list of non-deductible expenses follows, including "real estate agents' fees and legal fees incurred as part of buying or selling the property".

Note, though, that this is about deductions from your rental income each year.

What Craig Macalister was talking about on October 19 is deductions from the sale price, when calculating depreciation clawback after you've sold. It is quite a different situation.

In IR260, Depreciation, under Disposals, page 100, it says, "Costs incurred in selling an asset, such as commission and advertising, can be deducted from the sale price before you work out the loss or gain on sale".

To get this publication on the IRD website, www.ird.govt.nz, do a search for "depreciation". Click on "An introduction to depreciation". That then leads you to the booklet.

You might want to print out only the bits you need. The whole booklet is 122 pages.

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