The Situation

Derek is a successful businessman. He and his wife Jess own four Christchurch- based rental properties, all four considered “existing” under the new interest deductibility tax rules. So soon they’ll pay significantly more tax.

They plan to start a family in the future and will potentially go down to one income when that happens.

Because of that the couple wants their portfolio to remain positively geared even after interest rates rise and the new tax laws are phased in.

The Challenges

Without the new tax rules, their portfolio was forecast to generate $170,000 in cash flow over the next 15 years. That’s even after accounting for higher interest rates.

However, with the new tax laws a reality, their portfolio (as it stands today) will be negatively geared by $111,000 over the same 15 years.

For Derek and Jess, the tax changes mean paying $281,000 extra to the I RD, with $111,000 coming out of their own pockets.

Faced with this reality, Derek and Jess needed to make some changes since they wanted their portfolio to be positively geared.

The Changes

Because cash flow is a big concern, their first step is to decrease their non-tax- deductible debt.

They plan to sell two of their existing rental properties to do this. They’ll then use the money to pay down the mortgages on their other current rentals.

They then decided to replace these properties with new-build investments, which are exempt from the government’s tax changes. Since all their properties are currently in Christchurch, they wanted to diversify and decided to purchase in Auckland.

They first purchased a 3-bedroom townhouse based in West Auckland. This was followed by a dual-key apartment in Ellerslie.

Dual-keys are a unique property type where two apartments are placed on the same legal title. Effectively that means 2 apartments in 1. These tend to earn better cash flow, but grow in value more slowly.

Finally, they’ve decided to invest in a South Auckland townhouse. When we looked at it, the property had a registered valuation of $1.24 million, but was priced at $999,000, effectively a $240,000 discount. So, the property was purchased undervalue.

How did they get such a good deal? The developer needed to sell the townhouse so he could get the development underway. The developer was happy because he could get on with the project. Derek and Jess were happy since they made significant instant equity by buying undervalue.

The Impact

Through these changes, the 15-year cash flow moves from minus $111,000 to positive $106,500. That means they can start a family, go down to one income and not worry about topping up the properties from their personal incomes.

On top of this, their portfolio will grow from four investment properties to five.

And the value of their properties has also increased. Instead of $2.1 million of assets with $1.2 million of debt, they’ll have $4.15 million of assets with $3 million of debt.

So, by changing their portfolio composition, they’ll improve cash flow and have significantly more assets.

As the property market increases in value the capital gains will be more significant since they’ll own higher-value properties.

Based on my projections, they’ll have $5 million worth of net assets in 15 years, rather than the $3 million they were on track for before the changes.

The Lessons

• Selling one property to buy 1 or 2 more can often be the right decision in today’s market. That is especially true when you sell one property with poor cash flow and redeploy the money into a better cash flow property
• If you already own several properties in one city, it can be a good idea to diversify and buy properties elsewhere. This is because property values increase at different times around the country, so diversifying helps you keep a foot in both races
• There are some serious deals to be done in today’s market, especially with new builds. This is because developers are finding it harder to sell their properties and are willing to negotiate. These investors snagged a deal because their finance was sorted, and they made a quick decision.

In all my columns, I mention creating 15-year cash flow projections. You can download the spreadsheet I use — minus a few unique features — here: opespartners.co.nz/roi