The Situation

I met Alexandra three years ago. She owned her own home and two investments back then – one in north Auckland and one in Tauranga. Since then, she’s invested in three new builds over two years. These properties will continue to have interest deductions as part of the Government’s new regime.

Before reviewing her portfolio she owned five investment properties in total – a very good-sized portfolio. She wanted to analyse her portfolio so she could: a) set a plan to slow down working and b) get rid of her personal mortgage.

The Issues

Before the interest deductibility changes, Alexandra’s portfolio was predicted to earn positive cashflow of $156,000 over the next 15 years. That’s just over $10,000 per year. But under the Government’s new tax rules, that portfolio was forecast to be negatively geared by $46,000. That’s a massive $200,000 difference, totally driven by the additional tax the two existing properties will soon pay.

But if existing properties are high yielding enough they can still earn positive cashflow.

However, in this case both properties were severely under-rented. That’s because the rents had not been kept in line with the market rate. Low yield is probably tolerable when the properties are making money, but once the cash flow turns negative — $200,000 is a lot of pain.

The Changes

After reviewing the numbers we decided to sell the Tauranga property. That will free up just under $600,000 since the property is worth $910,000 and has a $315,000 mortgage.

She’ll then use the proceeds to pay off her personal mortgage, which was her goal.

Alexandra will then use any leftover funds to purchase another new build in Auckland and claim the tax exemptions. As part of the portfolio analysis, her property manager will bring the North Auckland property’s rent up to market level to increase the yield and limit the negative cashflow.

In three years she’ll add one final new build to her portfolio, investing for long-term capital gains.

The Impact

Because the investor is taking equity out of the investment portfolio to decrease personal debt, her overall LVR across her investments will increase. So, while she won’t have to make payments against her personal mortgage — her mortgage payments relative to her rents will rise.

That does mean that her portfolio will still be negatively geared by $66,000 over the 15 years. However, she’ll redirect those funds into the investment portfolio because she won’t be making payments to her personal mortgage. In effect, she’ll pay less money into her properties than would otherwise be the case.

Whether for your own home or holiday home, personal mortgages stop you from borrowing more than investment property mortgages do. That’s because investment properties have rental income that offset the debt repayments when the banks calculate servicing. So, paying off the personal mortgage helps improve bank servicing, which means borrowing more. Based on the 15-year projections, Alexandra should have just shy of $4.5 million in equity (adjusted for inflation).

Based on a net yield of 4%, this investor will be able to achieve an annual passive income of $180,000 in today’s money. This will allow her to retire early at 55, with the property portfolio supporting her lifestyle.

The Lessons

There are three main lessons property investors can learn from this:

a) When the tax system changes it’s OK to sell one property to buy another as long as you do so understanding the numbers and it makes sense.

b) In some cases, it’s also OK to sell an investment property to pay off your personal debt. If that’s the right move for you, you can then re-leverage against your own home, purchase another property and stack the mortgage against the tax deductible investment.

Disclaimer: Just remember this is a column in a magazine that goes out to thousands of people, so this is not personal financial advice. But it is an example of what happens when you get financial advice. So if you’d like some advice, come and see me. At Opes, we do a portfolio analysis for $999 incl GST. Email Andrew.nicol@opespartners.co.nz to book.