The Situation

Manu is very successful. He’s 37, and when we reviewed his property portfolio, he had 6 investment properties.

When we sat down for the review, he had two goals. First, he wanted to see how the Government’s interest deductibility tax changes would impact his portfolio.

But then his ultimate goal was to retire early and replace his income through property. That’s no small task, given that he’s a high-income earner and pulls in $350,000 annually.

For any new property investors reading this, bear in mind Manu is not your typical investor. Very few people own this many investments and earn that sort of money by 37. So if you’re not there yet, that’s normal. If you’re in a similar position, well done.

The Challenges

Based on our forecasts, over the next 15 years Manu was projected to have just under $7 million worth of equity. And his portfolio would be negatively geared by $216 per week before the tax changes.

Based on the rule of 4%, that equity would earn him a passive income of $280,000 by the end of the period. Really good, but not quite his goal.

On top of that, once the Government’s tax changes are fully introduced, his portfolio would go from $216 negatively geared per week to $300 a week.

This is a smaller change than most investors I work with would have. But that’s because a) he holds little debt against the affected properties, and b) half his portfolio was made up of new builds, which aren’t impacted by the tax changes for the first 20 years.

The Changes

First, Manu decided to sell one of his run-down Christchurch properties, worth $375,000. This had low debt, so we then used the money to pay off the mortgages on his other two existing properties that would soon pay more tax.

If there’s no debt on the properties, there’s no interest to pay and no impact from the tax changes.

Manu then bought a new build townhouse in Auckland for $900,000. This is a more valuable property than the one he sold, which means he’s got more assets under control and more room for capital growth.

After making just these changes the cash flow of his portfolio is expected to be back where it started, about $213 negatively geared per week.

So it costs him the same amount of money, but he’s negated the tax changes and has an extra $525,000 of assets.

We then identified that one of his properties had development potential. He could build 2 new builds on the back. This would add value to the property and generate significant cash flow.

The Impact

Manu made 4 changes to the portfolio – he sold one property, paid down debt, bought another, and then did a development.

In the end he still had 2 properties that were considered existing and 4 that were then regarded as new builds (one of those properties had 3 dwellings on it).

Based on our forecasts, he is on track to have $10 million worth of equity by the time he turns 52.

Based on the rule of 4%, that suggests a passive income of $400,000 per year – a whopping $120k more than what he was previously on track for.

In addition, his portfolio will move from being negatively geared by $216 per week to positively geared by $235 per week – a $451 weekly difference.

The Lessons

• Selling an existing property to buy a new build is one legitimate way to respond to the interest deductibility tax changes
• Another is to have low debt on the properties that are affected. In this case, Manu will hold his debt on the properties where interest remains a tax-deductible expense (new builds). In contrast, his existing properties have no debt
• Holding properties with negative cash flow is not automatically a bad thing. But, if you have the ability and the money to add a minor dwelling(s), this will improve cash flow
• For first-time investors reading this, you might think, “How am I going to get 6 properties?” Manu had options because he’d already been investing for 8 years, starting when he was 29. Because he started when he could, he had options later on.

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

Disclaimer: Just remember this is a column in a magazine that goes out to thousands of people. It’s not personal financial advice. But it is an example of what happens when you get personalised financial advice. So, if you’d like my team to create the above analysis for you, come see us. At Opes, I offer a portfolio analysis for $999 incl. GST. Email Andrew.nicol@opespartners.co.nz to book.