Mitigating risk in property investment
Investing in residential rental properties can be an excellent way to generate passive income and build wealth over time. However, as with any investment, there are risks to consider. One of the most significant risks for rental property investors in New Zealand currently is rising interest rates.
Interest rates are a critical factor to consider when investing in rental properties, as they directly impact the cost of borrowing money to purchase and maintain properties. When interest rates rise, it increases the cost of financing, making it even more challenging to generate positive cash flow from rental properties. It is important that landlords understand any potential shortfall and make a plan on how to address this. Especially when considering the impact of the changes in the tax rules surrounding the diminishing interest claim, the combination of both increasing interest rates and reducing tax claims can have significant impact if you do not plan for it.
In New Zealand, interest rates had been relatively low for the past several years, however this has changed and changed rapidly. Gone are the days of interest rates at 2.5% with now residential rates starting at 6.5%+ for a one-year fixed rate. There is currently a lot of uncertainty in whether interest rates will continue to increase, plateau or decrease.
One of the most effective methods for dealing with rising interest rates is to move to paying off the loan over a more extended period. By extending the loan term to 30 years, investors can reduce their monthly mortgage payments, which can help to offset the increased cost of borrowing. However, while this method can result in higher overall interest costs over the life of the loan, it can help to provide short-term relief and protect cash flow. The downside to this is that you will pay a greater amount of interest. A smaller loan term means less interest over the life of the loan and vice versa.
Another option for investors to consider is, to lock in interest rates for up to five years. By doing this, investors can ensure that they will not be subject to any interest rate hikes during that time, providing stability and predictability in their mortgage payments. This approach can be especially beneficial for investors who are looking to hold onto properties for an extended period. Typically New Zealanders have locked their interest rates in for only a year, locking in longer may give you certainty on cashflow in the years ahead. Many finance brokers are suggesting that we lock in for a year as current longer-term forecast indicate that things could start to full in the next 12-18 months. That said, if you need certainty on your rate and payment then you may want to lock in for longer. The downside is that you may miss out on any potential drop-in rates. Forecasts are very much crystal ball and just as no one predicted the COVID pandemic and the turmoil it would cause, no one knows for certain which way interest rates will go.
A third method for dealing with rising interest rates is to move to interest-only loans. While this approach may not be suitable for all investors, it can provide short-term relief by reducing monthly mortgage payments. However, it is essential to note that interest-only loans do not reduce the overall amount of debt owed, and investors will need to have a plan in place for repaying the principal once the interest-only period ends.
After looking at all the options above, you should also consider your personal budget. We would recommend reviewing what changes you can make here to cover any shortfall cause by rising interest rates. By reviewing your personal budget and ensuring that it can cover any potential shortfalls, you can help to reduce the impact of rising interest rates on your overall financial health. In some cases, it may be necessary to adjust your personal budget or investment strategy to ensure that you can continue to maintain your rental property portfolio effectively.
Regardless of the approach that rental property investors choose to take, it is essential to consider the long-term impacts of rising interest rates on their portfolios. For example, higher borrowing costs could make it more challenging to generate positive cash flow, which could impact an investor's ability to maintain properties and make necessary repairs and upgrades.
One way to mitigate these risks is to work with your property manager who can help to ensure that rental properties are well-maintained and generating maximum rental income. Property managers can handle everything from finding tenants to collecting rent and dealing with maintenance issues, allowing investors to focus on growing their portfolios and managing their finances. A good property manager can also help you mitigate the ever-changing legal responsibilities that a landlord faces and helps ensure you are compliant. There can be large penalties if a landlord gets this wrong. A good property manager can be worth their weight in gold.
In addition to providing peace of mind and support for rental property investors, property managers can also help to identify opportunities for growth and expansion. By staying on top of market trends and identifying properties with the potential for higher rental income, property managers can help investors to make informed decisions and grow their portfolios over time.
Finally, it is essential for rental property investors to maintain a long-term perspective and focus on building diversified portfolios. By investing in a range of properties in different locations and with varying rental income potential, investors can spread their risks and reduce their exposure to any single property or market. This approach can help to mitigate the impact of rising interest rates and provide greater stability and resilience to rental property portfolios over time. Spreading the risk could range from have properties in different towns, different suburbs or even considering options like Airbnb. If you are choosing to sell your property due to rising cost of living, make sure you are considering any long-term impact of this on future retirement plans. Further to this it is imperative you discuss any potential property sales with your accountant first, to ensure that you won’t be negatively impacted by any potential capital gain or Brightline tax.
In conclusion, after over a decade of historically low interest rates, we are entering a period where rates are more in line with the longer-term average. While this can be tough for property investors to bear, make sure you are looking at all options before concluding selling the property. There is no right answer, each person has a different situation and needs to find a solution that works for them. If you need advice, reach out to your trusted advisors to discuss.
Kendons is an advisory and accountancy firm that specialises in small and medium-sized businesses in New Zealand. We offer a range of services to our clients, including business consultancy, business valuation, systems consultancy and accounting and tax advice. Contact us today to learn more about how we can help you achieve your financial goals.
This article is provided for informational purposes only. Any rental property investors in New Zealand should consult with a qualified professional before making an investment decision. This article does not constitute professional advice.