FIRE and NZ Real Estate

• When you invest in real estate, you can possibly get FIRE'd much faster than investing in other asset classes due to leverage. However, there are some hurdles to invest in real estate - firstly, you'll get to have some money upfront for the deposit and need a strong enough credit history for a bank to lend you money. If you can achieve that, you'll effectively use other people's hard-earned savings to finance your purchase of a property. 
• Building a portfolio of real estate properties can be a passive investing strategy to fast-track wealth creation. Many news sites like the NZHerald (and their offshoot oneroof.co.nz) like to report on people who consistently buy properties.
• Such investors follow a similar formula - they take out equity from that property (after it has gone up in price) as a deposit for another house, then continue this cycle to buy 10+ properties. While this may seem like a hack to create wealth, it is extremely risky and requires a consistently rising property market, low rates and tenants that pay on time. This is not a consistent strategy and should not be undertaken without a proper understanding of the risks.
• With traditional mortgages, you'll need to calculate the income you earn against the payments you need to make each month. It is much easier to take out a larger mortgage in a lower interest rate environment as the interest payments will be disproportionately lower than if it were a high-interest rate environment.
  

More information: Visit New Zealand's Financial Freedom Authority - The Happy Saver. Ruth is a proven expert and has helped hundreds of New Zealanders on their journey to financial independence. Ruth also offers a phone-a-friend service which we believe is a helpful starting point to mapping out the financial situation you want to achieve. MoneyHub has no financial relationship with The Happy Saver, and mention it given its popularity, relevance, usefulness and trust.

There are a few tax implications when investing in real estate versus other asset classes (bonds, shares etc.). In general, tax-advantaged investments should be maxed out. However, some investment accounts can be set up as companies and may be more efficient than others. For example, if you set up a personal investment company, the top corporate tax rate you would have to pay is 28%, which is in stark contrast to the top personal tax rate, currently at 39%. While small differences in tax rate may seem immaterial, these differences can compound into massive sums over a long period. 

We outline the different tax on asset classes below:

1. Shares
The unique tax benefit for New Zealand estate is that capital gains are not taxed. For example – any gains for investing in New Zealand estate businesses on the NZX (assuming you are not a day trader/buying for the intent of profiting from short term price fluctuations) are tax-free. This is not the case in most developed countries – capital gains can range from 10 – 40% in countries like Australia, the USA, and the UK. This is effectively to incentivise New Zealanders to invest in local companies rather than other types of assets. However, the dividends issued to shareholders of companies are taxed. You can read more about investing in shares here.

2. Bonds
The coupon/interest payments from bonds will be taxed as income. For example - this means that a $100 bond paying a 5% yearly dividend ($5) will be subject to tax (which could be up to 39% - or around $2 in tax). This is one of the core downsides to investing in bonds. That said – a core reason people buy bonds is for the stability and consistent payment. Many FIRE followers use bonds as a proxy (4% rule, etc.) to reasonably rely on bonds to pay out a certain rate when they purchase them.

The argument for shares vs bonds is simple – the money a company (and therefore a share) makes is not taxed until it is paid out as a dividend. Meaning if a company generates profit and can reinvest this into the company (similar to what companies like Amazon do) – they can compound those small differences for much longer. In effect – shares get to compound their money faster than bonds. You can read more about investing in bonds here.

3. Real Estate
In earlier years, real estate was an extremely tax-efficient investment class. Rental losses could offset personal income tax - losses on the property (basically where a mortgage payment is greater than the rent coming in) could be used to offset personal income tax. For example, if you earned $100,000 in your job and owed $30,000 in taxes, and if your property generated a rent of $40,000 but your mortgage payments were $70,000, you could use the $30,000 losses to offset your personal income tax and pay no tax in that year).

This led to people putting down as small a deposit as possible to rack up large mortgage losses and effectively pay no tax for years. However, this was changed / ring-fenced in the late 2010s – and can now only be used to offset taxes on the real estate class only (can no longer be applied to personal income). This has substantially reduced the tax efficiency of real estate as an investment class. Find more information about this here.

Know This: Interest Deductibility of residential property income

• In late 2020, regulation was introduced to effectively reduce the efficiency and deductibility of mortgage interest.
  
• This effectively means you need to pay tax on all income from a non-family investment property, regardless of the mortgage payments you make on it.
  
• So, for example, if you had $40,000 a rent coming in but had $70,000 of mortgage payments, you would need to treat the $40,000 as income and likely pay tax on it at your marginal income rate – which could be as high as 39%). This has significant impacts for those considering investing in property – and substantially reduces the benefit of taking on a mortgage.
  
• This change will take a few years to come through fully – but the intention is to make mortgages entirely non-deductible. The IRD outlines more information about this here.
  

Understand the "Brightline Test"

• In 2015, the brightline test was introduced (a quasi-capital gains tax on short term investments into real estate).
  
• For non-family homes, properties brought and sold within five years were subject to capital gains tax. This was extended to 10 years as of 2021. This effectively means that selling within a decade of buying an investment property will incur capital gains taxes. As a whole, this has a significant impact on the hold period for investors.
  

Our View:
Taken as a whole – real estate has become significantly less tax-advantageous to invest in compared to other asset classes. As a result, the glory days in the early 2000s for New Zealand real estate investing in property are over – and there are significant changes that will impact many FIRE follower's intentions to invest in real estate.

When investing in real estate to get FIRE'd, it is important to understand how leverage impacts properties and how it can enhance your cash-on-cash returns. There are many things to weigh up for New Zealand FIRE followers considering investing in real estate:

1. Quick path to FIRE: You have the potential to get FIRE'd faster by investing in real estate than if you invest in shares or bonds alone. You'll need an initial deposit to invest in property and take out a mortgage to finance the remainder of the property. Be sure to calculate whether your monthly income will be enough to cover the monthly mortgage payments.

2. Reduced volatility compared to shares: In general, real estate exposes you to less risk than shares, predominantly because it's not valued every day (you only know what your property is worth after a CV check etc.). Once people retire and draw down on their nest eggs, they may face the danger of a market crash. Since you weren't contributing to your retirement savings anymore, your portfolio could diminish much faster due to your withdrawals. As long as your properties are occupied, they will continue generating income long after you retire.

3. Adjusted returns: When you invest in an index fund, you want to adjust for inflation when predicting your returns. In contrast, rental prices typically rise alongside inflation as the cost of living goes up. This is because landlords typically raise rents yearly after signing the leasing agreement.

There are different pathways to get exposure to real estate, but getting the process right upfront is essential. We outline proven steps to invest with full consideration:

1. Invest directly
If you're confident you'll act as an honest landlord and keep tenants, this is often the safest and most predictable route to earn income through real estate. You'll know exactly what proportion you'll make monthly, and you'll factor that into your FIRE plan.

2. Choose a high-quality property in a proven (or upcoming) area
Choosing which property to take a position in is one of the most important things to consider for real estate investors. To avoid common mistakes, you should only invest in a neighbourhood that's growing. While it's going to be tempting to shop for cheap properties on a budget in places that are struggling, it can be difficult to rent out these properties. On the other hand, fast-growing areas will have more demand for housing, which suggests you'll be ready to charge higher rental prices.

It can help to research locations you either already know or have researched thoroughly before. Work to know an area's vacancy rates and transport connections before putting any money down. Our checklist for buying a home has more details.

3. Choosing a property within budget
Unless you've got an electrician or plumbing license, it's a good idea to avoid the worst "fixer-upper" properties. If something like the cladding of the property is compromised, you'll lose thousands of dollars on repairs. Finally, you should calculate your returns, including your cash-on-cash return rate, before putting any money down. It is essential to work through the unit economics of a real estate investment and how it fits together with your budget and your FIRE objectives.

4. Prepare your finances
Most people need to get their finances so as if they shall buy a house to measure in. Investing in real estate is not any different.

5. Have an honest credit profile
You'll need a robust credit profile if you plan to get a mortgage or rental property loan with a low rate of interest, and you'll need a lower rate of interest if you plan to profit off your property investment. To benefit the most from your real estate investments, you'll want to take advantage of the current rock bottom interest rates. To get the best rate possible – your credit history comes into play. This can be challenging if you're young and haven't built up that much credit (the length of credit history influences your credit profile). Our guide to credit scores has more details. 

6. Assemble your documents
You'll also need certain documents to accumulate a mortgage:

• Recent pay statements
  
• Tax returns
• Bank statements
• Investment account statements
• Purchase agreement
• Proof of funds for the acquisition 
• Existing mortgage statements
  

7. Have the right amount of savings
Confirm you've got an adequate amount stashed away to cover any unexpected expenses and closing costs on your properties, as anything can happen. You will also need to have sufficient savings to make up your initial deposit. Make sure to include enough money for closing costs, fees to brokers or lawyers and unexpected expenses.

8. Finance your investment
There are a few ways to accumulate the financing you would like to take a position in property.

a. Investor capital
One of the top ways to finance a property purchase is to use other people's money. While this isn't always an option, succeeding with it often comes down to having the proper people in your network; it can be a significantly faster way to get onto the property ladder.

b. Traditional loan options
With investment properties, the big four banks will typically require a 30%+ deposit or larger. Banks typically like better to provide mortgages to people that shall sleep in the homes they buy, to not investors. You'll also need to have a robust personal financial history to secure a mortgage.

c. Family and friends
Pooling funds together with family and friends can be another alternative to accessing financing for property investing. In addition, promissory notes or other peer-to-peer financing options are alternatives to taking out a mortgage from a bank.

It is often tricky to work out how to make the FIRE movement work for your specific needs, especially when it involves real estate investing, as every market is different and requires a singular approach from investors. For young investors that follow the FIRE movement, taking a higher risk higher reward position when investing can be beneficial. In most cases, you'll get a better return on your cash by spreading it out among several properties than by owning one piece of real estate alone. The income per property is going to be less, but the income from four properties with a mortgage will be much more from one property without one. As you build equity in your properties, you can leverage the equity to invest in other properties. 

Get educated in the value of real estate, the nature of the transactions and other unique elements are important. Given the cost of housing generally, your mistakes will hurt a lot more if you don't understand what you're investing in (unlike shares – which typically don't deal in the hundreds of thousands). When pursuing FIRE using real estate, the investor must have a firm understanding of what they're trying to realise. It's easy to mention we would like to make more money, but you want to understand how and understand the different situations that may affect the investments.

Tips from experienced real estate investors include:

1. Specialise in learning the way to find good deals.
There will be hundreds of different properties for sale on websites like Realestate.co.nz, Trade Me and Homes.co.nz. One of the top things to do is understand the different areas and what they typically sell for. 

2. Find out how to accurately forecast rental income.
Early retirement requires income, so generally, FIRE-oriented real estate investing means rental investing. Get very conversant in forecasting expenses, especially, and get comfortable running the numbers during a rental income calculator. The last place you would like to seek out yourself is buying a property that costs you money annually instead of earning you money.

3. Find out how to screen tenants thoroughly.
It sounds simple, and it is, yet many new landlords gloss over this step. As a result, the standard of your returns directly correlates with the standard of your tenants, and bad tenants can cost you dearly.