Your accountant should, at the very outset, help you to determine your investment goals in acquiring investment properties.
You may be looking for high rental yields (often at the expense of capital appreciation) or for high capital appreciation (with a sacrifice in the yield). Your accountant will help you to plan the correct mix of investments in a well balanced portfolio. Your portfolio should probably be tilted towards rental yields since you will see returns on your investment almost immediately. Investing for capital growth takes a lot of patience since you can never be sure how long you will need to hold the property. Your accountant will also almost certainly advise you to settle for the bird in hand.
Get your chartered accountant to explain yields
If you are investing for rental yields, the underlying assumption is that the value that you are willing to pay for a property depends on how much rent you will receive.
With the guidance of your accountant, establish a minimum yield below which you will not consider buying a property. You may decide that a minimum yield should cover all of your borrowing costs, assuming that you are borrowing 100 percent of the value of the property.
If mortgage rates are running at seven percent per annum, rental yield should be seven percent plus. In other words, let’s assume that you are considering a property for $400,000. You would only consider buying it if you can rent it for at least $28,000 per year. If you spend some time scouting out rentals for similar properties, you can arrive at a pretty accurate estimate of your yield.
Ask your chartered accountant about internal rate of return (IRR)
IRR is a more complex calculation but there are a number of spreadsheet software packages that will perform the calculation for you. Factors such as capital appreciation, rental, and expenses (like taxes and insurance and tax benefits) are included in the calculation.
The internal rate of return will be the return that you achieve on the capital that you have actually invested. For example if your return is $28,000 per annum on an investment of $360,000, your IRR is 7.78%.
IRR versus yield
Whilst IRR can produce a more accurate investment appraisal, subjective factors such as capital growth can render it unreliable. You are probably better off staying with the simple and easy to understand yield method. Concentrate on maximising rental returns and treat any capital growth as a bonus.
Rental properties have been an excellent investment for many Kiwis. You should consider them as an integral part of your investment portfolio. Get started on your investment plans today by getting in touch with your accountant.