ANALYSIS: With government’s announcement on the return of interest rate deductibility for property investors fresh in mind, it’s worth asking: just how much money can you make from investing in property?
Some Kiwis stick with the mantra that properties double in value every 10 years, thinking that if they buy a house for $800,000, they’ll sell it for $1.6 million a decade later, and make a minimum of $800,000 profit.
Unfortunately, the above scenario is wishful thinking (but scotching the “doubling every 10 years” myth is for another column). Property investors don’t always make money. Property prices go up and down. Property is not a one-way bet. And investors need to think about their rental returns, and not get bedazzled by capital gain.
To show how much money investors can make, I’ve selected a random a three-bedroom property in New Plymouth (I’m purposefully not mentioning the address as the house, as far as I know, has not been used as an investment property).
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Based on rental data and house price growth in New Plymouth over the last decade, the property would likely have sold for $360,000 in 2013 and generated rental income of around $390 a week.
The modelling used in the graph below also includes changes in interest rates and inflation as well as the three different property tax changes that occurred in the last 10 years.
According to the model, the house would have more than doubled in value by the end of 2023 and the owner would have enjoyed just over $400,000 in capital gain.
But again, it wasn’t a one-way bet. When you look at the returns on an annual basis, the money made (and lost) is more volatile.
In 2016, our investor would have made a lot of money, almost $52,400. That’s because property prices in New Plymouth rose, and rental income would have covered most of their costs.
In other years, though, our investor would have lost a lot of money. Property prices plunged in 2022, so they would have lost almost $45,000.
Overall, the gains outweigh the losses, but the path to those gains is a bumpy one.
There are three lessons to take from this:
1. You don’t make money every year
In the first year, the value of our investor’s house rose by $19,000. But the rent didn’t cover all the costs so they would have had to top up the property by $3000. Overall, they would have been just $16,000 better off.
The following year, house prices increased slightly faster. Our investor made $28,000 from the jump in property values, but they still had to top up the property by $3000, so they were only $25,000 ahead that year.
Opes Partners resident economist Ed McKnight: "Deep down, most investors know that the bulk of the returns come from house price growth." Photo / Fiona Goodall
The following year wasn’t so good. Our investor’s house dropped in value by $1000, and they had to top up the property by a bit more. In total they lost $4460.
And those bumps continue. In their best year, 2021, they made $176,000 on the back of booming house prices. But the very next year, they lost $44,800 as house prices fell.
The message is clear: if you invest in property, you need to be ready for the ups and downs.
2. House price growth makes more money than cashflow
Ninety-nine percent of the returns from this property were the house going up in value.
Only 1% of the net returns came from the rental income. Deep down, most investors know that the bulk of the returns come from house price growth. These numbers show this is true.
3. You need to hold for the long-term
In the long-run, our investor would have made $404,900 from owning this property.
And if you graph the numbers differently, it looks like they made money almost every year.
But our investor had to go through the ups and downs shown at the top of this column to get those significant returns. You’ve got to hold for the long-term. At least 7-10 years. The longer you hold, the more likely you are to make money.
Property owners who make money in property tend to hold for seven years on average. According to CoreLogic’s Pain and Gain report, those who lose money tend to hold for just two years.
Right now, higher interest rates are hurting investors. Property prices are only just recovering. Those who hold on for the longer term are more likely to make money than those who only dip in and out of the market.
- Ed McKnight is the resident economist at property investment company Opes Partners
