HOW TO MANUFACTURE EQUITY (Even if the market is stagnant)
In an uncertain market, we often see investors looking for other strategies to create equity in their property other than relying on capital growth. Right now, the New Zealand property market is shrouded in uncertainty. Yes, there are areas that have hot capital growth or sizzling rental markets, and some even have both (Wellington and Queenstown). But investors are starting to wonder, how long will this last? As we ve been saying for the last 6 months, Auckland is no longer the driver of the nationwide market. What we are looking at now is a much more localised market, with places such as Wellington and Queenstown being driven by internal economic factors. Queenstown is a top tourist and adrenalin destination with local workers preferring to fight for top dollar accommodation in the city than staying somewhere that is a 2-hour commute (Source: The Spinoff). Wellington has a booming technology sector on a world class scale, the film industry is buzzing, and start-up culture has well and truly infiltrated the city. And with thousands more students battling each other out for the low supply of rental stock each year, rents are skyrocketing. You re lucky to find a 2-bedroom unit for less than $500 that s Auckland prices, but without the advantage of a higher average wage. But other areas have much more tentative growth. Most notably, Auckland s rapid value increases seem to have eased. Though overall prices are still rising, we re seeing more supply on the market, fewer punters at the auction house, and longer turnaround times. As a global city, it s hard to imagine that Auckland will decrease in value any time soon, though it s possible we will start seeing arguably more healthy and steady growth. Needless to say, many speculators are pulling back from the buy-and-flip strategy, though it s definitely still happening one punter recently flipped two Auckland properties for a profit of $600k in just 3 days (Source: Stuff). So, if investors are becoming less confident in their ability to source locations with strong capital growth, how else are they quickly manufacturing equity? There are three things to consider when you are looking at growing your equity. You have to decide: which of these are the most important to you? It s most likely you are going to have to compromise on at least one of them. Fast equity Easy equity Guaranteed equity If you re looking for 100% guaranteed, reliable equity growth, the only way you will get this is by paying down your mortgage. This is both hard work and will take time. The easiest strategy? To wait for the market to cycle up over time, giving you equity growth as the value rises. But this is both slow, and never guaranteed. Of course, you re almost certainly going to see some growth at some point, but you could be waiting 10+ years, depending on when and where you ve bought. If you re looking for fast equity, you could manufacture your equity. For example, you can create equity by renovating and adding value to your property. 2
Strategies For Manufacturing Equity So how are other investors making massive equity gains right now? Yes, there are savvy investors out in the market who are actually achieving this. These investors are manufacturing their equity. What does manufactured equity mean? Equity is simply the difference between the value of your property and and the value of the mortgage over it. If you have a property that is worth $500,000 and your mortgage is $350,000, then you have $150,000 equity in that property. To manufacture your equity means you are creating the equity. In the renovation example, you are manufacturing your equity by adding more value to your property than the cost of the renovation. Here are 5 strategies for manufacturing equity: This strategy is both fast and guaranteed; the hardest part is finding the deal at the discounted price. People often think okay, so I ve got to go out and find a desperate, vulnerable vendor and negotiate a cut-throat deal. That s not what we re about, and it sure isn t the only way to get a discount! Try specialist investment agencies who have good relationships with developers and have strong negotiating power for clients. Our Acquisitions team do this as a full time job and they re working around the clock to find the best deals for clients. 2. BUYING OFF THE PLAN Buying a property off the plan is an easy and effective way to create equity. Essentially, you are waiting it out to see capital growth, but it s different from buying and holding an existing property. 1. BUYING AT A DISCOUNT If you purchase a property for, say, $485,000 when its market value is $500,000, you have instantly created $15,000 in equity. That s an instant $15,000 you can put towards purchasing another investment property. When you buy off the plan, you purchase at today s prices for a property that is 6, 12 or even 18 months away from completion. You sign an unconditional contract, but you don t settle until completion in the future. In the meantime, you re benefiting from market growth until settlement, so when you settle, your property is worth more (if you bought in the right location) and you ve got a tidy sum of equity. Buying off the plan can be a great strategy if you get into a rising market. Here s an 3
example of some wicked growth our clients saw in an off the plan deal: In 2016, some of our clients bought apartments in Grace Victoria Quarter, a stunning off the plan development in Auckland that is currently being built on Sale Street. Back in June 2016, 1-bedroom apartments in Grace could be snapped up from $540,000. Now (April 2017), similar 1-bedroom apartments in the same development are on the market from $715,000 upwards. 3. RENOVATION Renovation is a common way to manufacture equity. I d bet that a lot of successful investors started their career with a renovation project. Renovating is relatively cheap (compared to building new or developing) and is faster than waiting for capital growth. But taking on a renovation project if you already work full-time can be overwhelming and exhausting. The key with renovation is to make sure your profit margin is wide enough for it to be worthwhile. This sounds obvious, but it s actually often overlooked. Make sure you research what upgrades actually increase the value of a property for example, a typical strategy is to add an extra bedroom, give the property a fresh lick of paint, or renovate the bathroom and/or kitchen. You re best to get as much advice as possible if you want to add maximum value to your investment. You don t want to work on a project for months and only come out a few thousand dollars on top. Remember: With DIY renovation projects, you are usually limited to a project that is close to you unless you re willing to travel long distances to work on your project! This means that investors often choose a project based on proximity to where they live, rather than choosing a project in the strongest property market. 4. SUBDIVIDING In this strategy, you might find an 800m2 block of land with a house at front and subdivide the land into two 400m2 sections. The idea is that the value of the two sections is much greater than the original section on its own. 4
The subdivision strategy plays on a warped perception of value. An owner-occupier looking to buy a house might think that a bigger backyard is worth $50,000, whereas to an investor looking to subdivide it might be worth $100,000+ for that extra land. In their eyes, every 100m2 beyond the minimum is a wasted opportunity. Bear in mind that time and cost is involved in subdividing land, and that you may have to pay tax on profits of the subdivided land if you begin the subdividing process within 10 years of acquiring the land. Subdivisions are generally more advanced and costly than renovation, and are sometimes considered more of a small-scale development. 5. DEVELOPING / BUILDING NEW Developments range from simple and small in scale (e.g. buying a block of land and building three townhouses) to large (e.g. a 200-unit residential tower). Investors who buy sections in subdivisions and build a house to sell before or on completion for a profit also fall into the developer category. The key principle in any development is maxing out the potential of the land. In the townhouse example, you may have bought a piece of land with a stand-alone house on it, but the council planning rules allowed a multi-unit building. So you recognised the potential, and had the funds to undertake the project. A development will take more time than a renovation because you ll need to wait for council approval. This strategy is much more advanced than renovation, and will require more funding, but it often yields much greater profits. Generally, the larger the development, the bigger your profit margin. Banks typically only look at bigger projects if the investors are experienced developers, or have the assets to back their project. 5
Where to from here? We ve now talked about how investors can increase equity by Waiting for capital growth (easy) Paying down their mortgage (guaranteed) Manufacturing equity (fast) I hope this guide has got you thinking about your plan for equity growth, and how these different methods of increasing your equity can be applied to your overall investment strategy. When you re planning your next steps, ask yourself questions such as: Should you buy in a location where you know there is better growth potential but no opportunity to manufacture growth? Or should you buy close to home in an ordinary market so you can add value and save on costs by doing it yourself? Don t let myths, preconceptions, and uninformed advice rule your investment activity. Make sure you examine each individual investment opportunity on a case-by-case basis, work out the return on investment. If you can employ a range of different strategies for building equity, then you don t have to be stuck in a 9-to-5 grind paying down your mortgage until you ve built enough equity to buy more property. When you attend your local Property Investor Night, you ll learn how manufactured equity, mortgage reduction and other investment strategies work together to create you wealth for the future. 6