Safe as houses?

Kiwis tend to regard property as the bedrock of financial security, but times are changing. In our latest MoneyMakeover, we look at the case of two sisters who decided to pool their money in housing in hopes of a sizeable return.

Lucy and Chloe, 30 and 29 respectively, are sisters. Lucy lives in New Zealand while her sister lives in Australia. Three years ago they pooled their savings to buy a joint property investment. They bought the house for $369,000 and its GV is now $350,000. They have $308,000 remaining on the mortgage. Together they have saved another $40,000, which they are looking at using to buy a second property. They have pre-approval for a mortgage up to $400,000. At the moment they both rent, but their goal is to sell their properties in 10 to 15 years and walk away with enough in the bank to buy their own homes, or at least put down sizeable deposits. Lucy says the financial partnership has worked well in the past and neither foresees any problems. Still, they wonder whether investing in a second property is the best way to grow their money given their respective incomes and shared debt. They approached MoneyMakeover for advice on how to set up a better financial structure.

Here's how their situations break down individually.

LUCY

Assets

Cash $20,000

KiwiSaver $2092.29

Superannuation $10,195

House (jointly owned) $350,000

Car $6500

Income

Gross annual $90,000

Weekly rental income (shared) $400

Outgoings

Mortgage (shared) $310,000

Household expenses monthly (including food, rent and holiday savings): $2260

Power (monthly) $180

Transport (monthly) $184

Insurance (monthly) $50

CHLOE:

Assets

House (jointly owned) $350,000

Pension: $10,750

Income

Gross income: A$61,000 (NZ$75,000)

Weekly rental income (shared) $400

Outgoings

Household expenses (monthly) $1688

Power (monthly) $60

Insurance monthly $52

For an expert opinion, MoneyMakeover consulted Sheryl Sutherland, a women's financial planner based in Christchurch and Martz Witty, a business consultant and chartered accountant. Here's what they had to say:

* * * * *

Lucy and Chloe's situation is not an uncommon one. Their goals are to have two properties with a view to selling in 15 years and buying their own homes individually. Travel is a very real part of their lives and they want to ear-tag $10,000 a year for such pursuits.

The question asked is how best to spend their money in order to gain financial security for the future (10-15 years). Neither has a current focus on retirement savings.

The first thing to look at is their need to heavily subsidise the first property.

Rent received is $400/week and the mortgage repayment is $1241 a fortnight. There is a very real cash out-flow on the property just to keep up with the mortgage repayment, let alone rates, insurance and repairs and maintenance.

Salaries are not guaranteed for life and each really should consider taking out an appropriate income protection policy (which is tax deductible, thankfully). This will give some assurance in case of accident or illness. An average income earner will typically earn over $1.4m through their working life. ACC does not pay in every circumstance and, interestingly, about one in 20 disabilities lasting six months or more is related to accidental causes. Here's the frightening part, two out of every five people are likely to be unable to work for six months or more during their lifetime due to a sickness or accident as reported in the ACC BERL Report, November 1996.

In addition to income protection Lucy should look at some additional life insurance (she currently holds about $52,000 of cover), while Chloe has $584,000 life cover. Each should explore a trauma component to give peace of mind in the event of suffering one of the four main critical illnesses (heart attack, heart disease, cancer or stroke).

The recent Budget announcements will have a relatively minor impact on Lucy and Chloe by disallowing depreciation on the rental property. The biggest challenge to them both is the heavy debt gearing they have. At a rental income of $400/week they are enjoying a modest 5.9 per cent gross return on the investment (before any expenses). The current interest rate is 5.5 per cent with the bank. They are relying on a significant capital gain at some time in the future, and statistically they can probably sit fairly confident that this will eventuate.

Interestingly if we look at statistics, stocks and shares – when invested knowledgeably and prudently – consistently out-perform residential rentals. The trick, as always, is knowing what to invest in.

If the true goal is financial security in the future then adding a second property to an already debt-laden portfolio is not the answer in our opinion. There is good debt and there's bad debt. Good debt is that debt which gets paid off by others (such as tenants) while bad debt is subsidised from other personal sources as we see is happening with Lucy and Chloe. To load up a second property right now will further add to the risks and stress levels for them both. Ideally, the existing rental property would be at worst cash neutral, that is, the inflows equal the outflows. This then enables a concerted savings scheme by the two sisters towards a second property, or a portfolio of shares and other investments. A second property should be attained when there is sufficient deposit to have it also cash neutral.

Another big decision is current lifestyle over future financial security. To spend $10,000 a year on travel that could be used to increase a capital base is a personal decision, it just means that the ultimate financial goal will be prolonged somewhat. That's a valid decision, it just needs to be a conscious and deliberate one.

The quickest way to create wealth is to only have good debt that is paid off by others and to retire all other debt, especially the likes of credit card or discretionary spending like hire purchase agreements. Given the circumstances as presented to us by Lucy and Chloe, we would use the $40,000 currently in savings to either reduce the debt on the existing property to a more manageable level or assuming they are comfortable with the cash top-up they require each and every week then alternatively diversify the investments for retirement by using a suitable investment coach and explore shares and the like. Protecting their biggest investment (their ability to earn sizeable incomes) is an essential step in moving forward also.

Martz Witty is a qualified chartered accountant and speaks professionally on tax and business development issues. He is an accomplished author and a regular contributor to magazines and major newspapers. www.martz.co.nz

Sheryl Sutherland is a financial planner and an independent adviser with her own business, Women's Financial Strategies. She frequently features in broadcast and print media matters relating to investment. www.strategies.co.nz

No person or entity will be responsible or liable for any errors, omissions or inaccuracies in this article or liable to anyone for any loss, damage, injury or expense suffered or incurred as a result of reliance on the information provided and opinions expressed in the article. Disclosure documents for advisers are available upon request from the participating parties.

Are you interested in being the subject of a free MoneyMakeover? Send your details to: amanda.morrall@press.co.nz.

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