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How to Turn a Profit in a Downturn

Building an empire is much easier when money’s cheap and property values are skyrocketing, but now is still a good time to grow a portfolio, Ben Tutty discovers.

8 March 2023

How this property investor turned one house into an empire.

Up to early 2021 you would have seen countless headlines like this on the pages of Stuff, The New Zealand Herald and even Informed Investor. And looking back it’s no surprise: the average house price in NZ increased by over 80 per cent from 2017 to 2021 and mortgage interest rates reached record lows of under 2 per cent.

Building an empire is much easier when money’s cheap and property values are skyrocketing. However, in late 2021 something changed and those headlines vanished. I haven’t seen one since, have you?

The reason these headlines have disappeared is no mystery. The average house price in NZ has decreased by over $100,000 since its peak, one-year fixed mortgage interest rates have almost tripled to around 6 per cent and inflation is rampant (meaning most people have less disposable income to invest and service debt).

Graeme Fowler, a New Zealand property investment legend who famously bought 20 properties in 2014 with no money down, says things are much harder for investors now.

“Prices then were about a quarter of what they are now and rents about half what they are now. Because rents haven’t kept up at the same pace as prices and interest rates are now similar [to 2014 levels], it makes it [investing] a lot more difficult with lower yields,” he says.

“There have also been a lot of added compliance costs with extra insulation, often ground-vapour barriers, extractor fans, new heat pumps, etc.”

What’s more, you need a 40 per cent deposit to buy an investment property in most cases today due to tightened LVR restrictions, which would be over $300,000 if you bought at NZ’s average price. Higher prices, higher costs and higher interest means holding property is more expensive, and growing a portfolio is harder.

“At the time I bought 20 properties in a year I was finding properties with yields of 10 per cent and often more. Now it’s not that easy to find the same type of properties for much over a 6 per cent yield, and often a lot less.”

Despite all those difficulties Fowler reckons building a property portfolio is still very much possible in 2023 and beyond (and if he says so, it probably is).

Plenty of opportunities

The main risks for property investors in an environment like this are obvious: a higher exposure to house price decreases and interest rate increases. Andrew Malcolm, author of The Three Property Formula and director of mortgage advisory firm mortgagehq, agrees that despite those risks there are plenty of opportunities.

“Now is the best time to buy. Confidence in the market is really low and high inflation erodes the real value of your debt,” he says.

When prices are falling, Malcolm explains that the three fundamentals of successful investing are still the same: buy property under value, focus on cash flow and add value wherever possible.

To buy undervalued property Malcolm says you need to spend a lot of time searching to identify opportunities.

“Essentially you need to find someone who’s willing to sell at under market value. You want your purchase to be the statistical anomaly that brings the market average down.

“They [the vendor] may be already committed to the next property, they could have too much debt and need to sell. Whatever it is, there are some circumstances that are forcing them to sell now and possibly accept a lower price.”

Cash flow still king

Next, Malcolm says that as corny as it sounds cash flow is still king. You need to buy something that will generate income from day one.

“If your investment can’t generate income, its value decreases and you need to sell, you’ve broken the number one rule of investing: don’t lose money.

“Investments with solid cash flow, on the other hand, can be held indefinitely and you’re always getting a return on your capital to pay your debt, fund improvements or buy more property.”

The last, and perhaps most important investment fundamental is to add value wherever possible. It’s one that may not suit many investors, according to Fowler.

“This takes a very different set of skills to do this well … having done hundreds of these trades successfully I know it does work well but for someone with little experience doing this, it’s not easy.”

There are two main options when it comes to adding value. To quickly build equity you could buy well, renovate and sell (as Fowler did). Or you buy and renovate to either increase the property’s value so you can leverage it and buy more property, or improve the property in a way that increases its yield. Malcolm agrees, this bit isn’t easy.

“You have to see the value where other people don’t, you need insider information or to know something that the market doesn’t.

“Value add is what separates passive from active investors. If you’re really serious you should be thinking about this.”

The trick of adding value

Adding value could mean cosmetic renovations, but if you’re really trying to make an impact, adding a room, or a sleepout and improving the home’s layout will have a larger impact (and increase your yield, as rents generally increase with the number of rooms). How do you learn to identify opportunities where this could work? Malcolm says it’s all about listening to those who’ve done it before you.

“You’ve got to read, listen and learn from hundreds of other successful investors. Pore through case studies, read books, listen to podcasts. Make relationships in the industry with other investors, real estate agents and developers.”

The property investment chat group that Fowler started on Facebook is a good place to look for specific advice and lived experience. You could also start with Fowler’s book, 20 Rental Properties in One Year, or Malcolm’s book The Three Property Formula (which was published in 2022 and includes lots of recent case studies).

Learning the fundamentals is the first step in any successful investor’s journey, but it’s also good to understand the key drivers which influence the market.

To that end, interest rates are high and they’re only going to get higher, according to Jonathan Ball, property investor and director of Fortis Capital, a leading non-bank lender that specialises in the development finance market.

“It’s increasingly difficult to guess, however my view is interest rates will continue to rise into the first two quarters of next year followed by a slow decline with shorter term fixed rates stabilising in the high 4s.”

Since property prices are heavily influenced by interest rates that means prices could keep going down.

“QV data shows that the rate of price softening is slowing though and we could reach the bottom of the curve around Q2 next year.”

Forget bias, look at the numbers

While it’s good to keep the numbers in mind, Malcolm says that ultimately the last thing anyone should try to do is time the market, or wait until interest rates pull back.

“You need to be analytical, forget your biases and look at the numbers. People get stuck and high interest rates stop them from doing deals, but ultimately your interest rate is just a part of a bigger equation,” he says.

“Don’t worry about your interest rate on its own. Look at it in relation to your investment’s purchase price and its rental income.”

Ball agrees and says, “You have to be disciplined with your purchasing criteria. For existing properties strong cash flow is non-negotiable and ideally the property will have add value potential through development or substantial renovation.

“Alternatively new builds are an attractive option because of tax advantages and lower bank funding deposits, however usually lack the ability to add significant value.”

One opportunity that Ball sees as low hanging fruit in the current market is to target new builds from motivated developers.

“For example, let’s say there’s a proposed development of 10 houses, the developer might need to pre-sell four off the plans to secure finance through a non-bank lender. The pre-sale market is going through a quiet phase which gives purchasers in that market significant leverage in situations like this.

“If you find those developers it’s a win-win for both parties. You get a new build property for a good price, with all the associated tax deductions and usually 12-18 months to get your finance together while it’s being built.”

The development route

Ball adds that value add plays for existing residential properties that worked in the past are much harder now with stricter lending deposit requirements and tax changes. So, if you’re planning to add value to an existing property you need to find opportunities to add rooms, bathrooms, minor dwelling/cabins or even undertake a multiple unit development if your site permits.

He ventures that if you were to go down the development route there’s still money to be made. However, it’s important to find the right site and assemble a capable team around you.

“There’s a lot of opportunity right now to buy good development sites from over-leveraged developers and homeowners at a competitive price. If you were to do this the first step would be to engage with a town planner who specialises in medium-density housing,” he says.

“They’d help you figure out what density you could achieve for each site while adhering to local planning rules and identifying any potential risks in achieving the necessary consents.

“Then, the key is preparing a development feasibility, understanding build costs/sale prices and stress testing all values as you go to ensure the project you wish to undertake provides a profit margin worthy of the risk.”

Just like investing, it’s still possible, you just need to be strategic and analytical when you make decisions.

Most importantly, Malcolm says you need to put in the hours and the work to gain rare insights, consistently beat the market and map out a strategy that works for you.

“If your commitment is low you should lower your expectations. This is a lot of work.”

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