You can’t eat investment property

The Official Cash Rate was at a low of 0.25% in September 2021 before rising sharply to 5.50% as of May 2023. Many investors have seen the rent they receive fail to keep up with their interest payments. The unshakeable faith in the rising New Zealand property market has also been tested with the average house price having fallen 13.2% from its March 2022 peak. While prices remain 24.3% higher than pre-Covid levels, there is a concern that if interest rates remain higher for longer, capital gains, the main driver of property investor returns, will be slow to return.

The tax landscape is improving for property investors, but is it enough?

There was hope that the current tax year would allow for a retrospective 60% interest deductibility rate to be applied this year. However, this failed to make it through the recent coalition negotiations and interest deductibility will remain at 50% for the 2023/24 tax year, before increasing to 80% in 2024/25 and moving to 100% in 2025/26. While this is good news for indebted property investors it will most likely reduce their tax burden rather than move their books back into the black.

So where does this leave the average Mum and Dad investor who just wanted to fund their golden years with the money earned from their investment property? In short, it depends on how much debt they were carrying on their investment property and what it is yielding. Property investors with debt have seen the free cash flow generated by their investment property portfolio dwindle or in many cases require them to make contributions to top up their mortgage. Even investors who own their investment properties debt free are in many cases earning a cash yield in the low single digits as rates and insurance costs rise.

With the incoming reduction of the Brightline test to two years many Kiwis are reassessing the use of rental property to fund their retirement. As well as the volatility in the investment property market, the burden of having to spend time dealing with tenant issues (every landlord will tell you, passive income from investment property is never truly passive), and the lack of liquidity in their investment is prompting many property investors to look for investment alternatives. Drawing money above the cash yield from your rental property is very difficult: you can’t just sell one of the bedrooms and property transaction costs can be exorbitant.

Most of the returns from investment property do not come from the cashflow but from capital gains. But just like you can’t eat a spare bedroom, you also can’t eat unrealised capital gains. Your retirement lifestyle need not be held hostage to how much cash flow your rental property throws off. Cashflows can be incredibly variable, and it doesn’t make sense to have to adjust your retirement plans in the event that your investment property has a burst pipe or needs its roof replaced.

If not investment property, how can I fund my retirement spending goals?

So what are the alternatives? At Axiome we build personalised investment portfolios to help our clients achieve their financial goals. Our portfolios have the advantage of diversification, liquidity, low transaction costs and for those clients in the higher tax brackets, a full Portfolio Investment Entity (PIE) option. The advantage of building your wealth through PIEs is that special tax rules apply allowing your investment income to be taxed within the fund at a maximum rate of 28%. This also makes them tax efficient for family trusts which will have a flat 39% tax rate from 1 April.

It can often be difficult after a lifetime of financially prudent behaviour to convince yourself to sell down hard-won assets and enjoy the proceeds. In retirement there are two broad financial strategies that our clients pursue. The first is to live off the cashflows of the assets that they have built up over a lifetime. The second is to sell down a portion of these assets to supplement the assets’ cashflows to fund their lifestyle.

The choice of strategy and how quickly you sell down your assets will depend on considerations such as:

• Risk tolerance
• Personal health
• Lifestyle goals
• Inheritance / Philanthropy

Ultimately, these factors will determine what approach will allow you to attain your financial goals and support the lifestyle you envision for your retirement.

If you are interested in seeing how changing your asset mix to incorporate managed funds can unlock more cashflow from your portfolio please get in touch for a no-obligation free consultation session at www.axiome.co.nz.