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Unwary landlords can find themselves caught up in a host of financial complications and be burned when they discover the cost of owning a rental property.
Property tax expert Mark Withers is warning the new wave of "accidental" or "reluctant" landlords - homeowners renting out their properties because they can't sell for an acceptable price - to beware of traps.
If things aren't set up properly, tax deductions can be disallowed.
Property manager Mark Claridge of Quinovic says there has been a "huge increase" in private landlord numbers as homeowners have tried and failed to quit their properties in the slumping market. Those moving to Australia also swell the "reluctant landlord" ranks, Property Investors Federation president Martin Evans says.
These landlords have typically built up some equity in their home so are able to buy a new house without selling their existing one, Withers says.
They borrow money secured against their existing property to buy the new home and rent out the old one. Mistakenly, they think they can claim the interest on the loan as a tax deduction where the outgoings on the rental exceed the income.
But tax law prevents this because the purpose of the loan is to finance the landlord's new home. Those without significant equity in their home can deduct mortgage interest if it becomes a rental because the debt funded the original purchase. The problem arises where home owners have paid off some of that loan then borrow against it to buy a new place.
Evans says the accidental landlord phenomenon is unique to the current property cycle: there is demand for quality rental properties from would-be first home owners who can't afford to buy, coupled with would-be sellers who can't get the price they want and put up the property for rent instead.
These landlords hope conditions will change so they can put their properties back on the market but in the meantime they have to top-up outgoings where there is a rent shortfall.
Apart from tax considerations, landlords need to figure out how long they are able to support the property in this way before they have to put it back on the market - which looks set to deteriorate further.
"They're certainly not making any cash flow on it and their prime objective is to sell," Evans says. Unfortunately having a property for rent and for sale at the same time deters tenants.
While those who bought at the property cycle peak lose capital on selling in the slump, they also lose money on renting if this doesn't cover the mortgage and other costs. And rents have stayed stagnant, "going for the bottom of their range" says Evans, without demand driven by immigrants or returning expats - for now.
An upside is that accidental landlords attract better-quality tenants more quickly, he says, because their houses have been primed for sale. And the dearth of spec houses under construction points to a future demand build-up that will boost rents.
Andrew King of the Auckland Property Investors Association says unintentional landlords may not know the correct market rent and tend to undercharge. An average family home often equates to a superior rental property. King says it's easy to undercharge rent by $30 a week - throwing away more than $1500 a year.
Where a rental property has been the family home, often the landlord overlooks giving requisite notice to tenants when accessing the property, the Department of Building and Housing's Jeff Montgomery says.
Scotney Williams, lawyer and principal of Tenancy Practice Service, says residential tenancies legislation sets out a "dramatically" higher number of unlawful acts that a landlord can commit compared with a tenant.
New landlords also trip up when they neglect to run credit checks on tenants or to inspect the property regularly. Monitoring rent payments and taking landlord insurance are important too, Williams says.
Reluctant landlords who rent their homes furnished should be prepared for damage to their property. "If you have an emotional attachment to the house - don't rent it out."
* Phone the DBH on 0800TENANCY for a free CD rom on managing properties effectively. Also visit the Property Investors Federation website for advice: www.nzpif.org.nz
