Diana Clement: Gearing up for a property slump

The property market is full of doom and gloom. But if you're a home owner and can stay put, any problems may pass you by.

Not so for heavily geared investors who have little equity in their property portfolio, or those who are having to fork money out of their own pockets each month to make ends meet.

Worst-case scenario for property investors - many of whom have only seen the good times since the year 2000 - is that property prices fall, the investor loses a tenant (or their own job) and can't afford the mortgage. Forced to sell, they make a capital loss and find themselves still in debt to their lender.

Rents have not been keeping pace with property prices in recent years, and as a result, yields may have dropped below the mortgage interest rate - which is not good for investors' bank balances - even if they are sitting on paper capital gains.

What's more, Gareth Kiernan, an economist with Infometrics Property, believes that some investors have got themselves into a dangerous situation mortgaging their own homes to the hilt in order to buy large numbers of rental properties.

"There has been a bit of publicity that [home owners] should negatively gear themselves to buy investment property," says Kiernan. "If you have $180,000 equity in your own home, you can buy 10 properties, they say."

Typical of those at risk, says Mark Withers, accountant at Withers Tsang in Auckland, is the novice investor who has bought negatively geared apartments or other developments expecting a large depreciation claim and ongoing capital gains. Often the developers have made exaggerated claims to sell the property.

"This is an absolute classic," says Withers. "We have people turning up at our office with expectations that they can depreciate fit-out items at high rates. But the Inland Revenue's attitude is only true chattels, items not integral to the building, can be depreciated at higher rates."

If the proverbial hits the fan, banks that happily lent hundreds of thousands or even millions of dollars to you can ask you to repay it any time they want. Come lean times and that's just what they do, says Stuart Wills, director of Mortgage Link West Auckland.

Wills estimates that up to 80 per cent of landlords have their properties "set up as dominos" where if one investment goes awry, each property is securitised against the next right back down to the family home. "They have a relationship with their local bank for their homes, businesses and investment property and are grateful," says Wills. However, it is a dangerous situation if the market turns.

Key to setting yourself up to survive the lean times is: selling off the lemons, improving cash flow, buttering up tenants, and getting your mortgages in order. If you have them, it's time to visit your accountant, mortgage broker and, in some cases, trust experts. If you leave it until you're in arrears, your options become severely limited.

When it comes to mortgages, it's important to make sure your lender can't take your shirt off your back. Allowing lenders to take security against all of your other assets can be perilous.

It's possible sometimes, says Wills, to get a lender to agree to split securities if there is sufficient equity in each property. Otherwise it's a good idea to remortgage so that the mortgages on your investment properties are with different lenders.

The next step would be to ensure that you have access to cash should you find yourself without a tenant, says Wills.

One way to do this is to set up a revolving credit facility on one property - to dip into should you need cash.

Another is to remortgage a property, take out cash, which could be put on deposit at the bank or in a term deposit for a rainy day.

Another insurance policy against the lean times, says Wills, is to set up your mortgages on an interest only-basis, but make payments of principal and interest - effectively making overpayments. Should you find yourself without tenants you could, with a flexible mortgage, take repayment holidays.

Flexibility in mortgages is also important for negatively geared property investors - so that you can apply tax rebates and other windfalls to the mortgage as and when they arrive, adds Wills.

Property investors do worry about falling house prices, according to a survey published in the New Zealand Property magazine, which found that 42 per cent of investors who had bought within the past two years were concerned about the possibility of falling prices.

Bargains are something that many old-timers, who've seen more than one property cycle, are awaiting in anticipation. Many have "buckets of money" on hand and snap up bargains when the less prepared feel the pinch, says Andrew King, president of the Auckland Property Investors Association.

If you don't want to become a statistic, says Withers, you should consider:

* Selling low-yielding properties to consolidate

* Working hard to keep your tenants

* Keeping your properties well maintained

* Fixing mortgages

* Only buying more property when the numbers stack up

* Get your tax returns in early to take advantage of the benefits of any tax losses.

* Completing an IR23 to reduce the tax rate you pay up front on your income if you have losses from property to increase cash flow, rather than waiting for a tax refund

* Make sure you maintain your own personal income to ensure that you can fund any shortfall in your investment properties. "This isn't the time to go chucking in your day job," says Withers.

If you consider it's worth holding onto your properties for the long term, through thick and thin, but you're having trouble making ends meet, then it's probably worth increasing cash flow by:

* Regularly reviewing rents, and putting them up in line with market rents - which can be checked by looking at Tenancy Services' website

* Reducing outgoings such as maintenance if possible, or management fees

* Increasing your own personal income and spending less

* If your property is making a loss, set up a loss attributing qualifying company (LAQC), which enables you to offset them against your personal income.

*The Auckland Property Investors Association is holding a workshop entitled "Secrets of Property Investment" on May 14.

King says the workshop will provide investors with the skills to get themselves out of difficulty should the property market turn sour.