Money: Options open for serious savers

By MARY HOLM

Q: I have a mortgage-free home valued at $350,000 and have recently purchased a flat, which is in a block of eight, for $141,000.

I borrowed the full purchase cost. The rent return more than services its costs.

I have owned flats before and enjoy the business and see the purchase of all eight, over time, as a way of building up a superannuation scheme of a sort.

I have a salary of $80,000 a year with very low financial commitments.

I am considering purchasing a second unit in the block. The bank is more than happy to lend the money as most of the mortgage is placed against the flat, leaving me the possibility of raising even further mortgages by using the house as security.

This all seemed too simple, so I asked how many of the units I could purchase by borrowing virtually 100 per cent of the purchase cost. They implied that three or four would be no problem.

I expect to pay off the first unit by lump sum principal repayments from my earnings, until the debt:equity ratio is such that the rent relatively quickly finishes off the rest of the loan (I am a disciplined saver).

This process would be repeated for the subsequent purchases and assisted by the returns from the first, now mortgage-free, unit.

Am I oversimplifying things here, or is it really this simple? Are there any pitfalls which I have overlooked?


A: Two or three. Or four. But we'll start with the good points.

You're in a strong position to buy all eight flats, with your mortgage-free house, high income and few financial commitments. I'm not surprised the bank loves you.

And by owning several flats rather than one, you're much less likely to suddenly have no rental income between tenants.

Also, the building sounds good. First, it's probably rather different from your home. So you haven't got all your money in the one type of property - or at least not to the extent of people who rent out a suburban house near their home.

Second, experts say that purpose-built rental property, such as blocks of flats, tends to bring in higher rent per dollar spent than separate houses do.

Third, it's more efficient to own lots of flats in the same block. When you fix the roof, paint the exterior, repave the drive or work on the garden, all the units will benefit.

Another couple of pluses: Your plan gives you some clear goals to aim at, which makes saving easier. And - importantly - you enjoy being a landlord.

But will you still enjoy it if things go wrong? Let's look at a scenario:

* Mortgage interest rates rise. That doesn't look likely right now. But Don Brash warned us this week that "it is by no means inevitable" that there will be further interest rate cuts. In a few years, who knows?

* Local government problems lead to much bigger rate rises than you expected.

* More people continue to leave New Zealand than come here. The latest figures show a net loss of 11,770 people a year - the highest level in more than 11 years. It could get worse. Fewer people means less demand for rental property. Rents fall.

* You are made redundant. To your surprise, you can't get another job that pays nearly as well.

* Two developers put up apartment buildings near yours. The flats are newer and more attractive. You have to drop your rents further to fill your building.

* The tenant in Unit 3 rings you at 1 am complaining about loud music in Unit 5. She rings again at 2 am complaining about a noisy fight in Unit 2. The Unit 5 tenant rings you at 7 am complaining that the kid from Unit 3 is skateboarding noisily outside.

* You hire someone to manage the block, so you can sleep. But they charge an arm and a leg to be on call 24 hours.

* Several tenants say the nice clean-cut guy in Unit 4 is dealing drugs. Nobody can prove it, but three tenants move out. With lots of "undesirables" hanging around, it's hard to get new tenants.

* You settle for tenants you're not happy with. Most don't pay their rent on time. After a while, some don't pay at all.

* By the time you're forced to sell, the place is so rundown that you get less than you paid for it.

* You go to jail without passing Go, so you don't get $200.

It's all yours, mate! I admit it is highly unlikely that all of this will happen. But just two or three of these events could knock you sideways.

You're not only putting all your money into one type of investment, but into one building. The lack of diversification would make any economist squirm.

I would rather see you buy eight flats in different buildings in different neighbourhoods.

Better still, buy two or three flats if you must, but put some of those lump sums into an international share fund.

The fund might not do as well as the flats. But it might do much better. Have a bob each way.

Q: I am 56 1/2, and have just been made redundant for the third time! (after nine years, then five years, then 3.5 years in the admin field - getting closer!). I am not relishing the prospect of getting back into the traumatic job application/interview treadmill again.

Fortunately, my wife and I both worked and saved hard in our earlier working years and are relatively financially okay.

However, we have no super/pension until NZ Super, starting in 2003 for my wife, 2009 for myself.

We have our own mortgage-free home, which at this stage we would not like to sell.

Now to the crux of all this: What safe annuity could I expect to be able to buy for say $500,000?

Alternatively, with care, we could maintain our current lifestyle, by drawing down, say, $30,000 living expenses for the first year, increased per year to allow for inflation, which should get us to about 2012-13 - major "unforeseen" expenses permitting.

Your answer and view would be appreciated.


A: My enthusiasm for annuities has lessened a bit lately.

I still think they can be excellent for people of, say, 70 or older. At your age, though, they're less appealing.

That's because the insurance company that provides the annuity expects to be paying out for many years. So the annual payments can be rather disappointing.

Even so, an annuity might still be a good choice for you.

For those not familiar with the idea, when someone buys an annuity they give an insurance company a large chunk of money. In exchange, they get monthly payments for the rest of their life.

If they live for longer than average, they do well out of them. If they die early, they're not around to worry about it!

The money that goes into an annuity is, of course, not available for inheritance. It doesn't sound as if that's an issue for you, but it is for some families.

Still, I think elderly people are entitled to enjoy their money in retirement. Also, by getting an annuity, they can assure their children that they probably won't need to draw on them for support if they live particularly long lives.

In getting a quote for you, I've assumed your wife is 62, and that you would like an annuity that increases by 2 per cent a year, to allow for inflation.

Insurance companies don't offer inflation adjustments as such, because nobody knows what might happen to inflation in, say, 30 years. But you can get an annual automatic increase of a set percentage.

Your annuity would be guaranteed for 10 years. If both of you die within that time, payments of the full amount would continue to your estate until the 10 years is up.

Otherwise, payments will continue until the first one of you dies, and then drop to two-thirds until the second one dies.

If you gave Tower $500,000 for such an annuity, it would pay you $23,700 a year in the first year, with 2 per cent rises after that.

Alternatively, if you wanted payments starting at $30,000 a year, you would need to pay the company a bit more than $632,000.

These deals don't look as good as your $30,000 from $500,000 in savings. But there are two factors to take into account.

The first is that annuity payments are already taxed at company level. You would pay no further tax. Im not sure if your calculations included tax.

The second - crucial - factor is that the payments wouldn't stop at 2013, but would continue until you both die. Tower puts your life expectancy at another 23 years or so, and your wife's at around another 20 years.

You might feel you won't need as much money in your 70s and 80s as you do now. But, unfortunately, that's when many people face high costs for medical or other care.

If you don't face health problems, you might both be sprightly enough to continue travel and other expensive pastimes.

You could be extremely pleased, 12 years from now, that you took the annuity route.

Another option would be to put off starting your annuity for several years. Then you would get more for your money.

Perhaps you could take an easy-to-get part-time job in the meantime, just to cover current expenses. Try something really different. You might be surprised how much you enjoy it.

P. S. You two have set a great example of how wise it can be to save hard when you're young.

You're in an unenviable, but not dire, situation. And you've got several options.

* Mary Holm is a freelance journalist and author of Investing Made Simple. Send questions for her to Money Matters, Business Herald, PO Box 32, Auckland; or e-mail: maryh@journalist.com. Letters should not exceed 200 words. We won't publish your name, but please provide it and a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice outside the column.