Doing the numbers

Question from Bronwyn updated on 15th January 2013:

My daughter is hoping to purchase her first property in the near future. She is young and on a limited income. She has been informed that she can only obtain a mortgage of NZ$150,000. She currently lives in Palmerston North. In this price range she would be able to purchase a flat. Would this still b a great option for getting onto the property market? I have seen a property online for $138,000 which currently has a rental return of NZ$9,000 per annum. It is in a sound condition, has great potential for improvements and is in an excellant location as a future rental if she decided to leave Palmerston North. We understand the fundamentals about what to look at when inspecting the condition of a house when purchasing, however we are unsure about what we should be looking at in respect to a good yeild return and what formula to use when calculating this. Also with interest rates being low, would it be more beneficial for her to fix for five years?

Our expert Kris Pedersen responded:

In regards to yield to do a fair comparison between properties you need to use a net yield rather than a gross yield. I often see investors who think that they are getting a really good return who have purchased a very low priced property in a smaller town. However as often the rates and insurance costs are the same as larger cities the actual return they receive is often nowhere near what they were thinking. An example is a client recently who purchased a property for $66,000 that rented for $180. It however had high rates and insurance costs and the actual net return was under 6%. As this was in a town with high unemployment and vacancy it potentially would have been better to go to a larger city where those returns are stil achieveable if you look in the right areas. The difference between the two is that to calculate gross yield you just divide the annual rent by the purchase price whereas with net yield you deduct all expenses except for the mortgage off the annual rent and then divide it by the purchase price. In regards to interest rates it is a very unusual market at the moment with high levels of uncertainty. In most cases I have not been a fan of the five-year rates however there have been opportunities in some cases to get this term for a rate of 6%. In this case I believe this rate is strongly worth looking at however you need to be certain that you won't sell within the timeframes as otherwise you may incur break costs.

Kris Pedersen of Kris Pedersen Mortgages is a commentator on property and finance. His team sources top finance strategies.

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