Structuring debt

- Caglan Bagci | NZIJ MORTGAGES


You can use other people’s (bank/mortgage lenders) money to invest in property by borrowing. The rental income can then be used to service and/or repay the debt.  While it is possible to leverage into other asset classes, you can not borrow as much or as cheaply as you can with property investment.  Further to this the yields with alternative forms of investment are not normally as high or as reliable to service debt with.

Transaction values of direct property investments are also relatively high.  Normally several hundred thousand if not several million in the case of commercial investment is required to purchase an investment property, so almost all property investments have (and probably should have) some debt associated. If you don’t want to borrow to invest in property then direct property investment is probably not for you.

When structuring debt there are many things to consider and a good broker will help you consider what is relevant for your needs and will work with your accountant to find a structure that is optimal. An accountant will focus on structuring debt in a way that is optimal from a tax perspective. To this end they will give advice on the most appropriate entities (companies, trusts) to use to buy property and borrow money. They will also help you decide if you should structure debt on an interest only or principal and interest basis.

As a broker, I help people make decisions on fixed, floating and line of credit facilities on a daily basis. It is only natural that everyone wants to save money on interest rates and will be drawn to the lowest rates. The lowest rates are available on a 6 months fixed rate basis.  The longer the time period that one wishes to fix a loan for the higher the rate.  Five years fixed is sitting at 8.5% at this time.  Most borrowers take the greater portion if not all of their debt on a fixed rate basis.  Fixed rates have the advantage of providing certainty but do not guarantee that they will save you money as we can not predict what the interest rates will be next year or in three or five years time.  Breaking fixed rate loans mid term can be a costly business.

So what is an investor to do?  Most investors I work with will take a cocktail or combination of loans with any given transaction. The right combination of facilities will depend on each individual’s needs on a case by case basis.  If an investor told me that they needed to borrow $300,000 to complete the purchase of an investment property with the intention of holding it long term but they also wanted the option of making lump sum payments and may like to borrow more money in the future to buy further investments,  I may suggest 20% on a line of credit basis, 40% on a 3 year fixed basis and 40% on a 5 year fixed basis.

Line of credit facilities provide the flexibility of allowing lump sum repayments without penalty and allow redraw of funds for future needs (such as the deposit on future property investments).  Having fixed rates mature at different times provides some interest rate hedging to safeguard against a highly changeable environment.  This case is deliberately general for the purpose of simply illustrating the point.  Precise recommendations are normally made after detailed needs analyses on a case by case basis.  As always, the best policy is to talk with your broker and accountant before you purchase.

I am happy to respond to any questions on this article or anything in previous issues.  Send your questions to mortgages@nzij.co.nz