New builds: What are the pros and cons?

New Builds can be an attractive buy for property investors. But, despite the tax changes making them seem prettier than the average home, they’re still not the right fit for everyone.

They tend to work best for investors who want a passive strategy, since they tend to attract a better quality tenant and have lower maintenance costs.

They also work better for people on a budget, since they require lower deposits, so you can buy more property for the same amount of deposit. And, of course, they dodge the higher taxes brought in by the government earlier this year.

It all sounds great, so what’s the catch?

In this article, we’ll lay out exactly what the pros and cons are for buying a new-build so you can make an informed decision on what investment suits you best.

What Are The Pros To Buying A New-Build?

To start off, let’s discuss the pros of adding a new-build to your property portfolio.

Investing in New-Builds Is A Passive Strategy

New Builds are great for people who are “time poor”.

For example, working professionals with young children often don’t have the time to spend their weekends wielding paintbrushes and hammers to renovate existing properties.

Because a new-build property is a finished product - it also tends to attract a better quality of tenant. This means fewer headaches from your tenants, and less maintenance issues and costs for you to think about.

New-Builds Require Lower Deposits, So You Don’t Need As Much Money To Get Started

New-builds are exempt from the Loan To Value Ratio (LVR) restrictions, which means you can buy a new-build with half the deposit of an existing property.

Up until March 2021, you only needed a 20% deposit for your investment mortgage to be approved on an existing property.

Now, investors must fork out 35% because new restrictions cap loans at 65% of their property’s value.

New-builds are exempt from this, and you can still buy a new-build with a 20% deposit.

That means for a new-build property priced at $600,000, you only need a $120,000 deposit. Whereas you’d need a $210,000 deposit for an existing home valued at the same figure.

An investor can also sign up to buy a new-build with only a 5-10% deposit during construction. For instance, you can pay a $50,000 deposit to a developer to secure a $1,000,000 property that won’t be built for another 2 years.

If over that time the property market appreciates by 5%, then your new-build will be worth $1,050,000. So you’ve made $50,000 in equity by only using a $50,000 deposit.

The big benefit to using a lower deposit is if you put less money in, then any capital growth you get has a better return on the equity you invested.

How so? If we take a $600,000 property and achieve capital growth at 10% you get a $60,000 return.

Because you would have had to put in a $120,000 deposit for a new-build and $210,000 for an existing property, that’s a 50% return on your equity for a new-build and only a 28% return for existing.

No Renovation Costs

Even if you can stomach the higher deposit requirement for an existing property, you still need to pay for renovations.

Take the example of a $600,000 existing property requiring a $210,000 (35%) deposit. You might then need to spend $30,000 renovating the property.

The bank won’t lend you this money against your investment property, so you either need the $30,000 in cash, or you’ll need to borrow it against another property.

Some investors don’t have the available equity or cash available to fund these renovations. This is why people who are light on equity may opt to invest in new-builds.

Lower Maintenance Costs

A new-build is, as it says in the title, newly built, which means the investor will save on maintenance costs.

Most investors will budget about $2000 for annual maintenance on older existing properties, but often $500 is more than enough per year for new-builds. So, it’s an annual saving of around $1500 straight out the gates.

New-Build Property Investors Pay Less Tax

New-builds are also exempt from the changes to tax deductibility laws introduced by the government in March, 2021.

That means new-build investors will save between $3,000 - $5,000 in tax per year for every half a million dollars’ worth of debt they have ($60 - $100 a week).

This is because the change affected how interest costs are treated when calculating your property’s annual income tax bill.

Pre-October 2021, investors were able to include their interest costs as a taxable expense.

Now, interest costs don’t count towards that profit calculation.

So, on paper properties appear to be more profitable in the eyes of the IRD.

The difference in tax that investors need to pay is sizeable, enough to turn a positively-geared house into a negatively-geared one.

However, interest is still deductible for at least 10 to 20 years on new-builds.

Over 10 years this comes at a saving of $30K to $40K on a $500,000 mortgage, compared with an existing property.

It is important to note the bright-line test (NZ’s lite-version of a capital gains tax) is halved from 10 to 5 years for all newly-built properties.

This means investors avoid paying a blanket tax on the capital gains for properties they sell, provided they don’t sell before 5 years.

What Are The Cons To Buying A New-Build?

So, you might be thinking: “Wow, I’m convinced, sign me up for this tax-positive, low deposit haven of property investment”.

Before you go buying any off-the-plan builds, you need to understand the drawbacks too, because new-builds are not right for every investor.

No Added Value

Because you are buying a completed product, there is now no room to renovate a new-build.

So, if you are a super keen, renovations-focussed investor, new-builds will not be the right fit for you.

If you do spend time doing landscaping or maintenance, you are likely to over-capitalise – which means spending money but not getting a return.

This also means there’s no way to build equity in your property either. Your primary way of building wealth is through capital gains, and to a lesser extent cashflow. This leads to our next con.

Recycling Equity

Many investors want to use one property to buy another, but that can take a lot longer with new-builds.

A common way investors keep buying property is through renovations. They buy a house, then renovate it to increase its value.

Once the value has increased, the bank is willing to lend you more money against that property. So in some circumstances your renovated property will fund the deposit for your next purchase.

But because your new-build only increases in value through capital growth, rather than renovations, it’s going to take longer before you can borrow against it for the next property.

That might be an acceptable trade-off because you want to take a passive strategy, or you have extra equity in your own home to fund the next investment property. But you need to be aware of this trade-off.

Body Corporate

Often, new-builds are townhouses and apartments which come in packages of 6 or more properties.

When this happens you will often have a body corporate or a residents’ association.

Some investors don’t like either of these because of the additional cost associated with them, and there are some property owners who got burned by their body corporate during Auckland’s leaky homes crisis.

It’s not the end of the world, but body corporates do need to be managed so costs don’t spiral.

So … Do the Pros Outweigh The Cons?

The truth is that new-builds will be right for some investors, but won’t be the right fit for others.

And whether the pros of new-builds outweigh the cons depends on your strategy.

If you want a passive strategy where you’re investing over a 10 to 20-year period, then new-builds are likely to be a good fit for you.

But if you want to grow a portfolio of 20 properties in the next 5 years and you’re just starting from scratch, then new-builds probably won’t fit the bill.