Many people are experts in property. I am not one of them. Real experts are multimillionaires with property portfolios that dazzle the eye. They have built them with seed capital, geared the investments to multiply the number of units and they have built sufficient equity in their portfolio of cash flows from their portfolio in order to withstand even pandemics.
I am not, nor have I been, at that level but I have owned buy-to-let and/or bought, built and sold enough properties to position some guidelines for investors. I will focus on residential but many of the aspects of investment transfer to commercial properties. I hope the following, in no precise order, adds some value for Homeloan Junction’s readers…
ANALYSE YOUR CIRCUMSTANCES
Buy-to-Let was novel as a concept in 2002 when I introduced it into Nedbank. I had been to the UK to research the investment with local lenders. The numbers were compelling and, coming off the back of low returns in retirement savings, many people were supplementing their income by buying “the house next door” for let. It was not small but rather a multi-billion UKP industry.
When you invest in property, you are tied to a fixed asset. Key to such investments are personal circumstances. You need to understand, and I believe write down for future reference, the reasons for investing this way. Where you live and want to live, what money you have for a deposit and for a rainy day, your affordability of what for most people would be a second mortgage, where you see the market for people who’d want to rent, and the time you have to manage the investment.
All of these questions plus some, need to be carefully understood and answered realistically.Bottom line to this is that you’re buying a fixed asset. Forget the notion that “if you get into trouble you’ll just sell the flat.” Property is not a unit trust or savings account; you cannot just sell it because you need to do so one morning. With the knowledge of your circumstances, you could think about approaching a bank for a bond once you have found a property.
Obviously, if you have cash, you can buy the property, find a tenant and be on your way. For the less fortunate, you need a deposit. My recommendation, against many pundits, advice, is 30%. It is good for bank approval to have some “skin in the game” or equity in the property but the main reason I see is that your bond will have a smaller payment in times of vacancy. As regards the bond, the banks like no more than 30% of your gross income payable on bonds.
They will permit a percentage of the expected rent to be included in your income but the old rule of 50% of that monthly payment is no longer simply applied. In addition to the bond, there are services and maintenance costs to add to your budget. [Talking about budgets, any businessman needs one for any investment].
These costs include:
- Rates, Water and Refuse: I estimate that municipal costs are increasing by about 7% per annum compounded.
- Levies: This cost, budgeted and apportioned by the Body Corporate, are rising at least 8% per year.
- Maintenance: Maintenance responsibility is determined in your Lease agreement with the tenant, but you will have maintenance costs as the landlord.
- Tenant Costs: The costs of entering and exiting a tenant should be considered.
- Capital: You don’t need a global pandemic to tell you that you need some spare cash. Vacancies occur. My rule of thumb is 6 months’ rent in ready cash. You can sail much closer to the wind financially but getting bank approval for a bond on a second property is not that easy.
Gearing is possible in property. It simply means putting in as little as possible in order to obtain a maximum return. Say you spend R1000000 on a property and you deposit R300000 and bond for R700000. Your rent per month is R10000.
In this case:
- Your loan-to-value ratio is 70% [R700000/R1000000].
- Your investment is R300000.
- Your return on investment is 40% [R10000x12/R300000].
Some investors see Gearing this way, but I never have been able to. Rather, I prefer the acid test calculation. If you don’t think you’ve signed up to invest R1000000, just skip a payment with the bank. You will quickly know that you owe them R700000 and, if you need to sell urgently, you risk some of your deposit as well.
So, if you agree, then the more conservative calculation for return on investment is: R10000x12/R1000000 = 12%.
In this thinking, you have also invested the R700000 but just decided to use the bank’s money to do so. But remember, whichever way you wish to see the investment, the 40% or the 12% is gross return and your costs, including vacancies, come off the return.
What I have done in these regards is requested the highest bond possible; in some cases, 100%. But I insist that it is an access bond. Then, I store the deposit and the rainy-day money in the bond for easy access if I need it. In this way, I hold a reserve and save interest equal to the bond’s interest and over time, that is a big saving.
You get tax relief on property investments. In general, costs are deductible from rental income. Some would, therefore, say my use of the access bond is conservative. But for all the years, I have had no overdraft and simply used the bond as such. Finally, a word on interest rates. Now, the rate is at historic, 40-year lows.
My old rule was to do the bond payment calculation at your rate + 2%. Right now, I would push that to +4%. The reason being that the SARB will increase rates to protect the economy against inflation and the Rand. The normal rules have been discarded within the crisis we have, but the minute we as consumers begin to buy again and inflation looms, the rates will go up. When, you may ask? My sense.. from this time next year slowly but surely.
KNOW THE ASSET
So many rules apply to this. We have discussed the “fixedness” of the asset class. Right now, investment or primary property, prices are down 20 – 25% off 2019’s valuations. You cannot easily sell your property without a deep price discount. In fact, allied to this if you’re a Buyer, you should only deal with serious Sellers. If the price is too high in comparison to last year, walk away – you could be overpaying.
Then the Golden Rule [he who has the gold, sets the rule ] but not that one. Rather, Location, Location, Location. Where you buy the investment property depends on the kind of tenant you envisage. If normal working-class people, then proximity to schools, transport, shops etc become the driver of the decision. If, as many are doing, you’re investing for your retirement and want to let long-term while you work, make the decision of where you want to retire and buy in that location.
Two extremes of the same investment principle, but the essence is that you determine the target market of your tenants and then work back to the location of your investment property. The building itself is very important. If the sectional title, [which I see as a rule ie no standalone investment properties], then ensure the financial management of the complex is sound. The bank will ask for Body Corporate financials to confirm this but if you’re paying cash, do the investigation yourself.
Maintenance is a killer-cost so reserves, recency of painting, state of the gardens, etc need to be considered. “Needs a little TLC” is great but who is going to do it and at what cost to your return on investment?
Avoid lifts [their maintenance is very expensive] and ensure back-up power generators are in place or that the “special levy” has been collected and invested for the move to backup power. Finally, I have never found a “bargain”. You may, and I encourage you to keep your ears close to the ground. But for me, a good property in the right location at the right price is the foundation for a long-term investment.
My late friend used to say: “Trouble equals distance squared.” In other words, buy a property close enough to you to be able to respond quickly and easily. Living in Joburg with a burst geyser in Cape Town sets the scene for what he meant. However, I wish I’d invested more offshore. Nevermind the Rand depreciation, property in hard currency has provided very good returns over the last two decades.
At this stage, you are able to buy good management as well in places like Mauritius, England and Australia. This is taking care of administration, tenancy, rent collection, and maintenance. Once you’re in the position to do so, consider offshore. Some of the student rental complexes seem to offer affordable properties at a good return, for instance.
I appreciate estate agents. To begin with, they are professionally qualified to practice. They have access to sound legal advice from conveyancers when required and often know the complexes in which they sell very well. They understand property and how to buy it. Make them part of your network especially in the area in which you intend to invest. Their time is free, and a well-structured appointment will give you stacks of information as you research your investment. But you have to take personal responsibility; it’s your money!
Think carefully through your investment – how much, where, which tenants, what values, what rentals, what capital appreciation, comparative pricing, facilities, state of the body corporate, special levies etc? This information can be simply obtained but you need to ask for it. Your estate agent is not investing your money, You are. So, it’s up to you. A primary consideration, if you require the service, is rental collection and insurance – you may wish to only deal with an estate agency that facilitates this important function of your buy-to-let investment.
Investment in property is not for the gung-ho or light-hearted. Many an investor will tell you of poor or peaked returns after costs or bad tenants. If you don’t have the determination to manage your investment, rather buy a unit trust. In fact, for sad economic reasons, right now Property unit trusts are at very low prices and may have upside as the economy improves. At least there, your money is easily accessible and the properties are managed professionally for the best returns available.
HLJ provides Bond Calculators on their website www.homeloanjunction.co.za. Our staff can point you in the right direction probably with many an anecdote of their own property investments, though never as advice.
When it comes to your bond application specifically, our service is free to you and loaded with professionalism. Like any saving, the cost of delay is very high. So, start now, even if it’s just for the deposit on your new home.
Yours in Property.