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Invest in income-generating property

Many real estate investors believe that property should be seen primarily as an investment class; hence the view that it is better to rent a home and invest in numerous income generating properties as opposed to owning a house that is not income-producing.

The best philosophy to adopt is to realise that your primary residence is both an asset and a lifestyle choice, whereas your apartment portfolio is comprised strictly of investment properties, which means that you will look at different factors when buying purchasing these properties.

To investigate this further, consider the situation of an average household. The family has saved R1 million to put down as a deposit on a property. They then require a bond of R1.5 million to acquire a solid family home priced at R2.5 million. Their bond repayments are over R15 000 per month and their rates are another R2 500 per month.

So, their home costs them R17 500 per month, without the property generating an income for them. If they chose to rent, they would be able to rent an equivalent home for R13 000 per month. This would result in a saving of R4 500 per month. In addition, they would then be able to invest their R1 million in income-generating properties.

To this end, we would recommend buying either one property for R1 million cash, to generate a clean rental return. Alternatively, one could buy two properties valued at R1 million each, gearing each one on a 50 percent loan to value ratio.

She says this can be understood by considering the first option: remember that the lower the buying price, the higher the yield. So while a property of R2.5 million would generate a return of approximately R13 000 per month (6.24 percent yield), a property priced at R1 million could generate as much as R7 000 or R8 000 per month (8.4 percent yield). This means that you should ideally rent your home, and invest in cheaper stock, because you would then benefit from paying a low rental at the R2.5 million mark, and earning a good yield at the R1 million mark. “In other words, you want to benefit as a tenant from a low yield property, and benefit as an investor/landlord from a high yield property. This way, you score on both ends.”

To return to the example, you are now renting your home for R13 000 per month. You have invested your cash in an apartment with a good yield and are earning R8 000 per month. After your rates on your investment property have been deducted, you are clearing R7 000 per month. In addition, you have saved R4 500 per month because your rent is lower than your bond installments would have been on your home. Thus, you are earning (saving) R11 500 per month, and spending R13 000 on rent – you have almost covered your entire rent and reduced your living costs right down to R1 500 per month. Plus, you have a lovely investment property and are enjoying the same lifestyle as you would have enjoyed because the value of the home you are renting is R2.5 million.

Reynolds says the other option is to buy two properties and gear them. In this case, your asset base has automatically doubled, but you now have bonds. Each property generates a return of R8 000 per month; R7 000 after rates have been paid. Your bond installments are approximately R5 000 per month. Thus, each flat is paying for itself, and you have R2 000 to spare on each one, which can assist in paying towards your rent on your house. Therefore you have two properties that are paying off their own bonds, and you have an extra R4 000 per month to contribute towards your monthly rent on your home. Your monthly costs are reduced to R9 000 and you own two apartments that are not costing you anything, with a value of R2 million.

“From an investment perspective, it sounds like an obvious choice: rent your home and invest your money in income generating properties.” There are, however, other factors to consider that could impact on this savvy business plan, she says. Firstly, SARS encourages South Africans to buy their primary residences in their personal names. Thus, there is a capital gains tax (CGT) exemption that is enjoyed when you own the home that you live in. With investment properties, CGT will apply, and hence any capital gain will be taxed at between 10 percent and 22 percent, depending on the nature of the legal entity that owns the property.

Reynolds says secondly, if you are creative and enjoy upgrading and maintaining your own home, renting can be frustrating, as you don’t have the freedom to renovate and upgrade. In some instances, buying homes, living in them and then renovating and upgrading them can, in itself, be a lucrative business. Especially since there is a CGT exemption on any capital gain made as a result of the improvements, she says.

In an ideal world, Reynolds says the perfect scenario would be to have enough capital to do both: own a lovely home that has potential for cosmetic improvements, enabling you to maximise your profits on your primary residence, and then having sufficient funds to invest in apartments as a side-line wealth creation business. The best philosophy to adopt is to realise that your primary residence is both an asset and a lifestyle choice, whereas your apartment portfolio is comprised strictly of investment properties, which means that you will look at different factors when buying purchasing these properties.

When doing the sums, it is also important to factor in the income tax that will be payable on the rental income, she says. This will form part of your annual tax assessment, and you will be taxed according to your tax bracket.

Perhaps the second option, she says, whereby two apartments are bought, each with a bond, is the wiser choice, as these two geared properties would result in less (if any) tax liability.

Source: http://www.property24.com/articles/invest-in-income-generating-property/21065

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