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Measuring Investment Property Returns…

South African Buy-to-Let Return on investment (ROI) is a standard meassure in financial terms to measure and determine the effectiveness or profitability of an investment.

It measures the amount of return as a percentage of the initial investment required.

So if I invest R500000 into an account that pays 7.2% interest per annum (R36000), my return would be 7.2%.  Similarly, if I purchased a house for R500000 and rented it out for R3000 per month, thus R36000 per year, your return would be 7.2%

But what if I don’t use my own money to buy?   When I purchased that townhouse for R500000, I don’t pay cash, but raise a bond over the property and only fork out the costs (bond, registration, transfer fees, etc.).  This would amount to approximately R13600.  My bond repayments would be R5000 per month or R60000 in the first year.

Together with the initial cost of R13600, an investment of R73600 has been made in the first year.   If rented out at R3000 per month I would offset that R36000 income against my cash flow.

The ROI would show R73600 generates a R36000 return or about 50% in the first year.  This example is relatively simplistic, and leaves out rates and taxes and the possibility of Capital Gains on this property (as well as the tax necessary on the income), the point is made that the ROI of investing in property can be quite high when coupled with gearing or leveraged finance.  Don’t mistake ROI with cash flow though.  The cash flow in the above example is the difference monthly or yearly between the income and required expenditure.  A R5000 bond repayment and R3000 rental income makes for a minus R2000 monthly cash flow, i.e. R24000 in the first year.

So I have an investment that gives me a 50% return on investment versus 7.2% in the bank, but I need to pay in R24000 to get that return.  So I don’t see my ROI in my bank account right away, but it is there and only in years to come will that return become more and more evident, hence property is a long term investment vehicle, never mind the short term ups and downs on the selling price.

Investors forget that the idea was never to buy and sell property at a profit.  In the current market, there are not really profits, prompting many owners to sell their underperforming asset.  Is there a better asset?  Just ask astute stock exchange investors – they are just as worried about their assets no longer performing in the near future.

The idea was to invest for your retirement, i.e. R3000 a month cash in your pocket on a paid off asset x 10 = R30000 a month.  That still holds.  R30000 a month for not doing anything?  Than can work.

So we are in the best investors market in years to acquire those assets to get there.  Why is there so little buying going on?

Worried about inflation maybe?  Remember, you need something to outperform inflation.  Property and maybe gold, are the only assets that perform in an inflationary environment – note that it now costs 10-20% more to erect a house than it did 12 months ago due to the raw material costs.

Then the question posed is, do we really need more houses?  Of course we do – South Africa is one of the nations of the world with the biggest housing shortage vs. the population number.

And I can tell you what property developers need to develop next – 1 bedroom bachelor units of a high standard at an affordable rental price – these properties currently match bond repayments and rentals the best.

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