Investing in rental properties in South Africa can generate income and significant tax benefits as well as build equity over the life of the property ownership. But, as with everything, before you dive in head first, what do you need, what should you look for, expect and most importantly: is investing in property right for you and your finances.
The buy to rent investment market in South Africa has developed significantly over the last 15 years.
Residential property is an attractive investment and is easier to understand, purchase, and manage than most other types of property. And, if you’re a homeowner, you have already navigated the process and understand residential property maintenance.
When it comes to your residential property investment options, start small: sectional title town houses homes are a good start and work well for investors who don’t want to deal with building maintenance and security issues.
“Although many succeed investing in real estate, it isn’t for everyone. You need to take into account your investment preferences and even personality. Do you have the time to devote? Are you comfortable troubleshooting problems or prefer to hire a property manager?
“What we’ll see in 2015 is a lot more developments coming online. So, I think (later in the year) it’s going to revert to a fairly neutral market. I don’t think it will be a strong buyer’s or seller’s market,” says Richard Gray, CEO of national group Harcourts Real Estate.
New Development yield great initial investment returns. Areas where there’s new development or redevelopment is are where you want to be. The best investment properties are well located and physically sound but ‘cosmetically challenged’.
The average consumer is catching a few breaks this year. “With petrol prices coming down, people have a bit more income, interest rates have been low for a long time now … people have their heads back above water and buyers are not struggling as much with their finance,” says Gray.
It’s a sentiment shared by FNB household and property sector strategist John Loos, who expects interest rates to remain flat for the better part of the year, as lower oil and global food prices reduce inflationary pressures. On the plus side this will stimulate consumers’ interest in the housing market but, with fewer properties currently available, it will also lead to an estimated 8% increase in house prices come year-end, he adds.
According to FNB’s Property Barometer, following price growth in the previous two years, 2014 saw a mild deterioration in affordability. This could well continue into 2015 – somewhat limiting buyers’ property options.
“That may sound strange to some, because a lot of people think that the better the market is, the better the opportunities to buy but, in fact, it is quite the opposite. Buying on the lows and selling on the highs is the best-case scenario,” Gray says.
“The residential market will continue to be strong, but by no means are we in a ‘boom’,” says Everitt, adding that sellers still need to have strategies to outperform other sellers and be mindful of the strict lending criteria that banks still apply.
According to ABSA, the average growth on residential property over the past 20 years has been in the region of 13% per annum. It’s been a lot higher over the last four years, but let’s stick to 13% and do a little calculation. A house that cost R360,000 seven years ago would sell for R846,000 today. At first glance that seems to be a good property investment, but is it a good investment to buy houses and rent them out?
We at IGrow Wealth Investments believe RESIDENTIAL PROPERTY IS ALWAYS A GOOD INVESTMENT, but many investment managers won’t agree that it is good practice to buy and let, especially not in the current market. Their argument is that rentals are low and prices are high. If you pay R846,000 for a house and only receive R5,000 rental per month, you get an annual return of 7%. There are plenty of other investment instruments that will give you more. But what these investment managers lose sight of is that residential property is not about rental, but rather about capital growth. When we do the calculation as in the previous example above, everyone agrees that it was a good investment.
Investing in Property for Rental Returns in Cape Town, South Africa
Buy with your head not your heart
The decision to buy an investment property must be based on rational reasons, never forgetting that you are investing to maximise your return on investment. Do a detailed cost benefit analysis to ensure that your decision makes economical sense.
First income, then potential capital gain
When buying an investment property, your focus should be on the monthly rental income and only afterwards on the potential capital gain. By focusing on the cash flow first you will ensure that your investment will break even sooner than it would if you were focusing on capital gains.
Its a long-term game
Property investment is long-term investment, so you need to build your portfolio over time and be prepared to sit out any downswings in the property market.
Tips for first-time buyers
- First-time buyers should ensure they know how much funding they qualify for, before they start shopping around, Everitt advises. They should “…not necessarily have received their mortgage bond (because you can’t do that until you’ve made an offer to purchase), but they should go to a mortgage originator … and get them to pre-qualify them and find the right bank. They can motivate that particular client’s case better than they could if they went directly to a bank.”
- Most importantly, buyers shouldn’t over-extend themselves. That means not going for the maximum possible bond that they qualify for, because economic conditions could always change for the worse at any given time, leading to finances that they wouldn’t be able to manage. Interest rates will eventually rise again and it is important to allow some leeway for mortgage movement.
- It’s vital to have some kind of financial buffer – be it savings or investments – that can be accessed in the event of emergencies that could cause you to miss your mortgage payments.
- Generally, spending about 30% of your income on a home loan repayment is considered reasonably affordable.
- Critically, secure the lowest interest rate possible. “People tend to accept that their bonds require a monthly payment, which they have no way of influencing. In fact, there are many things that you can do that may alter the amount of interest you end up paying and the term of your repayments,” says Kay Geldenhuys, property finance processing manager at bond originator Ooba. She says many buyers hurry to accept a bond from the bank that offers them the biggest loan, with less regard to the interest rate. Securing a lower interest rate will save you a great deal of money long term.
For Property Investors: Section 13sex tax allowance
Yes, you read right: Section 13sex – the sexiest tax deduction around. This is for the slightly more sophisticated investor with more than five investment properties. It’s a great incentive for buying off-plan properties and not many investors take advantage of this allowance.
Very basically, if you own five or more residential properties you can claim, as a capital allowance, an effective 2.75% (55% x 5%) of the value of any units that were acquired directly from a developer. If, for example, you owned five apartments and one was purchased directly from a developer for R1 million, you could claim a tax deduction of R27 500 per year. If you are taxed, for instance, at the highest marginal tax rate of 40%, this could save you up to R11 000 per year. As with all capital allowances, it should be recouped on sale of the asset. Download our Article13Sex PDF
The right mindset: This might sound like a strange piece of advice, but it is also very important. When buying income-producing property it takes a different mindset than purchasing a home. Buying a home is an emotional purchase, whereas an investor buys a property because of its value, the income it will generate and its potential for capital appreciation. So make sure you view the property and investment with the right perspective and the end-goal in mind.