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Why property is a winner: Building wealth on a salary

I’VE ONLY ever met one rich person who believes residential real estate is not a good investment. A fund manager who started his own successful asset management company in Cape Town, he told me he does not believe that property is worth the hassle or the money involved in keeping a home maintained and managing tenants.

He is, of course, right in saying that there are many costs and potential headaches associated with residential bricks-and-mortar. However, he also has an advantage over other investors in that he has significant sums to invest in other assets. You generally need a big lump sum to generate reasonable returns.

The big benefit residential property has over other types of investments is that you don’t need much money to get into the game relative to the size of the asset you are buying. You can put down a deposit and, provided you have a good credit record and can prove you can cover the monthly home loan repayments, it is fairly easy to get a bank to cover the bulk of the purchase price for you.

Your returns, meanwhile, aren’t based on the size of the deposit but on the total value of the asset. If you hold the property for long enough, it can produce a huge return for only a small outlay.

For example, I have a friend who bought a bachelor flat in Green Point, Cape Town for about R300 000 in 2000. A tenant has paid off his mortgage for the past 14 years.

He put down a deposit of R30 000 and has spent roughly R170 000 on other costs, including maintenance, building upgrades and a messy legal action that involved the body corporate. Looking at what similar flats have been selling for in that building today – R2m to R2.5m – my friend can expect to make not far off R2m on an investment of less than R200 000 of his own cash.

He would have been hard-pressed to find an alternative investment that would have transformed R200 000 to R2m.  He has had some problems with tenants over the years, but the returns should more than make up for these.

Green Point is what is considered an excellent property location because it has upgraded as the nearby V&A Waterfront has been developed. But, the long-term trend is similar in many other suburbs in South Africa, even if the returns aren’t as extreme.

The way you magnify your returns by using borrowed money is called leveraging. You can borrow money for other types of investing, though it is not as easy – or as low-risk as in the case of property – for ordinary income earners to do this.

Some people don’t regard the home you live in as an investment, but I do. Here’s why: you have to pay for the roof over your head regardless of who owns it.

I would rather pay off my own asset than someone else’s. And, at times in my life when I have battled to find money to invest, I have always been grateful that at least my home is a type of forced saving.

My home will grow in value if I keep it for at least five years and preferably longer. History has shown that in the long run property prices tick up in line with inflation and often more, even if there are some blips in performance along the way.

Of course, renting means you can get a landlord to cover maintenance, insurance and other bills.

If you own your home, over time the monthly loan repayments are much smaller than what you would pay as a market-related rental. This is unless, of course, interest rates shoot to staggeringly high levels like they did in the late 1990s.

Eventually you will owe nothing to the bank for your home. When you retire (yes, that day will come!), it will be a huge relief to know that you own your property.

Another option, if you are paying off your home, is to rent it out when your mortgage repayments get to a level that is lower than average market rentals for your area. And, then, you can look for another home to live in, and start building up equity – or value – in a second property.

As for the other fund managers I know: The ones who have shared personal information about where they live all reveal that they own their own homes, many in suburbs dominated by luxury houses. Fresnaye in Cape Town is a particularly popular neighbourhood for asset managers.

Some, no doubt, have used mortgages towards their property purchases. So, even though they invest in other assets, like their own funds or shares listed on the stock exchange, property is still part of their overall wealth building picture.

If you are still in any doubt about whether you should be investing in property, look at what the ultra rich do when the global markets get rough: they put their money in bricks-and-mortar. This is why prime residential property has become a safe haven asset.

 

Fin24 – http://www.fin24.com/BizNews/Why-property-is-a-winner-Building-wealth-on-a-salary-20141112

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