I am biased about property

Property investment profitability – What a mouth full! I find many people on the interwebs and Twittersphere is vehemently against property investment. The simple reason for this is people favour the things that they know – this is cognitive dissonance at play here.

Even so, many people will tell you that property is not profitable – and in some cases this is true. There are also many stocks that are not profitable as well! Here are some of the myths:

Property profitability myths

  • Property cannot give you the returns stocks can
    • Well, then my calculations are wrong and I should just die
  • When you calculate the cost of repairs, maintenance and other costs it becomes unprofitable
    • I include these in my calculations and so should you
  • You will need to pay money from your own pocket monthly as the rent doesn’t cover the mortgage
    • Well, sometimes. It depends on the property you are investing in.
  • Rent and property value will not increase by inflation
    • This is biased, as many many stocks do not increase with inflation either – Steinhoff anyone?

Choosing your investment strategy

As with all investments, you need to have a strategy and see it through. If you change direction the whole time, you will end up with nothing in the end. Property is the same – don’t fail to plan!

Property type strategy: krugerrand or cashflow properties

All property is equal – but some are more equal than others. 

I personally believe there’s two types of property you can invest in – cashflow and krugerrand properties and a good property investment strategy has a bit of both. Here’s a quick summary of these:

Krugerrand properties

  • Upper class suburbs
  • Purchase price is expensive – you get what you pay for
  • small and large properties, but the price is steep per square meter
  • Low rent to purchase price ratio
  • A down payment or a large monthly shortfall is often required
  • Value often increases more than rental income

Cashflow properties

  • Often situated in below middle class locations
  • Often the price is competitive or cheap compared to other properties with similar specs
  • Small properties, such as flats, sectional title units and low cost housing
  • High rent to purchase price ratio
  • A small monthly shortfall is payable
  • Rent often increases more than property value

To give an illustration of the following, I normally compare my personal properties on a rent to purchase price ratio: If I buy a place for R 400 000, I expect a minimum rent of R 4 000 per month (a 1% rental factor). Often I would actually expect a rent of more than this – as I would prefer my rent to cover my bond and all monthly fees. This is an example of a cash flow property.

I could also buy a Krugerrand property. I could spend R 1 000 000 on a place that is a bit more upper class, but my rent is only R 8 000 (a 0.8 % rental factor), and my levies and taxes have been deducted yet.

Term strategy: rental properties or fix and flog

This question is rooted in the argument about what is more important – cash flow of capital gain. It’s also very much entwined to your personality and your physical abilities.

Passive income

  • You get paid regularly for not working – e.g. monthly rent for someone living in your flat
  • Low / No involvement with returns, without affecting your capital investment – think dividends and rent
  • Buy to keep – you are not planning on selling anytime soon, thus your taxes are lower

Capital gain

  • You do a deal to get a cash injection – e.g. buy, fix and flog a property
  • High / moderate  involvement to manage your invesment until you flip it
  • Your end goal is to sell your investment and use the profits for something else.

Many people will tell you in old age you need income – which is true, and many people settle for passive income, rather than drawing money from their living annuities. Well, the fact is you will need money then, and I would opt for passive income! But right now, it would be cool to have both. The cycle often works as follows: make money through capital gain, and invest this into assets that will give you passive income. 

I love passive income, but I do realise that your own money only will not make you retire early – unless you sell both your kidneys, heart and lungs. 

Financial strategies and planning

The whole purpose of this exercise is making money. Nevermind how much you love property and people – this is a business and you will need to manage it as one.  Obviously I will not tell you what to buy or how to buy, but will give you a few guidelines and ideas

Choosing between a mortgage or buying cash

If you have the cash – well done! If not, well then you need to settle for a mortgage / homeloan. But I do believe there would be reasons why you would not want to buy the property cash. 

I will do a separate article with the trade offs, but here’s some things to consider:

Mortgage

  • Many fees will be payable – see my blog post here
  • You could deduct fees and interest from tax
  • The majority of the monthly repayment could come from the rent

Buying cash

  • You generate instant cash flow
  • You only need to pay fees for the transfer attorney, not the bond fees
  • You can reinvest your profits to make more money

I think everyone wants paid off properties, but this really depends on your strategy and time you have left before retirement – If you are very close to retirement, you sort of need to make a plan to get monthly money coming in.

Fees, costs and other factors to include in your calculations

Many people do not know where to start when they need to work out if property is and will be profitable. Here’s some guidelines that could help you to work this out for yourself:

  • Know beforehand all fees:
    • Monthly fees
    • Yearly fees
    • Possible unplanned costs
  • Take into consideration the rent you will earn, as well as a possible rise in property value
    • You cannot determine by how much property values will climb, but you can look at historical data and compare that with stocks and bonds and other property. If you have had your property for a while, you can calculate these!
    • Call a few estate agents to get a better idea about market related rent
  • Calculate how much you need to pay out of your own pocket (your shortfall or deposit)
    • Compare this with other properties and other options that you know well
  • Speak to a tax consultant about the most effective way to pay less taxes
    • The best way on this is to have more expenses and less income. Note you should NEVER rent your property out far below the standard – SARS sometimes checks this with audits – and they check all your expenses as well!

    Calculations for investor savvy people

    If you are really tech savvy and have awesome Excel skills, you are able to work out some of the following:

    • Calculate the annualised return of your property by comparing the amount of money that you would need to pay out of your pocket, and including the rent and the property growth you have had,  minus your expenses of course!
    • work out your ROI over the 20 year term with projected rental income and property value increases. Note to include other fees as well and don’t estimate rental increase of 10%, this really is rare in the property market!

    Conclusion

    I see this post as an introduction to strategically planning your property investment. The most important thing from all of this information is that you need to be hands-on: you need to know what’s going on in your investment. Volunteer to be on the body corporate of your sectional title investments, be included in your neighborhood watch and speak to many of the estate agents and rental agents in the area to be up to date with the latest changes and news.

    The three most important strategy categories to take from this post is:

    • Property type
    • Term strategy 
    • Financial strategy

    Final notes about another upcoming post

    There’s so much info to share! I have here my first post that would probably be in a series of posts. I would expand on the financial calculations in a next post, but realise that I require the calculators to be build and completed as well for all of these to make sense. 


    Frugal Local

    Frugal Local runs his own company (Effectify). He does software development and helps small businesses and startups with digital solutions. He enjoys writing articles and simplifying complex things - such as the article you're reading!