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  I would not recommend buying physical property. Don't underestimate the PIE Act and it's implications - I have been the subject of a professional squatter and it was one of the worst experiences of my...  

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When is investing in property a good idea?

Reader’s questions answered.

CAPE TOWNIn this advice column Barry O’Mahony from Veritas Wealth answers a question from a reader who needs advice on whether to invest in property.

Q: Please may I ask you to assist me with advice regarding a dilemma my husband and I have right now? He is 69 years old and has two more years of working, earning R50 000 per month. I am 54 and have my own small home-based business which takes care of personal expenses, luxuries and family holidays.

We own our primary residence, with no bond, worth around R3.3 million, and a holiday house at the coast worth R1 million. The only debt we have is about R120 000 we owe on a car. We have one son who still has two years of schooling to complete, and four years at university.

Our investments include R5.5 million held with an investment company, R800 000 in a retirement annuity, R450 000 in a pension product, and R1.3 million in the money market.

An opportunity has now come up to purchase a townhouse for R1.7 million. My husband doesn’t feel that it the right thing to take cash we currently have in the money market and invest it in a residential property. He feels that he would rather invest it with the current investment company.

I however feel that a second property would be a better investment, particularly as this could be rented out. The rent could cover a small bond until the property is paid off and we could then have the benefit of a second income when he retires in two years.  

We could also potentially take the early retirement value on the pension product and use this towards the bond on the property. 

What would you advise?

 

In looking at your situation, you are both doing relatively well from an earnings point of view, but the 15-year difference in age is a huge factor that makes planning much more difficult. You also started a family relatively late and as we all know, kids are incredibly expensive, especially in their teens and early 20s.

Given your family situation, it counts in your favour that your husband plans to work until age 71. We fully support people carrying on their working lives while this is still fulfilling, and the additional economic contribution it provides increases your chances of being financially independent in retirement. If it is possible for your husband to continue to earn some money for another few years beyond age 71, this again would be an enormous help.

Before going into the specifics of your situation, there are a few considerations to bear in mind when considering the investment case for physical property against an investment in a balanced portfolio:

 

  • Property can be leveraged, balanced unit trusts should not.
  • You will receive a capital gain from the property and also earn an income once you have retired.
  • Liquidity in real estate can be a problem from time to time. The transaction costs involved are also very high and there is the hassle factor of maintenance and finding tenants. If you hire a management company to do this, then this will reduce the rental income. A balanced fund is liquid within a week and is hassle free.
  • Property prices are very interest rate-sensitive and rates are expected to continue to rise in the short term.
  • The long-term average return from SA residential property is lower than portfolios with high equity holdings.

 

To look at your specific circumstances, we performed a calculation to ascertain how long your money would last, and to determine what returns your investments would need to achieve in order to reduce the risk of outliving your capital.

Our analysis is based on the following lifestyle assumptions:

 

Living costs:

R30 000 per month

Education costs

R120 000 per annum for two years;

 

then

R80 000 per annum for four years

Student car                  

R100 000 in three years

Car replacement every five years

R200 000

Savings into retirement annuity

R72 000 per annum for 11 years

Income

Husband

R50 000 per month for two years

Wife

R40 000 per month for 11 years

 

Our model showed that you needed to target a return of CPI + 5% per annum on your investments. This is an important piece of information and a useful guide in choosing what is suitable and appropriate.

It shows us that your money could last until age 97, although this is a very demanding rate of return. Many asset managers would argue (currently) that this return will be hard to achieve in the short- to medium term.

The second thing to do is to look at your current asset base. You have R8.2 million in investments and R4.3 million in property (although these are lifestyle assets).

If you were to withdraw R1.7 million from the R8.2 million then you would have nearly 50% of your assets invested in real estate. Secondly, local residential property in the long term has given a return of CPI + 2% since 1967, although this does not include the net after tax rental you could also have received during this time.

While some investors may have achieved greater returns in recent years, we must be careful to look at longer time frames given that all investments eventually revert to the mean and we are talking about a 45-year period.

In summary, to achieve a CPI + 5% return you will need around 65% to 75% in equities (local and offshore) to achieve this long term. History tells us that shares/equities will give a higher return (CPI + 7-8%).

It therefore appears that your husband’s intuition may be correct in the long term. Our calculations also highlight that you cannot afford to have R1.3 million sitting in cash, as this is earning an after-tax return of CPI -1%. Inflation will unfortunately erode that capital over time.

A scenario where the property purchase could be justified is if you decided to sell your current primary residence in 11 years’ time to move into either your holiday home or the new townhouse. However, the likelihood that interest rates will continue to go up locally indicates that capital appreciation in property may be weaker going forward.

In terms of cashing in the pension benefit, there is no need to do this. If you need cash for any reason it would be better to take that from your R5.5 million investment.

This is because that would only attract capital gains tax. This tax would be lower than the tax on a withdrawal from a retirement fund and there may also be penalties applied by the fund on an early withdrawal.

Barry O’Mahony is a financial planner with Veritas Wealth in Cape Town.

If you have any questions you would like answered by financial planning experts, please send them to editor@moneyweb.co.za.


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Maybe a better idea if they do still want to go through with the property idea, buy two cheaper units for between R1.3 and R1.5 million (that’s the total for both together) and rent them out.

Easier to rent each out at around say R7000 than to rent out one property at say R12 000 (but yes, the costs will be a bit higher). And you have tenant diversification. If one units tenant doesn’t pay or its empty for a month, you still get something. And won’t even need a small bond.

Oh no! not again. This looks like an infomercial to me in any case. Big mistake to buy residential property in SA as investment. The initial costs are very high and the risk and tax hassles not worth it. Even fixed investment at 7% per year at bank much better option. All the projected income return figures for renting and “leverage” are pure speculation and smoke and mirrors. Never happens. Figments of financial advisor’s fertile imagination. Capital growth is a myth. Only ones smiling are estate agent and seller. Think I am joking-SARS Transfer Duty on R2.8 million transfer is R145 500 !! Conveyancers costs about R31 000. And that excludes bond costs. On R1.5mil SARS want R30 000. I got the T-shirt on BTL. It takes one bad tenant to wipe out your cash flow and “returns” for the next 5 years. Anybody involved in conveyancing and evictions will give a much better picture of figures and risks. Evicting tenants is a costly legal nightmare. You have been warned.

R1.3 million sitting in a money market fund is not a good idea. There a better alternative use of that money

I’ve invested in property and in the markets.

Although there are many factors to consider, I help my clients on retirement to get guaranteed monthly income and capital growth above inflation from the markets for these reasons.
Money is more liquid,
Fees are much less,
Income is guaranteed, about 8%
Capital growth is guaranteed, about 8%

There ar instances where property can be an option, but you would need a proper calculation tool to give you the full picture and point out the risk.

REAL growth of properties are less than 2% and some very strategic places it was 30%, but the rent you get and the running expenses, a whole list, can whipe out the fairytale.

Your income is also not stable due to tenants and interest rates.

Selling your property can take up to, true story, 5 years to get your money liquid depending where you buy.

Fees related to property would be:

7.5% Estate agent when buy and sell.
20% on estate duty if not in trust
Income tax
Levies can be up to 10% in some places
Conveyancers costs

Happy retirement!

Owning property in SA is not a good idea given the political environment. It is not impossible that the ANC might tax property owners more heavily and there is the added danger of expropriation. Best thing these people should consider is to send the loot offshore and invest in a vanguard or similar index fund, I would respectfully suggest.

I am bemused by some of the above comments on property investment. It is pretty obvious that all the costs involved in purchasing or selling a property should be included in calculating your return on the total deal (not just the purchase price). It is disingenuous to point to the costs involved as “expensive” as if it stands separate to the investment case.

If I was invested in African Bank, I may tell you that equities are a bad investment

Any investment has upside and downside risk. You can make money in either a bull or a bear market. The truth is that you will burn your fingers with property investment unless you have the same dedication in doing proper research that a fund manager does in selecting equity investments especially in bear market. There are no free lunches. If you cannot invest the time, be happy to pay the fees for someone else to manage your money.

I would not recommend buying physical property.
Don’t underestimate the PIE Act and it’s implications – I have been the subject of a professional squatter and it was one of the worst experiences of my life.
Rather buy property REITs if you want property exposure. You get diversification, you can sell it, in any size, you can still gear it, you avoid transfer duty, and you avoid the PIE Act.

Enjoy your retirement, rather than fixing breaking geysers and taking criminal squatters to court to get back what belongs to you.

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