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Is buying investment property with friends a good idea?

Reader’s question answered.

CAPE TOWN – In this advice column, Carl van der Berg from Alexander Forbes Financial Services answers a question from a reader who is thinking of investing in property with his friends.

Q: My wife and I have been given the opportunity to buy an investment home, but we don’t feel that we could afford it on our own. We are thinking of asking friends of ours to join us in the venture, but I want to make sure we consider all the pros and cons. Is it possible to get a joint bond in these circumstances? What are the most important things we should agree to beforehand and do we need to put any contracts in place to protect everyone’s interests? What are the major pitfalls we should avoid?

Any investment that you make will carry a certain degree of risk. So when making any investment, you should always be looking to achieve two basic objectives:

Firstly, you should be looking to reduce any potential financial or non-financial risks as much as possible per unit of return. Secondly, you should be making investment decisions that fall completely in line with your long term financial objectives – and these objectives should always include maneuverability and flexibility.

Buying an investment home with friends does potentially undermine these two basic objectives. Therefore any potential opportunity and financial gain must be measured against the additional financial and non-financial risks that would come with this initiative.

Before we get too negative, let’s unpack a few of the advantages of what has been suggested. The most obvious advantage of investing into property with friends is that you would be unlocking an investment opportunity that you would not otherwise have access to alone. Buying property is often not easy, and any assistance could be welcome.

The risks of ownership and the costs related to that ownership, such as insurance, could also be shared between the stakeholders, and therefore the risks and the burden of ownership would be spread. Perhaps the most dazzling advantage, and the reason why many people see much value in building up a property portfolio, is the fact that property has a capital growth component as well as the rental income stream – similar to owning shares that provide dividend income. Although nobody would pay you to live in your shares.

Unfortunately, this is where the advantages seem to end and many potential negatives become quickly apparent.

As already mentioned, property as an asset class has the advantage of capital growth as well as an income stream, but an individual property as a single asset limits you to merely owning a tiny fraction of the greater market. Here the value of your investment is affected by many factors beyond the general economic factors driving the property market. These include specific concerns relating to location, future area development, the quality of your tenant etc. As the poet Ralph Waldo Emerson said: “if a man owns land, the land owns him.”

You would also need to consider the non-financial risks of getting into business with friends or family, where roles and responsibilities would need to be shared. In the likely event that one investor becomes more involved than another, they might feel more entitled to a greater share of the rental income. This could lead to all types of conflict that can’t be plotted on a graph or solved with one’s calculator.

Perhaps the biggest potential pitfall is related to the availability of investment capital. You might be financing the house simply to lessen the taxation of the rental income, but in the event that either party needed access to the investment capital that was put into the joint venture, it is very likely that the initiative might have to be aborted prematurely. And there is nothing quite as potentially damaging as bringing a long term investment strategy to an untimely end, especially when you are dealing with sunk costs such as bond initiation fees, transfer duty, and the very expensive services of the lawyers who handle this for you.

As to the question of whether or not this is even possible from a financing point of view, most banks would consider as many as four applicants on a single bond application. Any more than that and you would normally have to set up a company structure that would buy the property for the members of the company. This could provide a greater degree of control and flexibility to the venture.

The most important thing that should be agreed on is to make any decisions in writing, perhaps seeking legal counsel when doing so. All of the dangers mentioned above (and even others that have not been mentioned) should be unpacked and mitigated against using appropriate proactive solutions.

Alternatively, for those looking to get exposure to property as an asset class, owning shares in a listed property company, or units of a property unit trust is often a great starting place.

Carl van der Berg is a financial consultant with Alexander Forbes Financial Services.

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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