Every type of investment comes with its own set of risks, and the same is true for investment property. While the Covid-19 pandemic served to highlight the inherent risks of tenant vacancy and non-payment of rent, there are a number of other risk factors that any would-be investment property owner should take into account. These include:
Owning property is synonymous with maintenance and it is important that you give careful thought to the number of hours you will need to spend actively maintaining your property, especially if you are employed full-time. If your day job keeps you busy during regular work hours, home maintenance may need to take place after hours and/or on weekends. If you’re self-employed, you must be sure that the active management of your investment property doesn’t encroach on your income-generating activities.
If you intend to manage the property yourself, expect to be permanently ‘on call’ for your tenants who may not hesitate to contact you in the evening or over weekends to address their concerns or complaints. Burst geysers, leaking roofs, burnt-out gate motors, and blocked toilets don’t respect office hours, and when incidents such as these occur, you will be expected to attend to them immediately. While rental income is often referred to as passive income, this is not necessarily the case as property management requires active involvement on the part of the landlord.
As much as you may try to budget for the associated expenditure that comes hand-in-hand with property ownership, it is difficult to foresee every possible expense. As a rule of thumb, it is wise to budget, on average, one percent of the property value per annum to cover the costs of maintenance and upkeep, although this is only a guide. Insurance excesses, damage and breakages not covered by insurance, thatch repairs, faulty irrigation systems, general wear and tear, electrical compliance and maintenance all cost money, and you need to ensure that your budget accounts for these potential expenses so that your profits are not unduly eroded.
Depending on the property market at the time, a property can take anywhere from two to nine months to sell, and this can adversely impact your financial position if you need quick access to capital. Having all your capital tied up in a property investment cash can be risky, and if you’re forced to sell your property at an inopportune time for a reduced price, you may end up losing on your investment.
Rental is market-driven
Just as investment returns are market-driven, so too is the rental income you can expect to generate from your property. The rental you are able to charge is directly linked to the property market and is largely driven by demand. Sadly, the Covid-19 pandemic has driven rental income down as those financially affected by the virus struggled to pay rent or terminated their lease agreements.
According to PayProp’s rental index survey that compares the second quarter of 2020 with the second quarter of 2021, rents in Gauteng experienced a drop from the year before, with tenants paying on average 0.6% less per month – the average Gauteng rental for the second quarter of this year was R8 292 per month. The average rental in the Western Cape increased by 1.8% from 2020 to 2021, with the average rental in the second quarter being R9 185 per month. With this in mind, be sure to do some financial projections based on various assumed rental incomes so that you can plan accordingly.
The risk of your rental property standing empty has increased considerably as a result of the pandemic. According to the new TPN Vacancy Survey for the second quarter of 2021, rental vacancy has stabilised at 13.15%, with the Western Cape being the hardest hit province – and it is taking longer to find new tenants, which is an additional risk that needs to be factored in. As a result, many rental property owners find themselves in a conundrum where they can’t afford to drop their rent but similarly can’t afford not to have paying tenants in the property. Many property investors also find themselves in a position where they drop their rental prices in order to look after good tenants which, again, impacts on investment returns.
High transactions costs
Unlike investing in the stock market, investing directly in property involves high transaction costs and, as a result, a buy-to-let property should be considered a long-term investment. If you’re planning to purchase a R2.5 million property with a 100% home loan, you can expect your costs to be around R177 000, including bond costs, transfer duties and deeds office fees. Being a large proportion of your overall investment, it does not make financial sense to buy and sell investment properties often as you will need time to recoup the upfront transaction costs.
Rental property legislation in South Africa is fairly difficult to navigate and often works in favour of the tenant. If any disputes arise between you and your tenant, or your tenant fails to pay their rent, it is likely that you will need to employ the services of an experienced property lawyer which costs money. Where you need to bring legal proceedings against a tenant for non-payment of rental, keep in mind that you will need to be able to cover your income shortfall while at the same time funding the costs of legal advice.
Besides these additional expenses, legal proceedings can be time-consuming and highly stressful, and it is important that you are financially and emotionally prepared for such an eventuality. While there are rental insurance options available to cover the risks of non-payment, these policies are generally quite pricey and only cover a period of three months’ rental – and these additional costs will only serve to erode your investment returns.
What is important to keep in mind is that owning a single property in one specific location is in itself a risk. As a concentrated asset that is exposed to the nuances of the area in which it is located, your property’s value and rental-generating capacity is wholly dependent on a single set of circumstances that are unique to that particular suburb and/or street. Plans for low-cost housing, the building of a new shopping mall, the onset of a squatter problem, or the building of a new highway, are just a few eventualities that can dramatically affect the value of your property. As the pandemic has demonstrated to us, it is almost impossible to predict how future circumstances may affect property demand and prices making the term ‘safe as houses’ some of a misnomer.
Keeping in mind that rental income is taxable, you will also need to account for ongoing monthly costs such as sectional title levies, building insurance, bond cover, rates and taxes, and general maintenance and upkeep costs. If you intend to outsource the management of your property to a rental agent, you will need to budget around 8% of your rental income per month for these purposes. When determining whether to appoint a rental agent, it’s always a good idea to do a cost-benefit analysis to determine whether it is financially worth your while.