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Should I take a bond on paid-up rental property to invest offshore?

It wouldn't be wise to put yourself in debt to fund an offshore investment.

Would it be prudent and wise to take a bond on paid-up rental income property to invest offshore?

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It is quite difficult to provide a comprehensive reply to your question without in-depth knowledge of your current financial circumstances.

Therefore, the prudent response would be to advise that a person in a position such as yours should not place themselves in a position of debt to fund an offshore investment.

Furthermore, one needs to take into consideration the probability of rental income continuing. In this time of Covid-19, property investment yield may come under threat, with tenants moving out of rental properties to move into lower rent properties as the economy slows – or even simply not paying rent altogether.

However, if one were to take a bond on a rental property to invest capital offshore, one would therefore be assuming that the interest charged on the capital drawn from the bond would be less than the capital gain generated from both the devaluation of the rand against the currency in which the capital is invested and the growth experienced in the offshore investment.

An example could be as follows:

  • Let’s assume an investment of R1 000 000, sourced from an access bond on a rental property where the interest is at 8.75% per annum and the investment is held for one year.
  • Therefore, the interest on the bond would be R87 500.
  • Let’s assume that the capital is invested in US dollars at a rate of R17.50 to the dollar and the investment is placed in a mix of offshore-based unit trusts.
  • Let’s assume the exchange rate goes to R18.50 over the year and the unit trusts perform at 5% for the year in question.

Therefore:

  • R1 000 000 at R17.50 to the dollar = $57 143
  • Offshore unit trust performance at 5% in the year = $57 143 + $2 857 = $60 00
  • Converting back to rand after one year = $60 000 x R18.50 = R1 110 000
  • R1 110 000 – R1 000 000 initial capital = R110 000 capital gain.

But now we need to consider capital gains tax (CGT):

  • R110 000 – annual exclusion of R40 000 (we assume this is the only realisable capital gain for the year) = R70 000
  • R70 000 x 18% (maximum effective CGT rate of tax) = R12 600
  • R110 000 – R12 600 = R97 400
  • R94 400 – R87 500 (the interest payable on the bond) = R9 900 gain.

Now this may seem like a viable investment strategy, but we must also realise that offshore investments carry risk on both the performance of the underlying offshore unit trusts and on the currency. So, what if we assume that the currency strengthens to R17 to the dollar and the underlying offshore unit trusts only provides a 3% return in the year.

If we redo the calculation above, then:

  • R1 000 000 at R17.50 to the dollar = $57 143
  • Offshore unit trust performance at 3% in the year = $57 143 + $1 715 = $58 858
  • Converting back to rand after one year = $58 858 x R17.00 = R1 000 586
  • R1 000 586 – R1 000 000 initial capital = R586 capital gain.

But now we need to consider CGT:

Due to the low nature of this capital gain, we assume no CGT payable in this case.

Taking into account the risks illustrated above and the fact that we do not know your circumstances (age, income, personal balance sheet and so on) – and even though many property investment books say that you should use the bank’s capital to grow your investment portfolio (usually by purchasing another property and using the rent on the initial property to repay the bond on the first property) – we would not suggest a decision such as the one you are considering to be taken without consulting a professional investment advisor.

In current times, such strategies must be considered very carefully with all the possible risks being taken into consideration, including the possibility of rental income going down or stopping altogether.

I trust this provides some answer to your question.

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