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Buying or renting a property?

Reader’s question answered.

JOHANNESBURG – In this advice column, Charl Bester, wealth and portfolio manager at Kruger International, answers a reader’s question about property.

Q: I live in South Africa, am 33 years old, work for an overseas-based company and get paid in the foreign country.

I want to buy a property here in South Africa, as I’ve been renting for the last two years. I am married with two children, work from home and would need a four-bedroom (let’s say R2 million) property. The banks argue that since my income is not earned in SA I am essentially “working abroad” and would therefore only be considered for a 50% bond.

So the question is: would it still make sense to buy? Having to put up R1 million and fees upfront would completely negate the leverage that is such a benefit when buying a house. The R1.25 million is currently invested in an equity unit trust, so at an annual return of 12% (which is on the low side considering the last ten-year average was around 20%, but taking into account a worse climate ahead), this 12% would give me a bit more than the R10 000 in rent which I am currently paying (and anything above the R10 000 rent would be capital growth).

Do I take the money out of the unit trust to buy? Or do I leave it to simply compound and grow?  

A: Buying or renting is an extremely valid question, although most people assume that buying automatically works in your favour, since you are paying off an asset. However, if you consider the right facts and do the correct sums, the answer is often in favour of renting over buying.

Let us assume that you could get a 100% loan from the bank. Your monthly repayment at a prime interest rate of 9.25% on a bond amount of R2 million is R18 863. Additional costs of ownership are rates and taxes, insurance and maintenance. These costs would conservatively add another R3 000 to
R6 000 per month to the total cost. In my opinion renting a house at R10 000 is substantially more beneficial than owning the same house. If one assumes an annual rent increase in line with inflation, it would take a very long time before your current rent matches your bond repayment and related costs of ownership. Until those costs match, you will have the difference in cash flow between renting and buying to invest every month. Further to that, it is likely that interest rates will rise in the medium term, which will increase the cost of ownership even more.

To add to the cost argument above, one should consider your own balance sheet and the assets that you are exposed to. We place a high premium on liquidity; by buying your own home the biggest exposure on your balance sheet would be a fixed property, which is relatively illiquid. When one considers the electricity crisis, general deterioration of our infrastructure and sub-par economic growth, we don’t find South African residential properties an attractive investment. We much prefer exposure to good-quality listed companies and believe that such assets will give you a much better return over time. 

Looking back over the last 30 years, the long-term return on South African equities with dividends reinvested, outperformed the Absa house price index many times over. Over that period, an investment of R100 000 in the JSE All Share, with dividends reinvested, would have grown to over R11 million. A R100 000 residential property would have grown to around R1.7 million over the same period, according to the Absa house price index.

We would therefore not suggest that you sell your unit trust (on which you will pay capital gains tax) and take the proceeds to buy an asset of lower quality, low liquidity and with less long-term potential. The caveat however, is that the difference between your rental cost and costs of ownership plus bond repayment is invested monthly, into high-quality assets such as listed equity shares. Exposure to an appropriate diversified portfolio of listed companies or an equity unit trust can provide protection against a depreciating currency and weak economic fundamentals.

It is however important to bear in mind that, in South Africa, we are in the 6th year of the current bull market and that the JSE return in future might be substantially lower than what we have become used to over the last few years. As such we find international listed companies more attractive and have been switching from locally listed shares to high-quality international equities such as Apple, Berkshire Hathaway, Johnson & Johnson, Unilever and YUM Brands.

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A R100,000 would been sufficient to cover any interest shortfalls and costs on a 100% loan over R1,000,000 worth of property 30 years ago until it could turn cash positive. The same property would be worth R17,000,000 today (assuming your ABSA house price index is correct). It should provide you with a R850,000 annual income, based on a conservative 5% yield, today.

Great advice! The mantra we were taught as children (“own your own house!”) is clearly false. The fastest savings rate I ever achieved was during the decade that I rented.

I question DavidConsult’s calculation in the comment below: A residence (note, we are not talking about commercial property here) worth R17mil does not return 5%. There are R40mil residences in the Waterfront returning only 2%.

Thanks for the article – could you possibly touch on free cash flow and the tax effect ? How would the potential leverage of the fixed assets to build up a property portfolio have panned out ?

This topic will never disappear.
Rental inflation should also be considered as it increases cash outflow over the period and will at some stage catch-up and even exceed cost of ownership. One should also consider the possibility of stock market crush/price corrections which can negatively hit your shares/unit trust portfolio. We can argue that interest rates will increase over time to the normal levels but its not an every year event compared to CPI.

What chances are there that you can rent a rent a R2mil property @R10K pm? Very unlikely. In Johannesburg it might get you a 2bed flat. This argument is somewhat flawed. The fact is a R2mil property will probably cost you in the 16-17K rent pm.

Your other option is to buy a property where you current rental equals the repayments. The rental escalation in SA is usually 10%pm. At the end of the rental period you have nothing, whereas if you pay the same amount at should you decide to buy a bigger place you can rent or sell. Rather buy a R1.25 mil property cash and start a new unit trust fund.

There are too many anomalies in this question and answer to be able to calculate what this reader should or should not do. Firstly his current rent is R10,000 per month which means that this property is only worth between 1.3 and 1.5 million. This is being compared to buying a 2 million property, so we are not comparing apples with apples. A 2 million property will rent for R13,500 to R15,000. Rentals usually escalate at between 8% and 10% per annum so the statement “annual rent increase in line with inflation” is totally incorrect. I have done this comparison some years ago when a large national estate agency was saying that renting is more beneficial than buying. Admittedly the breakeven point was somewhere between 15 and 16 years on a 20 year bond, but once you are past that point you are laughing all the way to the bank.

This is an emotional decision. There isn’t really a right or a wrong answer.

My biggest issue with buying a home is diversification. It will most likely be your biggest asset. Having such a sizable chunk of your money sunk into one asset is risky business. just like investing in only one share on the JSE would be.

In my mind the best way to handle this is to be humble in what you buy or rent. Rather than get the R2 million house, get something worth R1million. Do you really need a big garden, pool, second living area and spare bedroom?

The reality is that whilst most people see their home as an investment, you will only be able to realise a profit on your investment by cashing it in and buying something smaller or alternatively renting it out and moving into something more humble. People can become attached to their homes over time, and it would be difficult to rely on getting a return on the money that you’ve put into your personal residential accommodation. Your personal home is a lifestyle asset and not a money making one.

The place we’re staying in is valued near R2.1m and the rent is now R11k… Also, it’s not realistic to say that someone can keep increasing rent on a property annually by 8-10%. As the house price isn’t increasing in line with this, you’ll very soon be charging too much rent and the tenant will simply move out to somewhere where there’s a better deal.

I live in Cape Town and would love to know where you can buy a 4 bed house for R2m, never mind a house for R1m (as suggested below). Are prices that much cheaper in JHB?

I have to agree with Inge here. The numbers always go against buying, not only for a primary residence, but even in terms of a rental property. I’ve just sold my house, and if I take all factors into account (purchasing and selling costs, maintenance and most importantly loss of opportunity income), a R1.3m house has resulted in a lost of R2.7 million rand over the renting and investing option: http://investorchallenge.co.za/the-last-house-ill-ever-own/

The only case I could think of where it would be better to buy is for someone who has no control over spending, and would simply spend the savings being a renter would offer.

@RyanT -> Table View, Sunningdale have 4 bedroom places for R2m…

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