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.