CAPE TOWN – In this advice column, Carl van der Berg from Alexander Forbes Financial Services answers a question from a reader who is trying to come to terms with the benefits of renting and buying property.
Q: At what point does buying a property make better financial sense than renting? I have another four years, and just under R100 000, to pay off on my car at R2 300 per month, and a R39 000 credit card debt I’m paying off as fast as I can at R2 000-R3 000 a month.
I share a flat with two other people currently, and pay R4 000 rent. I’m considering buying a two or three bedroom flat in the future and renting out the other bedroom(s) to help pay off the bond. But there’s the risk of not finding tenants.
Is this a plausible idea?
This is not a straightforward question, so I will look at it from just a few of the many possible angles.
In my experience, many clients, friends and family members have been quick to brag about the superb returns that they have made through investment property. There is, after all, much to be said about getting somebody else to pay off your bond.
But in some of these conversations I have been able to scratch beneath the surface and discover that it’s not always as straightforward as it may appear. Property investing comes with its own set of exclusive risks that other investments do not carry.
Many people that I either know or have spoken to have not had just a few but many challenging experiences with property ownership, tenant instability, damage and so on. Suffice it to say that owners put in too much work for rental to be considered as purely passive income. It’s not as simple as thinking that you can sit back while someone helps you to pay off your bond. We, therefore, need to consider your specific situation a little further.
Based on your credit card being in a negative balance, I would also assume that you would not have the funds available to pay for the fees that you would incur when purchasing property such as registering a bond, or for paying the transferring attorneys. So these amounts would have to be capitalised into the purchase price of the property.
I would also assume that you would not have much stashed away in emergency savings, which is critical when owning a property since the unexpected can happen at any time. When it does, you must have funds available to sort problems out quickly.
Just out of interest (pardon the pun), if you are paying your credit card off at R2 000 per month at a flat rate of 20%, it would take you just short of two years before this outstanding balance was settled. This is not a small obligation.
In terms of building a model that you can measure, let’s consider the cash flows of the first few months of a hypothetical example:
Perhaps you find a lovely two bedroom sectional title property for R500 000. Because you are a first time buyer and because you can’t offer too much in the way of a deposit, let’s assume that the bank is unkind and gives you a rate of 10.5% (prime + 1.25%).
You are just happy that it got approved, so you forget to negotiate the rate with them, and you sign on the dotted line. If the bond is for 25 years, then the monthly payment would be R4 720.
You think to yourself: “wow, this is only slightly more than the rent I am currently paying”. However, if you were to amortise this amount and separate the interest portion that you are paying from the capital you are reducing, it would look as following in the first month:
Interest: R4 375
Therefore you would be paying more in interest alone than you current rental payment. And on top of this there would be additional costs to consider such as rates and taxes, water, electricity, as well as possible levies if the property is a sectional title unit.
With the introduction of a tenant, this could change matters, but you would need to make sure that the rent that the tenant is paying more than compensated for the interest and additional costs, otherwise you will not actually be in a better position in the short term. Over the longer term, you will however have outside assistance in paying off your bond, and this can be a very good thing. By comparison, nobody would pay you to live in your share portfolio.
Like always, I would encourage my clients to consider the softer issues of financial planning. You have mentioned that you might not be able to find tenants, and while this is a big risk, there is also the chance that you might not like the tenants – especially when they damage something belonging to you. Home should be a place where you can be at ease, and if having a tenant in your home will change this for you, then you really should not proceed with this idea.
Finally, for me, the purchase of any property that you or your family don’t live in should be reserved for investment planning, rather than for financial planning. Financial planning is where you put the basics together to protect your livelihood, your security and your financial goals. Investing is what you do next.
Carl van der Berg is a Financial Consultant with Alexander Forbes Financial Services.
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