For many people investing in property seems to be the most obvious, safest way to grow wealth. However, many fingers have been burnt by diving in headfirst without doing enough homework. Here are a few tips about the financing of investment properties that may in the long run save the investor a lot of money.
Here are a few tips I’ve picked up along the way.
1. Pay as much interest as you can
This first tip may not be for everybody, but it’s the most important from my perspective. In this low interest rate environment, it makes sense to try and keep your loans lean on equity (your own money) for two reasons:
- You want to pay more interest because debt is relatively cheap and interest is fully tax deductible.
- The more equity you keep out of the loan, the more cash you will have available to fund new investment properties.
In the past, banks would allow you to apply for full Flexi Facilities on everyday home loans. This meant that you were able to draw back up to the full loan amount or in simple terms, to take out any capital that you had already repaid on the loan. This privilege is now mostly reserved for private bank clients with structured facilities.
However, you can still effectively manage and reduce the equity in the loan by not committing too much equity upfront or applying for a future-use-facility (See below).
These days many financial planners (sometimes very undeserving of that title) encourage buyers to pay off a loan as quickly as possible by making additional lump sum payments each month. According to them, this allows you to “save” interest.
If you are a savvy investor though, interest can be your friend and you might benefit by pushing the loan out as long as possible and paying more interest each month.
As long as your rental income is covering your interest payments, the capital you owe is constantly shrinking in real terms, thanks to inflation.
2. A large upfront deposit is unnecessary
The first step in keeping your property lean on equity, is avoiding placing a large upfront deposit when you initially purchase the property. As a buyer, estate agents will try to convince you to put down a large cash deposit with your offer to show the seller that you are “serious” and are committed to the transaction. This is nonsense.
The deposit does not make a major practical difference in terms of securing the deal. An offer is binding regardless of whether you have put down an upfront deposit. A small securing deposit is enough to show you’re interested.
Many agents actually prefer the buyer to pay a larger deposit because they have a clause in the agreement stating that they can deduct their commission from the deposit should one of the parties be in breach of the contract and the deal does not go through.
So if you are going to put down an upfront deposit, I recommend you avoid placing it in the agents trust account. It’s preferable to deposit it with an impartial transfer attorney who will hold the funds until a dispute is resolved.
In terms of the benefits of upfront deposits see below.
3: Appeal and negotiate your interest rate
It is very important to secure the best possible interest rate on your loan. This loan is potentially going to be in place for the next 20 years! Every part of a percent that you can cut out upfront will save you thousands going forward.
I’m always amazed at how many people will just accept the rate offered at face value. There is always room to negotiate with the bank. I have negotiated rates down by more than 3 percentage points in the past. If the bank is unwilling to budge, they will normally allow you to appeal your rate at some point in the near future if you have an improved financial situation.
By way of example, a 1 percentage point saving on the interest rate for a loan of R1 million, will save you around R150 000 in interest over the term of the loan (assuming a 20-year loan).
4. Keep it Flexi
If you are thinking of using any excess cash you may have as a large upfront deposit, you may consider rather asking your bank to set up a Flexi Facility. This way you can deposit your cash into the bond post-registration of the property. You will have access to draw down on the cash at a really good interest rate should you want to buy a new property, renovate or even buy a new car. If you put down an upfront deposit, that cash will not be accessible again until you sell the property or apply for a further loan (which is costly).
Note: When it comes to negotiating your interest rate with the bank, there is a benefit to paying an upfront deposit. The lower the loan-to-value ratio (size of the bond over the purchase price of the property), the more favourable the interest rate.
I often ask the bank to quote me three different interest rates based on three deposit sizes. I then get a feel for how to strike a good balance and achieve the best interest rate using the money I’m willing to commit upfront.
5: The future-use-facility
If you cannot avoid putting down a deposit or your bank promises you a really good interest rate in exchange for a deposit, then make sure to register a Future-Use-Facility.
This is known by different names at different banks. Essentially, if you were to buy a house for R1m and put down a R200k deposit, the bank will normally only register an R800k loan against the property at the deeds office. However, you can ask them, prior to registration, to register a Future-Use-Facility for the R200k. This means that should you need access to your cash up to the full purchase price, you only need to undergo a simple bank credit assessment. Without a Future-Use-Facility, you will be required to register a further loan and pay the associated legal costs.
6: Use your own attorney
Another myth is that the purchaser of a property is required to use a transferring attorney nominated by the seller.
I nominate my own conveyancer and always tell the seller that this is a deal breaker for me for two reasons:
- If I can use the same conveyancer to register the bond and also to handle the transfer of the property, I can negotiate a better discount on the legal fees. Some banks don’t allow you to use the same conveyancer for both though.
- You should try to establish a long-term relationship with a good, reputable attorney. The more business you bring the attorney, the larger the discount you can negotiate. This can sometimes be up to 40% off the legal costs.
7: Find a tenant on the seller’s time
It takes time to find a tenant for your investment property. But you can minimise the risk of having an empty apartment for the first month or two by doing the following:
- Include a clause in the Offer to Purchase stating that the seller will allow you reasonable access to the unit for viewing purposes between the date of bond approval (i.e. when the offer becomes unconditional) and the date of transfer. This will give you anywhere between one and three months to find a tenant on the seller’s time.
- Include another clause to allow yourself the option of taking early occupation should you find a tenant prior to the transfer date. This gives you options – should you find a suitable tenant prior to transfer, they can move in immediately (if the place is empty) and if you don’t find a tenant, you will have no obligations on the property until transfer.
8: Section 13sex tax allowance
Yes, you read right: Section 13sex – the sexiest tax deduction around. This is for the slightly more sophisticated investor with more than five investment properties. It’s a great incentive for buying off-plan properties and not many investors take advantage of this allowance.
Very basically, if you own five or more residential properties you can claim, as a capital allowance, an effective 2.75% (55% x 5%) of the value of any units that were acquired directly from a developer. If, for example, you owned five apartments and one was purchased directly from a developer for R1 million, you could claim a tax deduction of R27 500 per year. If you are taxed, for instance, at the highest marginal tax rate of 40%, this could save you up to R11 000 per year. As with all capital allowances, it should be recouped on sale of the asset.
9: Sell your properties yourself
Selling your properties yourself is not as complex as people imagine it to be. There is no need to pay an agent a large sum of money for services that you really don’t need. In a sellers’ market – like the one we are currently experiencing – it is easy enough to advertise your property online and sell it within a few days. Your conveyancing attorney will normally help you with the sale agreement at no extra cost.
10: The experts aren’t always experts
Try not to believe everything that estate agents and financial planners tell you. You’re better off deciding if something makes sense yourself. Remember: when it comes to buying a property, almost everything is flexible – so structure things in a way that makes sense to you and your financial situation.
Dean Gerber (28) is a CA(SA) who works for VAT IT Pty Ltd. He bought his first investment property at the age of 21 and now owns 14 properties in Sandton and Illovo. He can be reached at email@example.com