Chartered Wealth Solutions’ RetiremeantTM Specialist and Certified Financial Planner®, James Carvalho, assesses the value of rental property as an investment.
Over the past ten years or so, I have been party to numerous conversations that have debated the merits of rental property. I have frequently wondered what lies at the heart of this affiliation to property.
I have concluded that it is most likely the ability to own something tangible – you can see and touch it. (You seldom hear braai-side talk of share portfolios or unit trust portfolios!)
While property is certainly a viable option for investing, what many may not realise (if unprepared for the rigors of renting out property) is that this investment can be a source of persistent headaches.
The case for diversity
In 2011, in the wake of the 2008 global financial crisis, one of my clients was overwhelmed by her emotion in our meeting. She owned eight properties and suddenly, four of them were standing open. Three of the tenants had lost their jobs and one of them had moved to Cape Town.
Rental payments from her remaining tenants were barely covering her bond costs, and she still had three bonds over the properties.
For years, I had been encouraging her to diversify her risk in her investments. But, as so often happens, she was lured by the exaggerated returns in the property market, based on the promise of the boom years from 2002 to 2008. And the unfortunate consequence has been that, at present, she has managed to sell only two of the properties, and her rental incomes are not beating inflation, and nor is the annual growth on her property.
Still a sound investment?
Through a planning process, we as financial planners would establish what the optimum investment return would be for your money to sustain your lifestyle and to last the term of your retirement.
Generally, we find retired people aim at achieving a return of approximately inflation plus 4% with their funds.
In light of this goal, I note some of my clients’ responses, when I ask by how much their rental fees had increased. “Nothing this year; it’s been a tough year for my tenant,” or, “My tenant just lost his job so I am giving him a contribution holiday.”
Perhaps the most concerning comment was that the tenant would not pay and possession equals nine tenths of the law.
Despite these tales of rental regret, there are still many investors whose investment in property has given a positive return.
I would suggest that, if you are thinking of buying property to rent out, you consider the following:
- Buying off-plan is appealing as there are no transfer duties. Transfer duties is a sunk cost: it is doubtful that you will recover this cost.
- Schedule fixed rent increases in your lease – it obviates having to negotiate these every year. Rent should increase by more than inflation every year.
- Establish a lease of twelve months, renewable with three months’ notice, thereby allowing you time to find a new tenant.
- If you are a tax-payer, bond your rental property so that you can write off the interest against the rent.
- Rental income is taxable and needs to be added to your tax return.
- When you sell a property, other than your primary residence, it will attract Capital Gains Tax.
- You need to be able to pay for repairs to the property; as a rule of thumb, you should keep 10% of the rent aside for maintenance.
- If you don’t have the patience to deal with tenants, use an agent to rent out the property. This usually comes at a cost of 10% of the rent, but it is often money well spent.
In conclusion, I reiterate the timeless sound advice to ensure you diversify between all assets when investing: shares, cash, property stock, and corporate and government bonds.
And, remember, that your financial planner is always at hand to guide and advise you.