Top tips for buying an investment property

It’s important when buying an investment property to do your homework so that your property becomes an asset rather than a liability. While astute investors can make good money, there are significant holding costs and initial fees, and a property is not as liquid as other investments.

An interesting article in City Press reviews the considerations that savvy investors should take into account.

It is important to be aware that even in high growth areas like the Western Cape, property does not always outperform shares and, over the past decade, residential property has actually underperformed the JSE. Contrary to what some people believe, buying an investment property is not necessarily less risky than investing in the stock market.

If you had invested 10 years ago, an investment linked to the average return of the JSE, with dividends re-invested, would likely be worth more than an investment property and the holding costs would have been significantly lower. However, people are still keen to invest in property as there is there is the ability to leverage a property, and a steady rental income can significantly boost your overall return.

The good news for property investors is that there are signs of improvement in rental yields in South Africa. According to FNB property economist John Loos, relative rental yields will start to rise as property prices start to weaken this year, which means that now could be a good time to consider buying an investment property. Loos expects average gross yields to gradually increase to 9.3% during 2017. However, it’s important to be realistic about annual rental increases as, according to the Tenant Profile Networks (TPN), escalations are only currently at around 5% per annum, but running expenses – such as levies and rates – may be increasing at a faster rate.

If you are considering buying an investment property, some experts have some important advice. Tommy Nel, Head of Credit at FNB Home Loans, warns against trying to time the market. Don’t get carried away with get-rich-quick tips and big talk, and don’t just view property as a simple way to make a fast buck. He believes that if you have at least a five-year time horizon and don’t buy in a property bubble or in a degenerating area, then property can deliver a reasonable return. However, it does also require achieving good occupancy levels.

Andrew Van der Hoven, Head of Home Loans at Standard Bank, emphasises that it is important to fully understand your financial position before making any decisions, as there are costs involved — such as insurance, garden services, renovations, and rates and taxes — that easily add up. He advises that you should have at least three to six months’ worth of payments in reserve to cover any costs if a tenant defaults on rent or if you can’t find occupancy. Before you make any purchases you should do your research about the property and be sure to have the house examined for any defects, such as electrical, structural or plumbing issues.

You should also do significant research on the area and take the time to find out the average property value and the rental demand in the neighbourhood. If it is close to schools, universities or offices, then you may be able to find tenants easier. It is also important to do your research on tenants, and review the TPN Credit Bureau, which has a database that provides information on tenants’ payment behaviour and whether they can afford the rental.
Before you buy a property, be sure to do all the calculations to work out whether the rental you will receive, minus the costs and maintenance, will make it a viable investment or not. For a property to be a good investment, it is important that your rental yield is sufficient to cover your costs, and to take into consideration that there is the risk of mortgage interest rates increasing.

If you want to buy an investment property, you may need to be prepared to put down quite a big deposit and be able to fund any monthly mortgage installments from your salary, as banks cannot consider any potential income streams from the property that do not already exist. Ewald Kellerman, Chief Risk Officer at Absa Retail, emphasises that it is also important to keep in mind that the income you receive from a rental property is taxable. “Interest on a bond and some maintenance costs are often allowed to be deducted as an expense, which can reduce the taxable amount considerably. Certain capital gains exemptions also only apply to your primary residential property, but not to an investment property. Make sure that you take this into account when calculating total return, and consult a tax practitioner to understand the full tax implications.”

If you have both a residential home and an investment property, you would, therefore, want the bulk of the mortgage to be on the investment property, in order to benefit from tax deductions.

Buying an investment property can prove a very fruitful exercise if you have critically analysed certain factors and considerations. However, it is not always a successful short-term proposition, depending on your financial circumstances. There are risks and running costs involved, and it is important to not rush into any decisions blindly.

Do not hesitate to arrange a meeting if you are considering investing in a property, so that you can be sure you understand the costs, potential returns and how they fit in with your current financial situation.

Posted in Blog, Financial Planning.