How to become a property baron

2011-10-15 13:45

In the 2000s people made a lot of money out of the residential property market as property prices soared by 400%.

But those days are well behind us and property prices have stagnated since the global credit crisis hit in 2008.

So, is property still a good investment? The answer is yes, but only if you go back to the basics. The real benefit of property is that it provides an income that increases with inflation.

This also makes property a good asset to accumulate for your retirement. During your income-generating years you accumulate the properties which, by the time you retire, are fully paid off and generate inflation-linked income.

You use banks’ money to finance the purchase of your asset and then get a tenant to pay it off.

Within a couple of years, the tenant pays more than the required amount and the property then generates an income for the rest of your life no matter how old you get.

If you purchase property for the income, then the actual property value will be less important.

So even if property prices fall, you will still be generating an income.

However, if the market moves into a property boom, you also have the advantage of capital gains as well.

Currently, property prices are the most affordable they have been in years as they have fallen while salaries have risen above inflation.

“If you want to become a property baron, now is the time,” says Funeka Ntombela, head of home loans at Standard Bank, who adds that this is definitely a buyer’s market.

However, she also warns that this market is only for someone looking for yield (income), not for capital gains.

Property prices are expected to remain flat in nominal terms for the next two years, which means after inflation, property will actually lose value.

Ewald Kellerman, a property strategist at FNB Home Loans, says property is a great investment but only if you have a five-year view.

He says currently rentals have not started to rise, however, this is likely to change.

As the banks have tightened up their lending criteria and demand higher deposits, more and more people are opting to rent, which will ultimately push up rentals.

The problem at the moment is that people are still under financial pressure and are resisting higher rental increases so it will take time for this effect to come through.

The Downside:

Raising funds

Trying to fund an investment property is difficult because banks have tightened up their lending criteria.

“You have to have a large deposit and earn a lot for a second bond. The bank will want to know you can settle the bond if you don’t have a tenant. Will you be able to carry two bonds?” asks Ntombela.

So while you may want to invest in property, you will have to be debt free and have a sizeable deposit.

Managing tenants

The whole property proposal is based on the idea that you have a tenant and that the tenant actually pays.

This is an important part of managing a property portfolio and you have to spend time vetting your tenants carefully (see sidebar). There are many horror stories of professional squatters who use the law to avoid paying rent and you have to know how to deal with them.

If you are not prepared to deal with these issues, then property investing may not be for you.

Interest rates

An unexpected increase in interest rates will increase the cost of servicing the loan so be prepared. Either opt for a fixed rate or build up a buffer by paying more into the mortgage than you need to so that you can absorb a rate hike.

Maintenance

When you are working out your finances, do not forget to include ongoing maintenance costs on your property.
As the landlord, you will be expected to deal with any problems likeburst geysers and broken garage doors.

If you are a DIY sort of person, that is great, but you may want to hire someone to manage the maintenance
on your behalf, which will add to your costs.

Bodies corporate

You will most likely buy into a sectional title property. All of these are run by bodies corporate who collect levies to maintain common areas.

However, many bodies corporate are in financial difficulty and have court orders to appoint administrators to run the buildings on behalf of the owners who, for various reasons, including lack of finances, have not been able to properly run and manage their complexes. You need to find out the state of the body corporate before you buy (see sidebar).

Tax

The net income from property rentalis taxable. You are able to deduct the interest on your loan and running costs such as levies and maintenance. But remember, once the property is paid off, this will be a taxable income.

How to build a portfolio

Koos du Toit of property investment company P3 Investment Group says the key to buying property for rental income as opposed to capital value is to buy at prices where your rental income is above 10% of the purchase price and in areas where there is a high level of demand.

Du Toit says one should look at properties of less than R550 000 with rental income of below R4 000 a month.

When buying a property, it is critical to manage your cash flow effectively so that you are able to meet the shortfall between the rental and mortgage repayments.

Example of a typical investment property

» The property: R450 000 for a two-bedroom flat.

»The rental: The average rental income of this investment property is about R3?800 per month.

» The mortgage: Based on a long-term average interest rate of 12%, the initial shortfall (difference between the rental income and monthly costs) is R2 375. This includes management fees of 10% of rental income, rates and taxes of R150, as well as R500 a month for levies.

Because rental income escalates by about 7% a year, the property will reach breakeven point (the point at which the rental income covers all monthly costs) at the ninth year. This even provides for one month’s vacancy every 20 months.

Once you are in a cash-positive situation, you can then purchase your next property and use the excess
rental from the first property to supplement the shortfall on the bond of the second property.

In this way, you are able to build up a property portfolio over time.

However, as a retirement plan, you would keep the property that the tenants will continue to pay off for you.

If you reinvest the full rental income after breakeven point, the property will be paid off in 13 years without it costing you anything extra.

You enjoy an inflation-linked income of R3 800 a month in today’s time value of money for the rest of your life, no matter how old you get.

If over your income-earning lifetime you buy 10 rental units, your monthly income in today’s value would be R38 000 before tax.

This income would not be affected by the capital value of the property.

Protect yourself against the body corporate

The best way to protect yourself is to become a more active owner. Here are five easy steps to make that happen:

1.Make sure you read all correspondence forwarded by the trustees or your managing agents, and make sure you attend and participate in all AGMs. Your vote can only count if you participate.

2.Make sure you understand the financial health of the body corporate and request to see the financial statements of the complex.

3.Become familiar with the Sectional Titles Act and body corporate rules. You can do so by reading various publications aimed at sectional title owners and trustees.

4.Know your rights so that you can stand up to trustees and managing agents who may try to take advantage of owners who often know very little about their rights and obligations.

5.If you have the inclination, you can become involved as a trustee.

br>Special levies

Homeowners may find from time to time that a special levy has been implemented. According to the management rules applicable to sectional schemes, the trustees alone have the power to raise special levies for emergencies.

These often include necessary and unbudgeted expenses, such as a broken lift or burst waterpipe.

Ideally, the body corporate would have accumulated a reserve for such expenses, but if not, a special levy can be applied and trustees are under no obligation to consult owners in this regard. The body is also entitled to raise special levies in accordance with the provisions of Management Rule 31(4).

But any improvements to the common property require a majority vote and, depending on the nature of the improvements, up to 80% of the vote is required.

Unfortunately, if the trustees did not follow due process, you cannot refuse to pay the special levy as this amount would show on your levy account and you would not be able to sell your unit.

This is because as a clearance certificate is required from the trustees to state that your levies are up to date before transfer can take place.

You would have to resolve the matter by way of the dispute resolution arbitration process.

In this case, it is preferable to ensure that as many owners as possible support your proposal for an arbitration to share the costs of such a process.


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