Building a property portfolio

2012-07-21 10:39

It’s not only an investment but a business from which a sustainable salary can be earned

Isaac is on his way to establishing a property portfolio.

“Although I have never earned a big salary, I have always believed in saving money,” says the 28-year-old, who currently owns two flats and is looking to expand his property ownership.

A year ago he bought a three-bedroomflat for R400 000.

He had built up his savings in a unit trust fund over the past seven years and was able to use this to put down a 10% deposit, and pay for the registration and transfers, which came to R80 000.

He then rented out two of the rooms to help him pay a R3 000 a month bond.

A few months later, Isaac bought a two-room flat for R350 000. This time the deposit and registration costs set him back R70 000, of which he had to borrow R30 000.

He is paying an extra R500 a month into the bond repayments as well as paying off the R30 000 he borrowed, and currently has only R15 000 left to pay on the shorter-term debt.

Isaac receives R3 000 rental from the two rooms he rents out in the three-bedroom flat where he lives and a further R3 700 from the two-bedroom flat.

“Basically, all these properties are paying themselves every month, including levies and rates and taxes,” says Isaac.

He is now in a position where he wants to expand and buy another property with the aim of one day having several properties that pay him an income.

He is concerned that he now needs to view his properties as an actual business.

“One thing I know I must do is to register the properties as a business and pay income tax from the rental, but I haven’t done this yet,” says Isaac, who also wants to know if the banks would finance his third property.

The solution:
‘Based on the background you’ve sketched, it is evident that you have made a conscious decision to be in the business of property investing.

“This is an active role you have taken in being exposed to the benefits of property investment,” says Ricardo Teixeira, a strategy consultant at acsis.

Teixeira adds that Isaac’s discipline in saving, budgeting and paying off debt has been and will continue to be rewarded as he gets older.

Keep records:
Teixeria recommends that Isaac needs to start keeping proper records.

“In order to be correctly understood and appreciated by your bankers as being in the business of property investing, you will need to keep and create records of your business income and expenses,” he says.

“This will assist the bank in making an informed credit-lending decision against your application for additional debt finance to buy future properties.”

Teixeria says many investors don’t realise that a property portfolio is in essence a business that needs to be run effectively to generate returns.

Although the management of a property can be outsourced, it is important to consider who you partner with to manage your property.

Those decisions will materially affect the future value of your property as well as your tenant’s renting experience.

“Acquisition and operating expenses, such as transfer duties, legal costs, levies and taxes, are important to consider when evaluating the viability of a property-related investment.”

Keep it simple:
Teixeria adds that one does not have to “register” as a business to be seen as a business.

Marius Marais, head of FNB Housing Finance, agrees and advises against registering the property under a formal entity such as a company.

“Running a business requires a lot of money to administer and audit. Therefore, registering a house could further cause unnecessary financial constraints. Keeping the house under your name has a lot of benefits than those of a company,” says Marais.

“Among others, these include less interest on bond and operational expenses, tax benefits as well as capital gains benefits. These could then result in more money in your pocket to supplement your wealth map.”

Isaac will need to declare the rental income to the SA Revenue Service. However, he can deduct expenses such as interest on the bond, levies and maintenance costs.

Marais says although FNB’s current credit policy does not restrict anyone from buying more than one property, the crucial aspect in approving the loan will be Isaac’s ability to pay the loan from his primary source of income – in other words, his salary.

Isaac will not be able to borrow money based on the assumption that he will be able to rent out the property to pay the finance.

If he is unable to find a tenant, the bank will want to know if he can afford to repay the loan himself.

Marais says the bank will look at Isaac’s prior and current repayment patterns, as well as their level of affordability from their main earnings.

“Repayment and affordability patterns can be determined through you providing us with your detailed income and expenditure analysis, as well as your bank statement where your monthly earnings are deposited.”

Isaac has made two major property purchases in a short period of time and has depleted his savings base.

It is important to remember that Rome was not built in a day, and now would be a good time for Isaac to consolidate and focus on paying additional income into the bonds and clearing the R15 000 short-term debt.

Once he has halved the bonds on both properties and is receiving income over and above the bond and running costs of the property, he then could consider a third property.

It would be a mistake to overcommit at this stage and possibly risk losing what he has already built up.

Passive property investing
If you want to have exposure to property but do not want the hassle of managing tenants, you could opt for investing in listed properties.

You can do this by investing in JSE-listed property unit trust shares or real estate property unit trusts through an asset manager.

This will also give you exposure to property without having to actively manage the property.

It is advisable to consult with a stockbroker or financial planner if you want to make a passive investment in property because of the wide range of choices.

Do your sums
If you are considering buying a property as an investment, make sure you do your calculations first as there are many additional costs that need to be covered:

» Transfer and registration costs need to be built into the total cost of buying the property;

» You will have to insure the property and consider taking out rental insurance to protect against non-payment by tenants;

» You will have levies and property taxes every month; and

» You need to set aside money each month for maintenance – especially if you are renting out the property.

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