Colen is an area manager and is married with three children. He has built a property portfolio made up of five properties, which has put him under financial pressure.
“Our way of managing the business finance is not well structured. We are struggling to separate the business finances from the personal finances and we need a system to ensure that the business is able to sustain itself,” Colen says.
Over the past few months, Colen has been working with Absa financial planner JP van der Merwe and Absa home loan specialist Miguel Martins.
“Before you start a property portfolio, you must have a plan in place that will guide your short-, medium- and long-term decision making,” advises Martins.
He explains that Colen largely fell into property investment by accident, grabbing opportunities as they arose.
“Colen needs to start thinking about how he is going to use these properties to create wealth.
“Some of the properties don’t make sense – such as an empty stand which draws 100% of it’s costs from him with no income,” says Martin.
Colen also needs to consider how he can restructure the debt on his properties. He took out a personal loan for one of his properties at a much higher interest rate than his property finance. If he can extend one of his home loans, he can reduce his monthly repayment.
Colen was not aware that the interest on the personal loan is also tax deductible from the rental income.
“The SA Revenue Service provides that expenses incurred in the process of generating an income can be listed as expenses and will give a tax benefit,” says Van der Merwe, who adds that Colen has not been making use of all the tax deductions available to him.
For example, if he keeps a logbook, he can deduct his travel expenses to and from the investment properties as well as his cellphone and internet bills for running the business.
He can also deduct all the maintenance and payments for services. But he needs to keep a proper set of accounts and invoices to claim the deductions. This is why it is so important for Colen to separate the business from his personal finances.
Van der Merwe says building an emergency fund is a priority for any property investor.
“If the investor has debt on the properties, an emergency fund of three to six months can cover the debts if one is not able to find occupants. This has become even more evident with the Covid-19 coronavirus lockdown and the risk of non-payment by tenants,” says Van der Merwe.
Colen also needs to consider moving the properties into a trust or a proprietary company. It is important to get good advice as there are different considerations, depending on your final goal. A trust is beneficial for estate planning and protection against creditors while a company structure can be more tax efficient.
Van der Merwe explains that Colen will reduce the percentage of tax he pays on the rental income from 41% to 28% by moving it to a company. However, a company will incur estate duty taxes, unlike a trust and it can be attached by creditors.
Van der Merwe says at this stage Colen’s property values are not high enough to warrant the use of a trust, but can be considered in future.
“In the case of investors who fall in a lower-income tax bracket, it may make more sense to keep properties in a personal name and trade as a sole proprietor. No investor in rental properties can copy the strategy or structure of another investor as there are many factors that need to be considered,” says Van der Merwe.
You will get different opinions from a financial planner, accountant and a trust expert as they will be looking at different aspects.
Ultimately, it is up to you as the investor to make the best decision for yourself.
Absa home loan specialist Miguel Martins says there are three rules a potential property investor should consider:
1. Have a smart 15-year plan:
If you are clear about where you want to go, you will make better decisions today.
“Having a clear vision of the life you want to create will determine the income you need to target, the type of investment and the route to take to get there,” says Martins. He explains that property investment has a long transaction cycle.
Over time, you build up equity in the property that allows you to refinance and start the cycle again with another property.
“Property you buy now will draw cash. If you buy it incorrectly, you will get stuck. If you buy at too high a value, or don’t price in the renovations, this will impact on your ability to create wealth. Always consider what you are buying now and what it will let you purchase next,” he says.
2. Put a power team in place
Treat your property portfolio as a business and have the right team of specialists around you. These include an accountant, trust attorney, financial planner and a banker.
Each will be a specialist in their field and the best investors know how to consolidate their advice for the benefit of the deal or strategy.
Martins says one should have a power team to help run and grow the portfolio, including a trusted estate agent, builders, electricians and conveyancers. “You can’t do everything yourself and it is better use of your time to look for new properties than be stuck doing it yourself,” says Martins.
He adds that this is also why keeping properties in close proximity is more efficient. “Currently, Colen has one caretaker per property, but he could use one caretaker to look after several properties if they were close together.”
Martins also recommends that Colen should join the SA Property Investor Network.
“The benefit is that other people are having discussions that apply to you,” he says.
3. Use home loan structures to enable financing for growth
There are two options with a home loan: a “readvance” and a “further advance”. A readvance is based on your original home loan value. Once you have paid off a portion of your home loan, you can apply for credit back to the original home loan amount, based on credit approval.
This does not require you to reregister the bond and has minimal costs. If you have built up equity in the property and it is now worth more than what you bought it for, you can apply for a “further advance”. This in effect allows you to increase your original home loan amount. However, this would incur costs to reregister the bond over your property.
In summary, have a long-term vision of how you want your property investment journey to enable your lifestyle. Then put a power team in place to advise and guide you to build a robust and profitable portfolio to reach your vision. This includes surrounding yourself with like-minded investors who will allow you to access a wealth of experience and learning. Lastly, understand how the features of a home loan can work to enable you to maximise your growth in a sustainable manner.