Rent, don't buy

"OWNING a nice house on the popular Pecanwood Golf Estate at Hartebeespoort dam will cost you at least R15 000/month more than renting the same house," was my advice last weekend to a friend who has the same passion as I have for golf but a much fatter chequebook. 

"Besides, you have a far greater likelihood of capital appreciation on an asset such as Satrix divi or, my favourite, British American Tobacco [JSE:BTI] (BAT). And fewer worries," I urged him as we enjoyed something cold at the 19th hole.

"Keep talking, my friend," he replied, "because this is where I'm coming to live permanently and play golf."

Just as background: Pecanwood is a lovely golf course developed by Jack Nicklaus. It's about 45km from both Johannesburg and Pretoria, and borders on the Hartbeespoort dam.

The course is green – beautifully so – after all the past month's rain.

There are around 900 completed houses, with about 350 of them occupied full-time. The rest are weekend homes and lifestyle pleasures and, of course, quite a few have been bought on the basis of the miracle of investing in property whose value will always keep increasing.

Pecanwood is almost 100% built up and the prices of the few remaining stands range between R700 000 and way more than R1m.

And after the major floods of the past few weeks, the water in the dam doesn't stink any more.

The waiter brought a pile of white serviettes to write on, as well as another bottle of something cold, and I began explaining to my friend.

The price of the 330sq m house on the golf course we'd looked at was R3m. It has a beautiful view over two fairways and a dam.

If there were a similar undeveloped stand, its price would be at least R1m.

Building costs in Gauteng are around R6 000/sq m. The 330sq m times the building costs of R6 000/sq m, plus the value of the stand, tells you R3m is already very attractive. We agreed on that.

We needed a new serviette to work out how much it would actually cost per month. My friend plans to pay cash for the house.

But that makes no difference to the cost. Every businessman will know there's something like the cost of capital that must always be built in before you can make any investment decision.

Go and look at Professor Joel Stern's economic value added (EVA) model.

We decided the current cost of capital in South Africa must be taken as at least 8%. That's low.

The earnings yield of at least 12% – the inverse of an earnings multiple of 8.5 at which many shares are currently trading – would be a better figure. But we decided 8%/year was right.

The loss of earnings – call it the EVA of a R3m investment at 8%/year – is R240 000. That's the starting cost of owning the house at Pecanwood.

But there are a few other costs to add. The monthly levy to the homeowners' association at Pecanwood is currently R2 000.

Rates and taxes are around R1 500/month. Add a bit for maintenance and you'll see the prospective owner must add a further R48 000/year to the building cost of R240 000/year calculated above.

So before your first round of golf or your first cold ale after the game, the house will cost you R288 000/year or R24 000/month.

Wouldn't it be better to rent a house at Pecanwood, I couldn't help wondering. We asked the agent – who was keen for us to buy the house – what was available to rent at R10 000/month.

We were even prepared to pay two years' rental in advance, I generously offered on behalf of my friend.
 
"Probably the same R3m house you've just looked at," she said. It seems the offer of two years' rental in advance was very attractive.

We turned to a new serviette and I showed my friend that even after two years of advance rental, he'd be left with R2.76m of the R3m purchase price and that could comfortably be used to buy 10 000 BAT shares at the current price of R270.

Tax-free dividends

The dividend on 10 000 shares would be R220 000 over the next 18 months.

"By the way, that's tax free," I slipped in, before the property consultant pointed out a tenant wouldn't enjoy the benefit of capital appreciation. There would be a lot of that over the next two years, she assured us - exactly in line with the investment advice most property consultants are always eager to give to prospective buyers.

"Let's discuss the two alternatives," I urged my friend and the property lady.

The effective cost of owning the R3m house at Pecanwood is R24 000/month. The same house can be rented at R10 000/month. That’s the first fact – and it's fixed.

If you invested the R3m in BAT shares rather than buying the house, the dividend yield on the BAT shares would be more than enough to pay for the current rental for at least the next two years.

That's the second fact – and we needn't debate it.

The third fact gives room for lots of debating. By renting the house rather than buying, you'd lose the chance of a capital gain on the house, my friend.

But in exchange for that you get the capital gain on BAT. But nothing is certain. The value of the house may increase faster than the price of BAT, or vice versa.
 
Personally, I think BAT will do much better than even a well-priced house at the lovely Pecanwood.

To start off the argument, remember that about two-thirds of the houses at Pecanwood are second (or investment) homes - and that's the sector of the residential property market now suffering the most.

Many such houses will come up for sale over the next few years. Capital appreciation may be scarce and, if you don't like BAT, buy Standard Bank or Satrix divi.

Once the waiter had come to our table again to show how well he handles his tray laden with glasses and whatnot, I gave my friend a last piece of advice.

"Take the share route and rent the house. That gives you a two-year cooling-down period." If your golf doesn't come right, or your health no longer allows it – or, more importantly, your wife says she wants to move back to town – it will be easier, quicker and cheaper to sell the 10 000 BAT shares than to try to market the house again.
 
"Yes, but what if the owner wants his house back after two years?" the agent chipped in, introducing another risk to the equation.

There are two or three points: in two years' time, there will still be many houses for sale or to let at Pecanwood. Even if the estate is full, in two years' time there will be many other houses available on many golf estates.

As the sun sank over the dam, we drove back to Pretoria and suddenly realised we hadn't even discussed the usual custom of a 10% or 20% deposit and a mortgage.

Anyway, something like that would be ridiculous in the current market. If you can rent for R10 000/month instead of having an expenditure of R24 000/month, the market is saying very clearly that property prices are still too high and that residential property isn't a good investment right now.

And even if you need a golf estate lifestyle, look carefully at the alternative. Rent for a year or two: it's much cheaper than home ownership and much easier to get out of if the lifestyle no longer suits you.


* De Klerk holds shares in BAT and plays his golf (22) at Cullinan, still one of the country's finest nine-hole courses.

** This article first appeared in Finweek.

To read more Finweek articles, click here.
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