For many investors, buy-to-let property is still a great way to invest money, as indicated by recent reports.
Today’s buy-to-let buyers are more sophisticated in their approach and focus on buying an income stream rather than just merely betting on property price appreciation.
According to the FNB Home Loans quarterly report, buy-to-let accounts for 8 percent of total residential property buying with More buy-to-let investors choosing KwaZulu-Natal (11 percent) followed by the Western Cape (8 percent) and Gauteng (6 percent).
Ewald Kellerman, head of sales at FNB Home Loans, says Home loans for buy-to-let property as with primary properties are hard to get as banks are strict on lending following the global financial crisis of 2008/2009.
Property returns
Kellerman explains that capital growth or price appreciation of the property encourages buyers to invest for a potential future increase in property prices.
“This was a great motivating factor driving high levels of investment prior to 2007 when property prices growth contributed a large portion of the total return.”
He says the growth rate at the time exceeded the lending rates and allowed amateur investors to make an easy return simply by holding on for a while and selling at a higher price.
When evaluating longer term performance of the FNB House Price Index, in real terms the index is -19.2 percent down on last decade’s real price peak reached in November 2007, while in nominal terms it is a mere 14.9 percent higher.
Kellerman points out that this growth rate makes residential investment a lot less attractive from a capital growth point of view.
“The lack of capital growth creates a necessity to place more reliance on the rental income stream generated from letting the property out.”
While it may not attract the same level of investment, rental yields are a much more reliable form of income.
Today’s buy-to-let buyers are more sophisticated in their approach and focus on buying an income stream rather than just merely betting on property price appreciation, he says.
But rental returns also pose challenges - high debt levels, pressure on income and slow economic growth since the 2008/9 recession not only influenced residential property price growth, but also impacted on the financial wellbeing of tenants.
These tenants have in many cases not been able to absorb large increases in rental payments, he notes.
Tenant Profile Network’s Q1 2013 report shows that nationally, 84 percent of tenants were in good standing, which includes sub-categories of 71 percent of tenants who Paid on Time, plus 3 percent paid in the Grace Period and 10 percent Paid Late, 8 percent of tenants were in the Did not Pay category while 8 percent made a Partial Payment.
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According to Kellerman, many landlords prefer to keep performing tenants in a property at a lower rental return than to increase prices too much and face the risk of losing good tenants.
The higher the loan-to-value ratio, the higher your bond repayment will be and the more cash you put in initially in order to lower your bond repayment, the better.
It also mitigates the risk of vacancy between tenants if the same party is not in a position to afford an increased rental amount.
“Increases in rates and taxes and maintenance cost of residential property squeezes the return and discourages potential investors from investing in buy-to-let properties.”
He says the margin on these investments is quite small, as such, eviction issues or damage to property by problematic tenants could wipe out returns very quickly.
“Our legal system offers a lot of protection to tenants from landlords, making disputes both time consuming and expensive, and in turn residential property a lot less attractive an investment,” says Kellerman.
He notes that the current low interest rate environment decreases interest expense and increases returns, but eventual upward movements in rates could create major fluctuations in yield and scare away potential investors who are not willing to stomach this type of risk.
“The resulting effect of low capital growth and pressure on the yield both contribute heavily towards the low interest in buy-to-let investment at the moment.”
Kellerman says the low supply growth relative to growing demand on the other hand is expected to ultimately start forcing rentals upwards.
A case for investment
According to Brendan O’Brien, chief executive officer of Urban Space, many property experts have pointed out that for those people looking to secure a good pension and earn passive income, buy-to-let property investment should be at the top of their list.
If you invest in property, you have control over your own investment, he says.
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Although rental returns income as Kellerman points out, has challenges of its own, O’Brien believes that property is the ideal place to invest, if you know what to look for.
“Historically, no one can dispute the statistics that show that property values increase over the long term.
“It may go through bubbles where the value ebbs and flows, but in the long term, property consistently increases in value and in the end, it beats inflation – which is something that cannot be said about all pension schemes.”
Unlike many people, he says he has never put money into any kind of pension scheme – other than investing in buy-to-let property.
“Buy-to-let investments are excellent for pensions as they are low risk and increase in value over time.”
He says when your bond is paid off, the entire rent is yours, earning you a passive income, which is exactly what you want in retirement, according to O’Brien.
O’Brien notes that the future of the property market in South Africa is a bright and predicts that values will increase in line with inflation over the next couple of years.
The first prize in the process is to buy the property at a price below its market value, which will allow you to increase your equity.
“In prime locations, I believe that these value increases will be up to 5 percent higher than inflation over the next few years and thereafter, property value in all locations will start increasing at a higher percentage per annum than inflation.”
Tips on buy-to-let investments
As with any investment, homework is a must if one is to make money out the property.
Location
O’Brien says location, location, location cannot be emphasised enough, having said that, a property that is very close to busy roads or noisy restaurants is something to avoid.
Quality of building
An investor should look carefully into the quality of construction, and the condition of the property itself, which could have a significant effect on the maintenance of the property.
Particularly with old houses, structural integrity is a very important aspect to look into.
Rental yields
The yield (the percentage of rental income you get in relation to the purchase price of the property) is essential to consider.
“It’s not always necessarily best to buy property with the highest yield, typically, the yield increases as the location worsens.”
He urges investors to look at the capital appreciation (the increase in the property’s value each year) too.
For example, he says the yield on a property in Mitchell’s Plain would typically be higher than that of a property in Constantia, however, the capital appreciation on a Constantia property would typically be higher than that of a property in Mitchell’s Plain.
“If you work out the numbers, it’s likely that over the longer term, the Constantia property may well prove the better investment option despite its initial lower yield.”
Purchase price
According to O’Brien, first prize in the process is to buy the property at a price below its market value, which will allow you to increase your equity.
Capital growth or price appreciation of the property encourages buyers to invest for a potential future increase in property prices.
Equity refers to the difference between the value of the property and the amount of loan on the property.
He says, if you are able to buy property (at an auction, for example) below its market value, you increase your equity at no cost by the amount that you manage to purchase the property below market value
Market trends
He points out that if an investor is not familiar with the property industry, it can be difficult to be certain that you aren’t going wrong in your potential investment.
“A lot of people not in the property industry assume that, because they’ve heard that property is such a good place to invest, any property will prove to be a good investment.”
O’Brien says these people don’t always consider all the factors or examine the numbers with due care, and therefore go in blind or rush in and buy on emotion rather than making a decision based on hard facts and figures.
Bond repayments
He points out that because of lack of this information, in reality, these buyers pay over the market value for properties they buy and if they haven’t worked out their bond repayments methodically, they could land up in financial difficulty.
“Your loan-to-value (LTV) ratio (the ratio between the purchase price and your bond) is another calculation that you cannot afford to gloss over.
“The higher the LTV ratio, the higher your bond repayment will be and the more cash you put in initially in order to lower your bond repayment, the better,” he advises.
He warns against taking out a bond with a loan-to-value ratio that will put your cash flow under too much pressure.
“Ideally, you want to be in a position where your rent covers your bond within a couple of years of buying,” he says.
While the thought of buy-to-let investment coupled with tenant management may be daunting, if you make a decision based on facts and figures and go in with your eyes open, it is likely to be a sound investment that you can rely on to provide you with passive income when you need it most in the future, he adds. – Denise Mhlanga
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