How can you create wealth through residential property investment?
11 September 2018
The idea of investing in residential property is considered so intimidating by some, it’s often avoided entirely as a vehicle for wealth creation. The thought of finding the perfect property, applying for a sizable loan, navigating taxes and transfer duties, and finding an acceptable tenant, is enough to make any aspiring new investor turn to easier options – with far lower barriers to entry and less commitment.
However, with investor sentiment for residential property investment sitting at over 70% for the past two years* - the professionals agree that investing in property is a smart approach to long term wealth creation.
If you’re new to the residential property investment game there are a number of factors to consider before making the leap. You have probably heard that property is all about ‘location, location, location’ and this rings true. Finding the right property (perhaps try shopping for a home like an economist?) in the right area is key, as some areas are considered reliable options with fairly stable growth (think leafy suburbs with secure neighbourhoods, great schools, good transport links etc.), whilst others may be inherently more risky, with greater growth potential in the short term (think up-and-coming, inner city apartments in areas currently undergoing rejuvenation). You also need to be sure you can afford to finance the property and that your current budget allows for what can be a very large upfront investment. You want to try and get finance that requires as little of your own funds as possible, with loan repayments that will mostly be covered by the rental income.
Property investment differs from other investment vehicles in three key ways. Firstly, it requires a much higher upfront investment, often requiring a down payment of over R100 000 for a deposit and conveyance fees. Secondly, it is less liquid than other investment types, so you won’t be able to get out of your commitment as quickly or easily, and you’re usually in it for at least three to six months, with the possibility of no return on your investment before then. Finally, property requires a level of management and oversight that other investments don’t; you need to look after the property and ensure the tenant is happy.
That being said, property does have many benefits over other forms of investment. You will likely be able to get a loan to invest in property, whereas you won’t get a loan to invest in shares on the stock market! Let’s say, for example, you have R100 000 to invest. You choose to buy a R1-million property, using your money as a deposit, where you then take out a R900 000 home loan for the balance. You will now see growth and returns on a R1-million investment, instead of on just the R100 000, had you used that to buy shares: essentially, you’re unlocking 10 times the value on your available investment funds. This is commonly referred to as gearing.
Furthermore, if you find a tenant to start letting the property from the start, they will effectively pay off the full investment over time, on your behalf, eventually leaving you with an owned asset generating passive income. This is known as ‘buy-to-let’ and is considered a great starting point for the property investor, as it is fairly safe and stable. This type of property investment usually requires a five to ten-year outlook and allows one to comprehensively assess factors such as tenant availability, demand for properties of this type, and potential future rental income. As a starting point, it also allows the investor to start ‘small’ and grow, building a portfolio of properties and gaining experience and knowledge to try out riskier forms of property investment, such as flipping – buying a property with the intention of renovating it and selling it within a short space of time, for a profit.
Given that the demand for housing is ever increasing, as our population expands, property is seen as a stable asset class (heard the expression, ‘safe as houses’). Property is a key part of wealth creation and helps people to save for their retirement and also has a knock-on-effect for the broader economy, by creating jobs for builders and related services. Due to these factors, the South African Revenue Service (SARS) offers various tax incentives to property investors. For example, all your property related expenses, such as the interest on your bond and maintenance costs – are tax deductible.
However, if you’re hesitant about committing to buying a property outright, you can still test the waters of property investment, by purchasing units in a listed property tracker fund, such as the award-winning Absa Property Equity Fund. This will give you access to a diverse portfolio of property with very little risk, stable returns, and the peace of mind of knowing it is managed by top fund managers.
But, if your mind is made up and you’re ready to invest in your first property, Absa is ready to finance your dreams and help you achieve your vision. Unless you’re in the very fortunate position of having the available funds to buy a property outright, you will probably need to apply for a loan. Before doing so you should ensure your credit record is in order.
For your loan application to be approved, the bank will assess your affordability ratio, which usually takes into account your current income (based on your salary, any existing rental income and other sources of income) and allocates a portion of this to determine what you can afford. This has traditionally been highly limiting, as one can only use current income and assets to prove affordability.
But Absa has now introduced the innovative Future Rental Income solution, a first of its kind in South Africa. This solution allows a loan applicant, who already owns two properties, to include part of the expected future rental income of the property they wish to purchase, to their affordability assessment. Let’s imagine your current income is R20 000 and as well as your home, you also have one existing investment property earning R6,000 rental income. You apply for a loan to buy a two-bedroom, sectional title apartment and based on similar properties in the area you determine that the expected rental income for this property is R8 000 a month. Absa will then take a portion of this expected future rental income, even if the property isn’t yet tenanted and add it to your total income. So with Absa Buy-to-Let’s Future Rental Income solution, you will qualify for a higher loan amount than before. It’s this kind of foresight and belief in the potential of investors that is changing the property investment game in South Africa.
Over and above our existing products and services, Absa goes even further in adding value to investors’ lives, by partnering with TPN and Trafalgar, to bring a suite of services to home loan customers, as outlined below:
Disclaimer: The advice contained on this blog is for general purposes only and does not take into account individual circumstances, objectives or financial needs. Accordingly, readers are advised to seek appropriate advice from licensed professionals prior to making any investment, or taking up a financial product or service.