LISTED PROPERTY VS BUY-TO-LET: WE CRUNCH THE NUMBERS
There are a number of factors to consider before you should try to build your own property empire.
with US presidentelect Donald Trump on everybody’s lips, our office has been flooded with property investment questions again. Although it is true that Trump made his billions from real estate, our research has found that one is not likely to achieve these returns through the buy-to-let (BTL) property market, which South Africans are obsessed with.
I explain in this article why you would have been better off (with much less risk) investing your money in a portfolio of listed properties on the JSE or through a listed property unit trust investment.
Buy-to-let and listed property defined
A BTL property investment in this article is a residential property that an investor buys with a small deposit and mortgage from the bank. The investor then gets a tenant to rent it and receives monthly payments from the tenant.
A listed property investment, on the other hand, represents a basket of real estate investment companies listed on the JSE. Examples of listed property companies include Growthpoint and Redefine. Listed property can also be a unit trust investment managed by a property investment specialist.
Measurement used for comparing buyto-let to listed property
In order to do a comparison between a BTL investment and a listed property investment, we had to build a model and decide on a metric. It was decided the best comparison measurement would be the annualised total return formula (XIRR formula in Excel), as it is a very popular metric in the investment industry.
In short, it calculates the geometric average amount of money earned by an investment each year over a given time period. It is calculated as a geometric average to show what an investor would earn over a period of time if the annual return was compounded. Another reason for this formula is that the cash flows don’t have to be periodic. (See box for a detailed explanation of the geometric average.)
For BTL investments the annualised return turned out to be a bit of a nightmare (as so many other factors associated with this type of investment). First, you have to build a model that takes into consideration many parameters. Below is a list of the most important parameters involved with this article’s BTL investment (also see table): Initial investment value – A R1m investment property was used in the model. The property was mortgaged and a 10% deposit had to be paid. Since the investor did not have the luxury of financing the listed property investment, the listed property investment was started with the same amount as the deposit placed on the BTL property, in other words an initial investment of R100 000. Interest rates – The average prime interest rate in SA over the last 20 years is just over 13%. The November 2016 FNB Mortgage Barometer predicted the Reserve Bank will leave interest rates unchanged for the time being, and that the repo rate is expected to move sideways through 2017 to 2019. In order to keep it simple, an average prime interest rate of 10% over 20 years was used in the BTL model. Rental income – An initial rental income of 10% per year of the value of the property
was used. According to the Tenant Profile Network, a credit bureau that specialises in vetting tenants for rental properties in Africa, the rent escalation average in SA for 2015 was just below 3%. The rent escalation from 2010 to 2016 however indicates an average of approximately 6.5%. It was decided to use 6% as the annual escalation rate, as it represents the higher end of the Reserve Bank’s inflation target rate. Property value increase – The Absa House Price Index is based on the total purchase price of all houses (including all improvements) in respect of which loan applications were approved by Absa. The data goes back as far as 1966. According to this index the average size house price (as the one used in our research) has increased by approximately 10% per annum over the past 20 years.
The model indicated that the buy-to-let investment, had an annualised return of almost 18%. The listed property investment had an annualised return of just over 21%.
Listed property parameters
Listed property investments are very easy to model as their annualised returns are freely available. The JSE has a total return SA Listed Property Index, which we decided to use as the benchmark for this comparison. The graph on page 20 indicates the annualised total return for this index over the past 12 years (since inception).
BTL compared to listed property annualised returns
The model indicated that the BTL investment, using the parameters above, had an annualised return of almost 18%. The listed property investment had an annualised return of just over 21%.
Listed property therefore outperformed BTL by only three percentage points, which is probably not that drastic. However, the BTL numbers did not take into account and don’t reflect the massive risks (see sidebar) associated with BTL investments.
Even if the technical BTL benefits increased the annualised return of BTL to be on par with the listed property investment, it’s unfortunately not enough for me. The inherent risks associated with BTL are just too big. It is also a very illiquid and complex investment with many variables. Unlike listed property, with a rental property you need to be consistently involved, at the beck and call of the tenant. For me it’s a no-brainer – I will never invest in BTL property again.
The inherent risks associated with buy-tolet are just too big. It is also a very illiquid and complex investment.