There are a num­ber of fac­tors to con­sider be­fore you should try to build your own prop­erty em­pire.

Finweek English Edition - - FRONT PAGE - By Mag­nus de Wet

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.)

BTL pa­ram­e­ters

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.

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