What you should know about buy-to-let
At the recent Allan Gray Investment Summit, residential letting expert Michelle Dickens spelled out the financial and legal factors that prospective landlords must take into account. reports
BEING a landlord can earn you a good income, but it is not for everyone. Buy-to-let property investing has enthusiastic proponents, such as Rich Dad, Poor Dad author Robert Kiyosaki, but there are also many detractors, who argue that you’re better off putting your money in the stock market.
If you are serious about investing in physical property (as against investing indirectly via listed property shares or unit trusts), you’ll need to manage your property as if you were running a business and fully familiarise yourself with the risks – and costs – involved.
Last week, at the Allan Gray Investment Summit in Sandton, Michelle Dickens, the managing director of TPN Credit Bureau, which specialises in the rental property sector, provided delegates with an overview of the residential rental market, and had helpful advice for prospective landlords.
Dickens says it’s essential to do your homework to find the right property in the right area, taking the following factors into account: • Property price; • Net yield, which is your rental income minus your expenses; and
• Risks, which include how long your property may be vacant in-between lets, delinquent (late-paying or non-paying) tenants and the legalities of removing tenants.
WHEN AND WHERE
When you buy a property, and how much you pay for it, is vital to the success or failure of your venture. Mis-timing the market may mean receiving a lower rental than you anticipate and a lower price if you have to sell.
Overall, the FNB House Price Index has shown little real (after-inflation) growth since the 2008/9 financial crisis, in stark contrast to 2004, the peak of the pre-crisis property boom, when South African residential property prices soared by almost 30%. Dickens says it was easy to make money in those years, but it is less easy now.
Where you buy is also important, not only because some areas experience higher price growth than others, but also because some areas (not necessarily the ones with high price growth) have a higher demand for rental properties than others, and their yields may be higher.
The Western Cape is far outstripping the national average for yearon-year house-price growth (about 5%). Properties on Cape Town’s Atlantic seaboard are growing at 29.9%, those in the City Bowl at 21.1% and those in the southern suburbs at 14.7%, according to the FNB index.
TPN’s market strength indicator for rental properties, which works on an average of 50% (when rental demand equals supply), shows that rental demand in Gauteng is 50%, in KwaZulu-Natal it is 53.98%, in the Eastern Cape it is 62.86%, and in the Western Cape it is 73.25%.
You need to consider whether higher-value properties are better rental propositions than lower-value properties in terms of both rental yield and quality of tenant.
Gross yields (rental yields before expenses) differ across rental brackets and areas.
Sectional-title units command higher gross yields than their standalone counterparts (see graph). Sectional-title properties are generally smaller and less expensive, so the yields you are likely to achieve are higher than on larger, full-title properties, Dickens says.
TPN divides the properties on its database into five rental brackets: under R3 000 a month (22.5% of residential tenants), R3 001 to R7 000 (the majority of tenants, at 53%), R7 001 to R12 000 (17.1%), R12 001 to R25 000 (5.6%), and above R25 000 (1.6%). Properties in the two middle brackets, representing rentals of between R3 000 and R12 000 a month, show the lowest vacancy rates (6.78% and 6.04%, with the national average 8.04%). They are also the brackets with the highest percentage of tenants in good standing – tenants who paid the rental on time, in the grace period, or paid late (see graph).
Price-wise, you should be looking at paying 10% to 15% less than the average property price in a particular area, she says, to earn a reasonable return on your investment after factoring in all the costs.
To work out the annual return on your investment, do the following calculation: subtract from your expected annual rental the ongoing expenses for which you will be liable, such as levies, insurance, rates and maintenance. Divide this figure by the total of the following: purchase price, plus transfer duty, plus conveyancing and bond costs, plus possible renovation costs. The result, multiplied by 100, is your net return expressed as a percentage before tax.
With regard to annual rental increases, Dickens says gone are the days in most parts of the country when you could increase the rental by 10% a year. Only in the Western Cape do rental escalations currently approach that figure, at 9.88%. The national average is 4.37%, with the Eastern Cape at 5.9%, Gauteng at 3.87% and KwaZulu-Natal at 0.68%.