Ever dreamt of being a property mogul – wheeling and dealing as you build up a formidable portfolio? Many fortunes have been made (and lost) this way, as it seems quite easy: buy a property, fund it with money from the bank, then rent it out. The rental income pays your expenses, and you have an asset that you can sell in the future for a handsome profit. Repeat, and grow rich!
But is it really that simple? It’s said that fools rush in, so best you understand what you’re in for before you get started.
Investing in property means being in it for the long haul, as the market operates in distinct cycles. ‘There are periods of steady growth, stagnation and sometimes even crashes,’ says Erwin Rode, MD of Rode & Associates, a company that specialises in property research, economics and valuations. ‘Depending on when you buy, you could benefit from an upswing, or seriously regret your decision. For example, if someone bought a property around 2000 and sold it seven years later, they would have made a killing.’
So if timing the market is crucial, and no one has yet found that crystal ball to predict the highs and lows, an investor would simply stay in the market and ride out the cycles. Is it worthwhile?
Returns relative to inflation
To make financial sense, any investment must at least match, and ideally beat, the inflation rate. With property, several factors need to be considered: the growth in the actual value of the property, the income that is generated and the level of debt on the property.
The FNB House Price Index has been tracking property price movements in SA for decades, and over the past 10 to 15 years, the average property price increases haven’t kept pace with inflation. But, says Erwin, once you add the income received from the property, the return does beat inflation in the long run, by about 4%.
So the combined return depends on when you buy and sell, as well as whether there is a mortgage on the property. Borrowing from the bank to finance the property is known as gearing, which can work for or against the investor, depending on market conditions.
The greater the percentage of debt, the higher the gearing. The advantage of gearing is that the interest you pay is tax deductible if it is an investment property. On the downside, the higher the gearing, the harder you’ll be hit if interest rates go up or if you don’t have a tenant. In boom times, gearing increases returns, but in economic downswings, negative equity can occur, says Erwin. ‘This means the outstanding amount on the bond is more than the market value of the property.’
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