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Six tips for buying investment property

1 Nov 2016

With house prices relatively subdued - the latest FNB National House Price Index shows renewed slowing in month-on-month house price growth and house prices down 20.1% in real terms since the peak reached in December 2007 - many people are looking to buy investment properties, which are mostly funded via a mortgage bond. Given the tax treatment of the income and the fact that the interest component of the monthly instalments is tax deductible, the rental income should cover much of the initial bond repayments.

It sounds idyllic: get someone else to buy your property for you. But before you make that decision, you need to be sure that you can really afford to buy the property. Here are six things that you ought to think about before purchasing a house for investment purposes.

1. Consider whether you will be able to ride out several months with no income from tenants. It is common for residential property to be without tenants for at least a few months every now and again. This could arise as a result of tenants not being available, tenants absconding without payment or the property simply not being desirable enough. Whatever the reason, be sure that you will be able to cover the bond repayments and other costs while waiting to let the property to a suitable tenant.

2. Have an emergency fund, ideally in the form of excess payments into an access bond. A property is let as a full service, so if there is any damage or the property is not liveable, you will need to make good in order to honour your side of the deal. Say, for example, the pool pump is broken. You may be able to live without a functioning pool at your own home, but you will need to repair it when you are letting a property. If your property is in a complex, you may be charged special levies to cover the cost of communal capital expenses. You’ll need to pay up, so be sure that you have cash reserves available for unforeseen expenses. Remember to build the cost of the emergency fund into your rental calculations.

3. Stress test your finances so that you’ll be able to keep up monthly instalments in a rising interest rate environment. Interest rates follow the inflation rate, so look at prevailing inflation trends and ensure that you will be able to keep pace with higher payments. A friend of mine recently acquired a R1.5m bond on an investment property. With interest rates at 8.5%, her monthly payment was R13,000. But as interest rates rose to 10.5% so too did the monthly repayment which increased by R1,950 a month. Given that leases are generally drawn up on an annual basis, the increased cost cannot be transferred to the tenant immediately.

4. Consider the economic environment. With South African inflation heavily influenced by movements in the rand – the weaker the currency, the higher our inflation rate – we can expect a certain amount of imported inflation in the wake of recent rand weakness given that South Africa remains a net importer of goods and services. The inflationary outlook is not promising for the country and we expect it to be sticky at these higher levels. This, in turn, does not bode well for interest rates.

Bear in mind that in a poor economic environment your own income might fall or not increase in line with inflation, which compromises your ability to subsidise the rental property should it be necessary. Would you be able to cope with this situation?

5. Look at the current rates and utilities for your account, such as refuse removal and sewage. In recent years, the increases in fees charged have significantly outstripped inflation. Again, these hikes cannot immediately be shifted to a tenant and the owner would need to absorb the increase for a period of time.

6. Property is an illiquid asset, so if you find you are unable to afford it after purchasing it, or need the funds for something else, it may take time to realise them.

You should be cautious to get involved in investment property if you are unsure of your financial position. As with all such decisions, you need to have a thought through plan and budget which allows for absorption of (un)foreseen and escalating costs or cover periods of no rental income.

The above points are some considerations in a long list of concerns to evaluate before acquiring your first investment property. If, after considering the above, you wouldn’t want to enter the “rental” property market, consider investing in listed alternatives either in the form of a direct property share portfolio or a low-cost Exchange Traded Fund (ETF) which offers dividends instead of the monthly rental income and requires much less effort and thought.

When aiming to gain exposure to an asset class, always bear in mind the different options available to you for investing in that asset class and the various pros and cons of each.