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Monday 11 September 2017

Residential Property Investing FAQ's

I probably should have flipped this
image horizontally... 
Should you invest in Listed Property or Residential Property?
Is this property a good investment?
Should you buy a rental property cash, or finance it?

These are some of the more common property investment questions I have seen/been asked directly - and they are all very interesting questions!

In this post I will look at these (and some other property investing FAQ's) and give my "this is not financial advice blah blah blah" opinion on them...

In a previous post about Residential Property Investing, I created and shared a spreadsheet which could be used to evaluate and track a property investment (I sent the spreadsheet to the blogs subscribers, but you can also download it here).

My software engineering brain has been panel-beated to always look out for "reuse". So when I saw that the spreadsheet could be reused for this blog post, I naturally jumped at the opportunity! The spreadsheet lends itself quite well to helping answer some of the more common property investing questions (well from the numbers side of things).

So I will be referencing the spreadsheet a fair amount below. Also, some things are best illustrated by way of example, and so I will sometimes reference my default, totally not made up example investment property which is for sale at R1 Million. I assume an interest rate of prime and all other assumptions are the same as the example in the Residential Property Investing article.

Right, let's check out some of the questions...

Is It Better To Buy A Rental Property Cash, Or Finance It?

Look at you with your couple of 100k just lying around looking for a new home (pun intended). Drinks on you tonight!

You have decided that you want to allocate this cash to a property investment. So is it better to throw the entire amount at an investment property, or should you rather finance it?

To check what would give better returns, then let's turn to our spreadsheet. First up, the returns of buying a house cash for R1Million. The returns of the first 15 years is shown below (click for larger image)

After 15 years you would have achieved a Compound Annual Growth Rate (CAGR) of around 10.5%. So what if you put down a R100k deposit, and financed the rest instead (again, click for a larger image)?

Going with a 10% deposit gives you a CAGR of 14.3% after 15 years compared to the 10.5% of the all cash scenario.

Also something to think about - with a 10% deposit, you could theoretically (and ignoring transfer and bond costs, difficulties getting finance, and the migraine level headache of all the admin) get another 9 similar properties with the rest of your money (10% deposit on each) which would decrease your risk (and your free time - imagine trying to manage all of those!)

Maybe the answer lies somewhere inbetween - you could always put down a 50% deposit on two equally priced properties?

So that's the numbers - but of course there also the fact that debt does not sit well with some people. Owning the property free and clear is also worth something...

Is It Better To Invest In Listed Property Or A Residential Property?

No general clear cut answer here, as it depends on the residential property you are looking at. Some properties can make for poor investments, and others have the potential to make you some really good returns..

Once you have a property in mind, you can again use the spreadsheet to compare the residential property investment candidate to the historical listed property returns and go from there.  Also worth remembering here is that the residential property is more risky (and so should have a higher return to justify the risk) because it is geographically concentrated and more than likely geared.

Let's say you had R140k to invest (you should really speak to the person in question 1 on how to turn that into a Million :-P) on a 15 year timeframe and you were considering the example R1Million property, you would see that the 15 year CAGR of 14.3% is a fair amount below the long term average return of listed property (16.28%). Also keep in mind that the listed property option comes with added benefits of improved diversification and minimal admin.

For more info on this question you may also want to check out this JSE Power Hour Just One Lap hosted and the spreadsheet which came out of that.

Is It Better To Invest In Shares Or A Residential Property?

Very similar to the previous question, and again you should evaluate this on a case by case basis. Use the spreadsheet to compare the returns of a candidate property to the long term JSE equity returns of 15.28%. Then decide if the increased risk of a single tenant in a single asset class in a single location justifies being invested in a variety of companies, in a variety of industries, in a variety of locations.

For the example property, the 14.3% over 15 years in my view does not make sense, and I would probably go for an equity investment instead.

You may also want to check out this interesting article by Glacier for more info (I must say occasionally those active managers put out some good articles - all of course fully funded by their fee paying clients!)

Is It Better To Pay Off Your Homeloan Or Invest In Property?

This is another one of those questions which is not just about the numbers. Paying off debt is never a bad idea.

Paying off your homeloan faster is a pretty good investment in itself! In fact this question is pretty similar to a question I answered in a blog post a while back "Pay Off Bond Or Invest?" Only difference is, for this question the alternative investment is specified as a residential property investment.

What you will probably find is that the spreadsheet shows the property returns and the associated risks may well be worth it in terms of the numbers. But it really depends on your appetite, or as a reader once said to me "whether you are willing to risk it for the financial freedom biscuit!"

Should You Pay Off Your Rental Property's Homeloan Faster?

In general, the numbers say that in order for you to maximise your returns, you should not pay off the loan faster. The extra payments reduce the tax deductible interest expense, resulting in more tax being due, and therefore lower returns.

Let's turn to our trusty spreadsheet and example property again - the spreadsheet allows you to input an extra monthly payment amount. The exact result is tax rate dependent, but in general you will notice that paying extra into the investment property bond actually decreases the returns (as less interest is payable and tax deductible). Using our example property let's add an extra R1000 a month into the homeloan and check the returns:

Paying extra into the homeloan has actually reduced your CAGR by around 1% per annum.

So in general, if you want to maximise returns you should pay the minimum into the bond. But as always, and you been hearing this a lot in this article, there is a case to be made for reducing debt and sleeping a little easier at night....

When Is A Good Time To Sell An Investment Property?

The advantage of tracking the property investment on a year by year basis, is that you can keep an eye on the returns and if they start diminishing you can determine if it is time to exit.

Using the spreadsheet, you will probably notice that returns start moving downwards as the rental income increases and the interest portion of the loan diminishes, resulting in a higher tax expense. Putting the actual values of your property investment into the spreadsheet can help you decide when the returns from your investment property are no longer worth it, and it might be time to sell and move the money elsewhere.

Is This Property A Good Investment?

This is a question I have received from a few readers. The spreadsheet saves me a lot of typing, because now everyone can answer this question for themselves :)

Plug in the numbers for the property you are interested in, and see what comes out the other side. In fact you should probably work through this article, and go from there....

Which Of These Two Properties Is The Better Investment?

If you have two properties you are considering investing in, but don't know which one to pick, you can use the spreadsheet to evaluate both options and determine which one gives the higher returns (but also factor in any other issues like tenant risk, location, geographic location etc.)

Till next time, Stay Stealthy!
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