Real estate investment calculation - are the numbers right?

[Houses4Rent]

I keep reading that the JSE is overdue for a correction...

Long Term Investment is key

At Investonline we believe a long term investment horizon will yield you the best returns over time. Equity markets have provided an average annual return of 17% p.a. over the last 50 years. However, over this time there have been periods of flat and negative returns, which have returned back to positive over time.

After 3 years of strong equity returns of 22% p.a. we believe we are entering a period of more muted returns and therefore we are positioning our portfolios more conservatively.

Our view is supported by the following two portfolio managers:

Dave Foord, Investment Manager of the Nedgroup Investments Stable and Value Fund, recently wrote an article where he analyzes past returns and the reasons behind this, and questions whether or not we can expect the same or better returns going forward.

The analysis shows that even though investors of financial assets have had exceptional returns, these types of returns are unlikely to be repeated in the foreseeable future. Patience and persistence, investing for the long term is key and investors need to have realistic return expectations.

Click here to read the full article

Omri Thomas, Investment Manager of the Nedgroup Investments Opportunity and Rainmaker fund, has similar view. His opinion is that it will be very difficult to repeat the fantastic returns investors have received in the past.

The South African equity market has reached new highs and valuations have become less attractive.

Local bonds offer reasonable value while inflation-linked bonds are expensive. The belief is that there is the continued risk of rand weakness, and therefore the rand being undervalued. This volatility offers an opportunity of advanced offshore asset returns.

[Houses4Rent]

1 - Firstly, look for properties where you have rental income and rental demand. Like anything - if the demand is there for your product, you'll be fine. If not...
Rule of thumb is 1% i.e. rentals in the area go for around 1% of your purchase price. this works for interest rate around 10% (yep, that is not 100% accurate - just rule of thumb)

Spot on

2 - spread your risk. Better to buy 2x houses for R750K than one for R1,5M. Simple - if one is empty, no income of R7500, but still for the other one. If the R1,5M one is empty, no income for R15000

Spot on

3 - shop around for homeowners insurance. Not just the premium, but also service. It is normally better to stick to the bank where your loan is, you write this cost off against tax anyway (remember I said you did not factor in all considerations - tax is one)

The banks give me (I manage 120 properties) the worst service. Shop around for sure, but stay away from the banks (they are banks, not insurers and make commission selling it to you) and direct insurers. Ask Phil Cooper on this forum for help...

4 - dont use a rental agency. They do very little, and you part with 7% - 10% for running an advert which you could have done for free

There is much more than running an advert... I generally agree though that almost all letting agents are rather useless. That is the main reason why I clucked my career and stared my own agency, with value add solutions which is still unique in the market after 7 years. If you only have one or 2 properties and they are newar you do it yourself and learn from it. Once you get tired and/or too busy or have more properties find a GOOD agent, then best you can get. The agent will not easily fool you as you have your own experience.

5 - take rentloss insurance. If the tenant defaults, they pay you up to 6 months and take all legal fees and work on them. Worth the 3% - 6% cost

In any case look for rental guarantees which remove the bulk of your financial risk as an add on product. Note a guarantee (pays on 1st) is not an insurance where you have to claim after the rent was not paid and may or may not get paid and lose cash flow in the interim.

6 - Increase your rent by 5% per annum. Most say 10%, but look at the economy and make your decision from there. Economy in this sector means other rental property prices in the area

Balance the increase with supply and demand. I never entertain any increase under CPI although CPI is the wrong yardstick, but a good starting point and much easier grasped by the tenants. 5% would be below CPI. The objective of investing is to outperform CPI of course. Stating a percentage as a rule is no good as it depends on the base. I might have offered my property below market value for various reasons in the first year and now do not need to do that any more in the second year. So that might result in an escalation of even higher than the traditional 10%. Evaluate the market each year and review the rent. Of course also consider whether you want to keep the current tenant or not and whether you could risk a vacancy or not. I always try to stay slightly under market value to beat the competition, but its no science and needs a lot of experience to be able to compare places and rents and areas. Having said that we start marketing a place 2 months before the lease expires. In only very rare cases we end up with a vacancy which then often is just down to Murphy. There are other factors to consider if timing e.g. plays a role. In a student area you need to stick to their roster as outside it demand will drop a lot.

7 - in a few years, take out the deposit amount you paid from the original purchase via your flexible bond account. Now you are using only the bank's money (not your own). Watch out for the rent again - dont want to increase your bond repayment to more than what you get in on rent. Another factor you did not consider in your calc

You can play your access bond in any way you like. Above is just one suggestion. E.g. I happily raise it above the rent income if I use the funds I pulled out for the purchase of another property.

8 - Take 2 months' deposit where you can. And inspect to make sure the property is maintained (yep, the tenant maintains, you maintain the large ticket items, which if it fails e.g. geyser, you could claim from your insurance anyway and write off against tax)

Hot topic. 2m makes it unaffordable for many people. We determine the deposit as to what risk we see in a particular applicant. Now there are these people coming up with deposit cover schemes (no deposit) which I do not think will work very well for many reasons. Too early to judge. I know at least one of them has folded already.

9 - remember that you make your money at the time of purchase. Always make an offer, dont just buy at the listed price. Bank Repo even better. Save on transfer duties (only applicable if property cost more than R500K, so if you could find those, twice better)

I also make my money when I buy i.e. buy below market value or at least try to get the income covering the expenses as close as possible. Transfer duty is waived until R600.000 and that applies for natural person and trusts. Buying in a trust if bought for the long term is in most cases the most appropriate vehicle.

10 - Dont sell. Fix, renovate, re-rent, re-loan, but keep it (in a Trust)

I also never sell, spot on. Rather look at other options like re-finance if you really need money. Selling costs a lot of money in expenses and CGT.

11 - always look out for properties with more than one unit for more than one rental income or the potential to add another unit

Does not have to be only that, but always look at opportunities to change the character of the property in order to generate more income indeed. E.f. ditch the dining room and make a bedroom out of it. Drywalling is cheap and reversible. Be mindful of share spaces though. People do want their privacy if multi tenanted. And who will maintain the shared space... Never rents rooms unless you run lodges for a living, always let the entire place.

There is so much more I could say about properties, but then we'll have to publish the book. So in a nutshell... Should you consider to invest in properties? It has worked for me. I "retired" at 34 and can easily live on my property income if I needed to (I have a business other than the property). The first (two) house I bought I sold 2 years later at double the price I paid for it. Shouldnt have sold. Ever since, whatever we have bought, we rent out. Every time I look at house prices I have heart failure and think how expensive it is, but I know in 5 years, that will have been a bargain price.
Examples: Bought a property in 1987 for R75000. Current value (low estimate) R1,8M. Rental income R12000p.m. Rates exp: R453
Bought a property in 2000 for R450000. Current value R2,2M. Rental income R17500 (it was converted into 3 units, renting out 2, parents live in the 3rd). Rates exp. R395
You do the math (remember, it is the bank's money, not mine - I took out my R65000 for that 2nd one in 2006, and the first one was done with a 100% loan)

It is more difficult today than 20 years ago, but in my view - my maths worked out and yep, I make some losses, but then the taxman does not mind to allow that as a tax deduction...[/QUOTE]
Well done, retire at 34? I am 46 and could maybe retire soon too, but that would be boring. I just keep on doing what I enjoy. If you are ever coming to Cape Town I would be interested in a chat investor to investor over a beer or two.

[reuphk]

^^^ This is why I like coming to online forums for info...post a thread and knowledge bombs get dropped out of nowhere...

There's a lot to absorb here...

reuphk I'm curious to know more about your 'don't sell' policy...I hear this a lot from property investors about how they regret disposing properties...also about property trusts, how do you structure your trusts? Do you transfer property directly into the trust or into a company that the trust holds shares in?

Basment Dweller, I have 3 trusts. One which has nothing to do with properties, but is a Share Trust i.e. any shares I have in companies is managed via this trust. I mention this because you asked about keeping properties in a company that a trust have shares in. Not to cause confusion for you, but I do have 1 company where there is a property (small farm) in and the shares is (with other shares) this trust.
The 2nd Trust is a FAmily trust where our family house (fully paid, no debt) is in.
The 3rd Trust is the Property Trust. This is where all the properties are in and managed from.
There is a lot of talk about Trusts and the benefits and drawbacks etc, so I will say two things about this option.
1. The benefit of a Trust is in the fact that it continues on (and on and on...) post generations and is not subject to estate duty. This is the best tax benefit for this vehicle. The rest is the same as for a company.
2. Decide when you purchase the property what you want to do with it. If you want to flip it, buy it in your personal name. You can live in it and get the benefit of reduced CGT when you sell. If you're renting it out, i.e. adding it to your "stock", put it in the Trust. If you have a company that requires some assets on the balance sheet and/or need expenses to write off against, place it in the company. The trick is to decide up front and then try to stick to that reason. I say try, as I have also done this with some of the properties, then ended up not selling as the rental income does not make sense to sell
I suppose in a nutshell, most investor "advisors" will say put in a Trust in case anything happens and then there is an arms length between you and the loan / bankruptcy. I say, why plan to go bust. If you do everything you have to correctly, you will just have some assets that is being paid by other people (tenants) that is funded by other people (bank). Take the right insurances and do your homework so you dont sit with duds. Pay the taxman what is due to him, not a cent more (nor less) and you have an income for your and your kids' life. If you, (or they) ever decide to sell, for whatever reason, you would have had your investment repay itself many times over already, so that is not a consideration, but there is always the option to change the type of property as the area changes...

I sold the first two houses I bought and this allowed me to buy another one, which we later split into two again. I cannot say I am totally sorry that I sold those - we needed the money at the time to buy the next one. If I had kept it, it would have given the same as that 2nd one we bought i.e. paid for itself and today would have been a passive income. When I bought them, the intention was that I would live in one, and rent out the other. The rent from the 2nd one paid my full bond i.e. I lived for free. As i said, know why you buy and manage it accordingly. where you can. None of those where in a Trust (didn't know about it at the time). So, all this said... a Trust is the better option if you are renting it out and intent to keep it.

[Basment Dweller]

Awesome input from bother houses4rent and reuphk.

Quick note on real estate agents...I have to say they are most irritating uselles bunch...mostly bored housewives that have nothing to do but go around getting comms. The only reason why it's worth using them is TIME, since I'm employed full time I don't have the time to have show days and meet people on site all day long. I do however know how to market the property, screen through TPN, do applications etc....but fielding calls, leads and meeting people on site is a waste of my time and I'd rather outsource it.

BTW you should read a book called Freakonomics and hear what those guys have to say about real estate agents. They don't work for the people who pay them i.e. the landlords because of the incentive structure, they just want a quick comm then move on.

Reuphk, about your trusts...who do you keep on your board? especially the family trust. Do you have any independent trustees? Do you have trustee meetings and decide how the proceeds are distributed?

[Houses4Rent]

Quick note on real estate agents...I have to say they are most irritating uselles bunch...mostly bored housewives that have nothing to do but go around getting comms. The only reason why it's worth using them is TIME, since I'm employed full time I don't have the time to have show days and meet people on site all day long. I do however know how to market the property, screen through TPN, do applications etc....but fielding calls, leads and meeting people on site is a waste of my time and I'd rather outsource it. BTW you should read a book called Freakonomics and hear what those guys have to say about real estate agents. They don't work for the people who pay them i.e. the landlords because of the incentive structure, they just want a quick comm then move on.

Did you mean letting agents rather as estate agents sell property in my definition. I fully agree on both. The frustration with letting agents caused me to start my own niche/specialized agency. The frustrations I have with estate agents when I am trying to buy is endless. I once even spoke to Bill Rawson about it and he agreed, but said it will not change. Almost all letting agents and almost all estate agents are useless. The average age of an estate agent is now above 60 - go figure. A friend once said and estate agent is a failed insurance agent....

Reuphk, about your trusts...who do you keep on your board? especially the family trust. Do you have any independent trustees? Do you have trustee meetings and decide how the proceeds are distributed?

Any trust must have an independent trustee to keep all at arms length.