Real estate investment calculation - are the numbers right?

[Basment Dweller]

I'm just playing around with a hypothetical investment here:

I purchase a 1 million rand House

- I pay a 20% cash deposit of R200 000
- The bank finances the remaining 80% at a fixed interes rate of 9% which amounts to R6000/month (800000 x .09 / 12)
- Capital repaiment is over 20 years = R3333/month (R80000/20/12)
- total Bond repayment = R9333/ month

- Rental income is R12 000/month
- I deduct 5% for repairs and 5% for vacancies monthly
- From the R10800 remaining income I deduct rates and taxes of R400/month and insurance of R300/month = R10100
- I then deduct the bond payment of R9333 from R10100

This investment is making a net profit of R767/month off a cash investment of R200 000, return is 4.6%. Am I better off investing in a REIT and not worry about the hassles of managing tenants? Do the numbers make sense?

[Houses4Rent]

Maybe a bit optimistic as I cannot see that you can fix your bond at 9% right now and then for 20y at that rate. Interest will unlikely go down from now, just up. So make provision for that an rather work on at least prime plus 2%. The unexpected increase in interest rate has killed many investors in the past for cash flow constraints. If you are self employed the bank will not fall over themselves to give you a bond either. Use a good bond originator.

Your instalment rate is wrong I am afraid as its not a linear function. At the beginning its almost all interest and in the end almost all capital repayment. Its easier to use an online bond calculator to work out your monthly instalment. I have a little spreadsheet and it spits out R7197.81. Excel can do that easily for you (PMT formula). So here is now even more profit for you.

5% for vacancy is a bit low. Just one month vacancy in a year is already 8.3%. And you might have to cover that amount in the first month after transfer, so look at your cash flow projections. The way you worked it out you would only have that 5% reserve built up after one year. Same for maintenance.

I am thrilled that you work out your ROI on the cash outlay and not on the purchase price which is what many people get wrong.

Don't forget the transfer duty and transfer costs and bond registration costs in your cash flow projections and ROI calculations. Since they are once off expenses I tend to exclude them for ROI for simplicity, but of course you need to have the funds upfront over and above the R200 000 deposit.

If its in an estate or flat you have to allow for levies too.

Park your reserves into the ACCESS bond and save you a whack over time.

Where can you buy for R1.0 Mio and get R12000 rent? That is outstanding. One is very lucky if one gets 1% rent on purchase price.

[Basment Dweller]

This is great feedback thanks H4R...

It's just hypothetical, I'm just trying to see if property investments make money at the end of the day....1mill rand property wont bring in a 12k rent, more like 8-9k...but the '1% rule' states that you shouldn't invest unless you're getting no less than 1% rent on the purchase price...

I'll try rehash this calculation based on your input and see what comes out the other end...

[Beancounter]

Remember that interest on a bond is compound. That means that as the capital balance of the debt decreases, so does the interest you pay. If you are lucky enough to get a 9% interest rate fixed for 20 years, the interest per month will be an average of R3864. You cannot deduct the capital portion from your rental income for the purpose of calculating net profit as the capital portion is part of your investment, not your expenses. If you are even luckier to get R12k per month in rental income, I calculate that you will average a rental profit before tax of R6400 per month (if everything remains static an never increases or decreases). Also bear in mind that your capital investment will supposedly grow if property prices escalate more than the inflation rate. Apart from the hassle of tenants, not a bad investment.

If you want hassle-free investments, put your money in government bonds, they render 8% per annum. And don't fret at the word "government". If government fails, so do all other banks and investment institutions.

[Houses4Rent]

If you are lucky enough to get a 9% interest rate fixed for 20 years,

No bank will fix for 20 years in my view, maybe in Europe only.

[Houses4Rent]

If government fails, so do all other banks and investment institutions.

Property will survive such events easily. The minute you rely on government, investment institutions or others in general you are doomed. More and more pension schemes fail. The only person who has your best interest at heart is yourself.

[Justloadit]

Property will survive such events easily. The minute you rely on government, investment institutions or others in general you are doomed. More and more pension schemes fail. The only person who has your best interest at heart is yourself.

Not always so, especially in Africa, and I note here in the last say 30 odd years, Angola, Mozambique, Zimbabwe, and currently the sentiment in RSA with the idea of land grabs.

[Houses4Rent]

Not always so, especially in Africa, and I note here in the last say 30 odd years, Angola, Mozambique, Zimbabwe, and currently the sentiment in RSA with the idea of land grabs.

I cannot exclude that chance, but I am sure my urban properties owned in a trust are not the easiest targets for a land grab.

[Justloadit]

I cannot exclude that chance, but I am sure my urban properties owned in a trust are not the easiest targets for a land grab.

Does not matter who owns the property, they simply take it over.

[reuphk]

Your calculations on the hypothetical scenario is too simplified and does not take into account a lot of factors.
I suppose we can have very many different views on this, but let me just explain my experience to you and share what I look at (I have been investing in properties for more than 20 years on a small scale, but doing fairly well)

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)
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
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)
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
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
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
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
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)
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)
10 - Dont sell. Fix, renovate, re-rent, re-loan, but keep it (in a Trust)
11 - always look out for properties with more than one unit for more than one rental income or the potential to add another unit
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...