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How to invest in rental property

By Buhle Ndweni

When considering an investment in a buy-to-let property, there are many factors to consider. finweek speaks to experts about what to look out for to ensure you make a decision that you will be able to manage and benefit from.

Areas close to economic activity always lend themselves to people looking for rental property. This is especially true in tough economic times, where people may struggle to obtain bonds or require the flexibility of a rental agreement.

how to invest rental property

Andrew Schaefer, MD of Trafalgar Property Management, says in the current environment there are two factors to keep in mind before investing in a buy-to-let property. Firstly, rising interest rates affect rental charges and the affordability of rental properties for tenants. Secondly, it also affects people’s ability to buy property, meaning more consumers are forced into the rental market as they cannot obtain financing from banks.

But before you put in an offer on your buy-to-let property, it is important to consider factors such as location, affordability, rental yields and legal pitfalls to avoid with tenants.

Does it make financial sense?

John Loos, household and property sector strategist at FNB Home Loans, says potential buy-to-let buyers should calculate the potential yield on the property. A simple calculation is to look at the annual rental income minus related expenses, such as maintenance, and divide this by the price you paid for the property.

Also include other costs, such as transfer fees, and the maintenance costs you will be legally obliged to cover in terms of the rental agreement. A non-paying tenant, who is hard to evict under South African legislation, may also force you to incur legal costs – an expense worth budgeting for.

“A lot of people do not understand the concept of a yield; they tend to buy to let based on their expectations of what capital growth is going to be. At the moment with the economy looking like it will remain stagnant for years to come, it doesn’t look like there will be much capital growth in property,” says Loos. “You need to be happy with the income stream that you are buying and not just focus on what you think capital growth will be; capital growth is only part of returns.”

Also consider the yield of other rental properties in the same area to ensure you do not overpay for the property, and to get a realistic idea of market-related rentals in the area. Sources for rental information include the classifieds section of the local newspaper, as well as property-related websites, says Schaefer.

Charging market-related rent will also mean it will be easier to find and retain tenants, says Schaefer.

Potential buy-to-let investors should consider financial and feasibility risk and determine whether they can service the investment property long-term, since this is a long-term investment. “Think about the long-term security and consistency, that’s why financial due diligence and feasibility are so important,” says Schaefer. There are also income and capital gains tax implications to keep in mind.

Location

Lesiba Mooka, founder and CEO of real estate company Cobalt Blue Properties, says a property in the right location for the right target market can be a worthwhile buy-to-let investment. It’s important to consider not only the affordability of the rent for potential tenants, but also the demand and supply of rental property in the area, he says.

“Think about your potential tenant and look at areas where they are most likely to rent,” says Mooka, who owns numerous residential rental income properties.

In Gauteng, areas like the Johannesburg CBD, Auckland Park and Rosebank will always be popular among young, economically active tenants or students. Many may still be dependent on public transport, so easy access to buses, taxis and trains and shopping malls will be a plus.

Schaefer says upmarket properties, depending where they are situated, have a thin market and take time to occupy, but income property owners specialising in that niche market tend to have contacts or know of expats who can occupy the units.

How to finance your buy-to-let purchase

Mooka says the major banks can be approached for a bond to finance a buy-to-let property. Up to 100% bonds can be awarded, depending on the applicant’s credit risk profile and affordability assessment. Existing bondholders can apply for a second bond.

“Typically small to medium investors would have some equity saved from other sources. They would then identify property and have the equity to develop it and they would have an existing bank relationship and then wage a second bond on the investment property. They would normally set it up so that it is paid off or cash flow neutral to take the long payment off the bond and slowly equity will grow, with rental increases and positive cash flow they will develop equity to invest into the next property,” says Schaefer.

Should you appoint a property manager?

While it may be cheaper to manage the property yourself, you need to determine whether you have the time and personality to do it properly. “If you have a normal 9-to-5 job and you don’t have time to run around managing your tenant and sorting out issues such as non-payment, it’s better to have a property manager,” Mooka says.

If you decide to manage the property yourself, there are companies that will vet potential tenants’ credit records for a small fee, says Loos. “[Managing a rental property] is not a passive investment where the money just automatically flows in; there is a fair amount of work to do,” says Loos. Even if you appoint a property manager, it will still require time to manage that relationship, he explains.

Do your homework

Loos says buying property to rent out can be a good or bad investment, depending on whether you know your stuff or not.

“What I have seen in some of the less seasoned buy-to-let investors that I have met is they often come short not because the property was a bad investment, but because they didn’t know what they were doing,” says Loos.

“In other words, they didn’t have a good grasp of their legal rights and obligations because tenants can go bad. They didn’t know how to manage the property and manage the tenants,” he says.

Schaefer concurs: “Often people don’t do their homework properly. It makes sense to be well-prepared and resilient on the property management and [be] able to grow your portfolio.”

Listed property as an alternative 

For investors who want exposure to property but don’t want to manage tenants, listed property offers an attractive – and more diversified – alternative.

“For a small investor, a buy-to-let property comes with a concentration of risk. You are spending a huge amount of money on one single asset and if the tenant goes wrong, you take a big financial knock,” says Loos, who himself has opted to rather invest in listed property. “Yes, the share market can be volatile. But if you bought into one listed property fund, you have already spread your risk into a number of properties, so the concentration risk isn’t nearly as much [as with a buy-to-let property].”

While the listed property sector in SA is dominated by commercial and retail properties, residential funds are starting to emerge. In June 2015, Indluplace Properties became the first specialised property fund invested exclusively in residential property to list on the JSE. Its portfolio includes more than 3 600 flats in areas such as Hillbrow, Berea and Randburg in Johannesburg.

– Finweek magazine

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