Property investment

Property investment: Is it a good idea?

Property investment, good idea or not?

Property investment ins-and-outs

South Africans have a fixation on residential property investment, because we are told from a young age that we have to own a home. So, when we start work we duly buy a home and embark on our lifelong property investment adventure. As we grow older and have children, we buy a bigger house with a larger mortgage. This carries on until we retire and decide to look for a smaller home. Hopefully this time without the need for a mortgage. Many of us never stop to question whether there is a better way to use our money.

The table below shows the long-term growth of all the main asset classes in South Africa and how they have beaten inflation. The growth is calculated annually over very long periods of time. We look at long-term growth because it eliminates the distorting effect of short-term events and therefore gives us a proper perspective on these investments. Where does property investment fit in?

South African asset classes: Performance over the long-term

Asset Class Indicator Long-term annual growth above after inflation*
Shares All Share Index 7,6%
Residential Property Investment ABSA House Price Index 1,5%
Listed Property SA Listed Property 6,5%
Bonds All Bond Index 2,0%
Cash STefI Call 1,0%

 

Compiled by Galileo Capital. Sources: I-Net, Nedgroup Investments and Absa

*Updated annually since 1900 to 2012, or longest available period.

From the table above we see the best performing investment (asset class) is the share market. Over the long-term it has beaten inflation by 7.6% per year, while listed property investment is the second best performing investment. It beats inflation by 6.5% per year. Residential property investment, in contrast, has only beaten inflation by 1.5% per year since 1966 when the index was started.

The growth of residential property investment as indicated in the table does not take into account the buying and maintenance costs of property. These include transfer duties, bond registration and legal fees. In addition, you will need to pay an estate agent 3% to 7% when you decide to sell. There are also the costs of owning your home. This could average as much as 1% of the value of your home per year. This may seem high. But you need to keep up your home and garden and pay rates or levies.

While most people view a residential property as a low risk property investment, there are some risks to consider. For example, suburbs can go through cycles where the area declines, e.g. Hillbrow or Sea Point a few years ago. If this happens, you may struggle to get a reasonable selling price for a property and rental income will also decline substantially.

You also need to consider the value of the capital that you have tied up in your home that effectively does not “work” for you. An example of this would be a cash-strapped, retired person who lives in a R1 million home that is paid off. The retiree could sell the home and use the R1m to generate more income, which can partly be used to pay rent. The rent on a property investment valued at R1m can be less than the income generated by a properly diversified investment portfolio worth R1m. In addition there will be no maintenance costs. These are be for the landlord’s account. This free up even more money for the retiree.

Financially, it often makes more financial sense to invest your money in growth assets and only rent a home. However, financial considerations are only one of the factors that influence your money decisions. If you are in a sound financial position, you may derive emotional security from owning your home. This cannot be underestimated. Property investment may just be the right thing for you, under these conditions.

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Uncertainty and volatility must not scare you

Uncertainty and volatility can seem scary… don’t let this worry you

Uncertainty and volatility can seem scaryThe devaluation of the rand. Labour disputes in the mining and agricultural sectors. Concerns about our economic future. These issues all unsettle investors. The fact that the stock market performed well in 2012 is amplifying the fear. Investors worry the market cannot continue going up for longer. Should you be worrying about uncertainty and volatility too? What should really worry you; uncertainty, volatility or inflation?

Volatility is not risk

I always get grumpy when I read marketing material from fund managers. They brag about the low volatility of their funds as if this means their funds are somehow less risky than their competitors’. It’s hogwash to equate uncertainty and volatility to risk. Especially if you are a private person who needs to make smart, long-term investment decisions. If you want to generate real capital growth, pray for uncertainty and volatility. Investments with no uncertainty and volatility are either very low risk and stand little chance of beating inflation, or these are Ponzi schemes.

Uncertainty and volatility give opportunity

Where would you rather invest your money today, in platinum miners or the listed property sector? I’m sure many people prefer listed property. The returns have been great (especially last year). There is a good chance these companies will generate income and profit in the next few years.

What about platinum? The unions seem hell-bent on destroying their source of employment in a lethal game of chicken to get higher wages for a reducing number of employees. Some platinum miners are even being publicly targeted by Government. This is never a good sign for investors. However, if forced to allocate money to only one specific sector today, I would consider platinum miners and not listed property. There is good value in these miners. They have no international competition, so they have a natural monopoly. The uncertainty and volatility facing the sector is precisely what creates the investment opportunity.

Manage uncertainty and volatility, don’t avoid it

Most international markets, including SA, have performed well recently. Uncertainty and volatility has reduced and most equity investors are in a comfort zone. This is probably a good time to start worrying. Complacency coupled with equity investment is never healthy. The chance that equity markets will generate reduced performance in the years ahead is increasing. It will be difficult for most asset classes to beat inflation over the next three to five years.

Am I saying you should sell out of equities? Definitely not. I do recommend you diversify your portfolio across a range of sectors and asset classes. No-one knows if the stock markets will continue to run for the next year or three. I prefer earning dividends and not interest on cash. Optimally diversify your assets  in volatile conditions as an effective strategy.

The best investors never invest with absolute conviction. They realise the stock market will always do the unexpected in the short-term. This means they don’t bet the house on one particular strategy. Smart investors allocate some capital to one strategy. But if they’re wrong, they will have capital allocated to other strategies too. They do not take unsustainable losses. Absolute conviction with investment is always fatal to capital growth.

Inflation is your real risk

Over long periods of time the effect of inflation on your money is your real concern. If you don’t invest in productive assets such as shares and commercial property, you are guaranteeing the value destruction of your capital. This is especially true if you invest in cash and other “low risk” assets, because you want to avoid uncertainty and volatility. This is not a good strategy for long-term investing.

Productive assets are by their very nature volatile. Ideally you should focus on the income from these assets. If the income they generate increases faster than the inflation rate, the volatile nature of the capital invested is not relevant. It’s one of the reasons why Warren Buffett avoids IT companies. He cannot predict their income in the next 10 years. Therefore he allocates his capital elsewhere.

If the markets take a beating in the next year or two, I will probably increase my allocation to shares beyond my normal targeted percentage. But I will always maintain some asset class diversification. Just in case.

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The perfect Portfolio?

Many South Africans love physical property as an investment. Personally, this fixation has always fascinated me as I wonder if these property investors know what they are missing by ignoring the other major investment types available to them. For example, listed property companies that trade on the JSE have been fantastic investments over the last 10 years. People who bought these companies have earned 22% per year over the last 10 years and they earned this growth without having to deal with tenants or maintenance issues. This is only one of the alternative investments available to individuals who are willing to consider alternatives to residential property.

Long term history is a good indicator

The table below shows the long term returns of all the major investment asset classes available to South African investors. The returns over 10 years are most relevant as the 2 to 5 year information is too short to be helpful although it does make for interesting reading.

10 Year Return of Major SA Asset Classes

10 Year Return of Major SA Asset Classes

It is clear from the 10 year history that listed property and shares (equities) are an ideal combination for long term capital growth. If you include bonds as a stable, inflation-beating asset, I believe you can create the ideal portfolio for any individual simply by using a stock broking account. If you are reasonably young and looking to grow your assets without an immediate requirement for income, you could combine an investment in shares with listed property. A good allocation would be 75% in shares and 25% in property.

If you are looking for a combination of capital growth and income, you could reduce your allocation to shares i.e.: 50% equities, 25% bonds and 25% in property. This combination should ensure that your capital grows more than the inflation rate whilst generating a good income. If you are not built to cope with the volatility of the stock market, you could reduce your investment in shares to 35% and increase your investment in bonds to 40% and property at 25%.

The costs of creating and maintaining any of these portfolios would be quite low (initial brokerage plus a monthly portfolio fee) especially compared to buying physical property assets. If you are considering buying residential property, you will be paying massive transaction costs and ongoing maintenance costs.

In addition, your risks in a listed property investment are significantly lower as your property portfolio consists of hundreds of offices, factories and shopping centres rather than a limited number of individual properties. You will never have to go to court to evict a non-paying tenant nor will you have to worry about inefficient municipalities etc. because your assets are managed by professional managers who get paid to do this stuff for you.

What to invest in?

The easiest (and probably most cost effective) way of creating a diverisfied portfolio for yourself, would be to invest in Exchange Traded Funds (ETF’s). ABSA offer two diversified ETF’s (called MAPPS) that you can buy via your stock broking account that will give you the necessary equity and bond exposure. You can then add your property exposure via the Proptrax ETF’s or you can buy individual property shares.

Some costs are declining

When ABSA launched the MAPPS ETF’s, I was really excited about these investments until I found out how much ABSA were charging to manage them. I am very glad to see that they have recently reduced the costs of these investments substantially; so that they are now really attractive investments. Unfortunately, I feel that Proptrax are charging too much to manage their ETF’s which makes it difficult for me to recommend these investments at this stage.

Is the market too expensive and should you wait to invest?

The JSE is on a charge at the moment and is breaching new highs on a regular basis and this is causing people to question whether the market is getting too expensive. This is one of the themes that financial journalists start repeating whenever the markets do well for an extended period of time. I agree that you need to be careful when investing your capital into this market however; your decision should always be made in context. The JSE index might be above 34,000 but the PE of the market (its real value) is near 13 which is well below its historic highs. I become very fearful when the JSE gets close to a PE of 19 but not at 13! Many fund managers are suggesting that foreign markets are trading at lower PE’s than the JSE and therefore we should rather invest offshore. I think this misses the point that the JSE itself is not in expensive territory yet. If you are investing on a monthly basis, you have no cause for concern whilst lump sum investors should probably make their purchases over a number of months to reduce the impact of volatility on their investments. There is certainly no need to avoid the JSE in the hope that it will drop in the near future, the market could continue on its path for many months yet.

Get advice

Will you have enough money when you retire? Thinking of investing? Wondering how to repay your debt? Where to invest your money?

With a dizzying array of asset classes, asset types and more information than anyone can possibly process alone, why not speak to one of our expert financial planners? Get advice that’s tailored to your unique financial situation now.