The case for buying property
As a kid I read rich dad poor dad written by Robert Kijosaki. It was a good read, but the whole book (and probably a lot of the subsequent books as well) can be summarized in one concept. You need to spend the extra money you have every month, on investments that constantly bring in additional money. It’s a simple concept, and it snowballs once you get the process going because of the effect of compound interest. One of the very first ways I identified of achieving this is with the help of investment property. It took me a year and two months to save the deposit for my first property. When I bought the property, it was literally my entire net worth, which looking back was idiotic.
Investment property just made sense. It was an investment 23-year-old me could understand. I imagined a future where I had 20 paid off investment properties that were rented out and I simply lived off of the rental income. I ran the math and it looked legit. The profit from the first property would pay of the second, until everything was paid off, at which point I’d retire and travel the world.
The mathematics of owning property
Let’s look at the mathematics of owning investment property. If you bought a rental property at a cost of R800 000. You’d be able to buy a two-bedroom, two-bathroom place and depending on the location, it might even have a small garden. Rental for a property like this should run for about R7 200 a month (I made a lot of assumptions just like everyone else running the numbers). By the end of the 20-year repayment period, you’d have investment property worth about R3 million. In comparison, if you were to invest in Real Estate Investment Trusts (REITs), your investments would be worth about R2.4 million with the same input capital.
This is 20% less than what you would have retired with had you invested in property. So far, so good. Let us now assume that you are retiring with property to the value of R20 million. Had you invested in REITs you would have saved up about R16 million, 20% less than when investing in physical property. The comparative growth can be seen below.
The property yield is about 10% (yearly income) with the property value growth about 7% per year. Typically, about 2% of the yield goes towards levies, rates and taxes and another 0.5% towards maintenance. That leaves you with an income of R1.5 million (the remaining 7.5%). However, you’ll be paying the worst tax you can be paying, income tax. You will only see about R980 000 of that money and the president considers buying another private jet (the other planes are lonely).
Living off your property
If in comparison you drew your money from your REIT portfolio, while still requiring 7% growth, you’d be able to live on the 7% dividends (the yield of the protrax ten). The growth on REITs average about 7% while the dividends average about 7.2%. Obviously, there are a lot of moving parts to this assumption. The tax on the dividends will be lower at 20%, leaving you an income of R921 600. You will be under-performing property by an estimated 6%. This brings me to my first reason for selling my investment properties. If you own property worth R20 million, you are managing about 25 properties. Yes, you can outsource the management, but that’s going to cost you 5% to 10% of your capital, in which case equities are owning your property performance.
I have to rent out a property on average once a year. That’s 3 showings of 2 hours per year. I also have to do maintenance about 2 times a year costing me another 2 hour each. Add paperwork, income tax submissions etc., of about an hour a year and you are looking at about 11 hours per year, per property. That is about 275 hours or almost two months’ worth of property management, in retirement. It also means that you have to be close to your properties. This leaves little time for sipping cocktails in the Maldives.
Equity in the form of ETFs has no management, the tax is subtracted automatically and can be done from anywhere. That’s my type of investment. Granted, you must make the decision for yourself as to what you want to achieve, but I’m all for low maintenance investments. There are a few other issues regarding property management that I will address in the follow-up article, 9 reasons why I don’t want to retire with property.
Be safe out there,