We South Africans love owning property. We like the security and sense of ownership; and this warm and fuzzy feeling sometimes spills over into buying a second property as an investment – but then different rules apply.
If you consider the second property as an investment, you have to measure that property against other investments you could have made with that money; like leaving it in cash or investing it in shares. There should be no more “warm and fuzzy”, only risk and return. The problem with property is that there are many hidden costs that you may forget to take into consideration when you are evaluating your return when you sell the investment property.
To highlight some of those hidden costs, we can take the following real-life example and see what the actual return was on such a buy-to-let property.
Total upfront costs
The apartment was bought in the Cape Town City Bowl for R1,7 million in 2020. It was a “fixer-upper” and R125 781 was spent on renovations. Transfer duty amounted to R69 734 and transfer admin R750. So, the total cost of the apartment was R1 896 265.
| Purchase price | R 1,700,000.00 |
| Renovations | R 125,781.00 |
| Transfer duty | R 69,734.00 |
| Transfer admin | R 750.00 |
| Total Cost | R 1,896,265.00 |
Rental income
The apartment was rented out for R15 000 per month and the running costs were: rates and taxes R750 p.m. and levies R5 500 p.m. The total monthly taxable net income generated was R8 750.
| Rental income | R 15,000.00 |
| Rates and taxes | R (750.00) |
| Levies | R (5,500.00) |
| Taxable net income | R 8,750.00 |
This gives us a before-tax yield of 5.53% per year if it was rented for the entire 12 months of every year.
As we can see, the 5.53% annual yield is not much better than cash, and depending on your effective tax rate, probably worse. The expectation is to make your investment profit when you sell the property. Although owners of properties usually believe their property is the best and their expectations are sky-high, your property is worth only what someone else is prepared to pay for it. And that can be very dependent on the housing cycle, location and situation at that specific time.
Profit from sale
If we take our example, the apartment was sold for R2,65 million six years after purchase. The estate agent’s commission was R152 375, the water and electricity clearance certificate was R7 343 and the rates and taxes for the three months before transfer amounted to R2 250. The ultimate amount cleared was R2 488 032, resulting in a profit of R591 767 after six years.
| Selling price | R 2,650,000.00 |
| Agent commission | R (152,375.00) |
| Water & electricity clearance certificate | R (7,343.00) |
| Rates & taxes (during process) | R (2,250.00) |
| Net amount after costs | R 2,488,032.00 |
| Less total costs | R (1,896,265.00) |
| Profit | R 591,767.00 |
This will translate into return, before capital gains tax (CGT), of 31.2% over six years, so 5.2% per year. If you deduct the CGT from this amount at 18%, you are left with a return of only 3.9% per year.
Total return
The total return on this apartment was 8% per year (capital return after tax = 3.9% and yield after tax = 4.1%). This is not a bad return if inflation hovers around 4% and you are not bombarded by the volatility of equity investments, but if you compare it to equities over the last six years, you probably could have achieved a double-digit return in equities. The most important thing property owners do not take into consideration is the fact that circumstances they do not control, can have a very big impact on the value of their property. Take, for example, the following:
- You had a great view but now a new apartment block will be blocking the view; or
- there is a lovely park next door, but now illegal squatters are taking it over; or
- the rates and taxes are increasing at a much faster rate than inflation; or
- new neighbours with three yapping dogs move in next door.
There is nothing wrong with buying property as an investment, but you have to understand that it takes a lot of work to buy, maintain and eventually sell it. Property is much more stable than equities and will cause you less anxiety. If you do your homework, property can be a solid investment, but equities will always remain the easiest investment to buy, hold and sell.