Deciding on your investment objectives
There are essentially two ways to approach investing in property: buying in the hopes that the price will increase and you will be able to sell for a higher price in the near future (so-called “flipping”), or buying a property for the rental income it generates.
Buying and then quickly selling a property at a higher price is only feasible if you can get the property at a price that is significantly below the market value, or if there is a very hot market and prices are rising continually. In both cases, the key is being able to resell – so you would have to be sure that there would be sufficient demand from buyers for your property when you resell.
Flipping is more speculation than investment.
The costs associated with buying and selling a property, together with a generous contribution to SARS, mean that the resale price has to be much higher than your purchase price to make the whole transaction worthwhile.
For example, if you buy a property for R1 million for cash, your costs could be about R30 000. Assuming you sold the next day for R1.5 million, the estate agent commission could be as much as 6%+VAT or around R100 000 (but you could use a low cost estate agent instead to save on this expense).
So your profit before tax would be R1.5 million – R1 million – R30 000 – R100 000 = R370 000. This profit would probably be taxed as regular income rather than at the lower capital gains tax rate. At a maximum marginal tax rate of 40%, the profit remaining would be R222 000.
In other words, in this example, if you sold the property at a price that was 50% higher than the price you paid, your actual return after tax would only be 22%. Of course, if you had bought the property with some bond financing then your actual return on investment would be much higher.
Buying for rental income
Buying for rental income is a much lower risk strategy than flipping. The goal is to earn an ever-increasing rental income as well as benefit from an increase in the capital value of the property over time.
Often you can finance part of the purchase price with a bond. Whether your investment property is initially cashflow-positive (where the rental income is more than the bond repayments and additional costs such as rates) or cashflow-negative will largely depend on how much of the purchase price you paid in cash and how large the bond was. Clearly, if you made a large cash contribution then the bond would be small, your bond repayments will be low, and your property would more likely be cashflow-positive.
Although it is ideal to be in a cashflow-positive position from the start, this isn’t always possible and you may need to “top up” the rental income to match the bond repayments and other monthly expenses. Hopefully the top-ups will be exceeded by the increase in the capital value of the property.
The idea is that you should take a long-term view and try to keep the property until the bond is paid off (at which time most of the rent will be pure profit) or even never sell at all. This means that the property you choose to buy should be in an area where you expect people to still want to live (and rent) in future – this is also important because if you ever do need to sell you want to know that there will be potential buyers around.
Once your investment is cashflow-positive then you can consider investing in another property, and in this way gradually build up your property portfolio and grow your wealth.
David de Waal
Steeple Estate Agents
South Africa’s first low cost estate agency[shareaholic app='share_buttons' id='5062783']