The most frequent question we get from our clients about property is, should we pay the bond or invest the capital. The second most common question we get is, should we use our investment to buy an investment property and rent it out, or just leave it?
The answer to both of these questions is not clean cut. The fact remains, unlike shares, ETF’s, or Unit Trusts (like the Deton funds) which are measured and priced, property is not. This means you can physically see an increase in your investment over a set period of time whereas with residential property, there is very little data to show the same. Property is an asset, but you only realize your profits or losses once you sell the asset. This means that there is no real return value on this asset. The general thinking is that you buy a property, sit on it for a few years, and you either rent it out or you live in it, and several years later you sell it for double. This may have been the case a few years ago, but since 2007, the property market has not really moved. Once again, as stated, this may vary depending on area and depending on leverage (bonded or not), but on average, property has not beaten inflation (according to states given by ABSA bank).
So the question is, do you use property as an investment or not? Well, if you had invested R1 million in property in 2007, (7 years ago), the truth maybe that you have only received 3% or less from rental income. And the capital price hasn’t beaten inflation of 5.7% (results will obviously vary), so your R1 million is now only worth R1,500,000, provided you can find a buyer for it. And you would have received R230,000 in rental income profit, once again, provided it wasn’t bonded. So your R1 million is now worth around R1,8 million after 7 years. The real question is, what would it be worth if you were invested in the stock exchange?
Since January 2007, the JSE all share has given us over 100% return. Which is around 10.75% compound over the period, meaning your R1million has now doubled and would be worth around R2,050,000. If you consider that the JSE All share is only ranked in the middle of the Unit Trust pack over 7 years, where would you be if you had invested in a Unit Trust? Well one of the well known Equity managers in SA has compounded at a little over 14% for the 7 years, meaning your R1 million would now be worth R2,5 million. If we use the top performing Equity manager over the same period, this return would be closer to R3 million.
Remember all of these figures and values above are just looking at capital price, and would exclude any dividends on the shares. I cannot factor in the other variables on the property like monthly rates and taxes, maintenance and general upkeep of a property. Seeing that different properties have different needs, this would also be impossible to work out.
Where does the above leave us with a rising interest rate cycle and bonded property? The truth is, we are in a rising interest rate cycle, and we could see rates going up by another 2% over a 24 months period. While this increase helps our clients with interest bearing investments, it doesn’t help the man in the street with debt. This means the higher the Prime rate, the better “return” you receive by paying off a bond. So with this being said, what sort of return could you see from paying off debt? With the current Prime rate at 9.25%, and a potential 1-2% increase over the next 24 months, this could mean you could see a return of up to 11.25% if you have the capital to pay off your bond. While this return is not a bad return, it is not a compound return, as such, a return of 10% plus compounded over 5-10 years on the JSE would still beat this 11% return. If we start seeing rates return to the 13-15% levels, then there may be an argument for debt consolidation versus Equity investments. But while the Equity space is giving 5-6% dividend yields and capital growth in the teens, my view is that Equity is still the place to be.
So based on the above, where does this leave us? Do we now sell our properties we live in and go rent? Do we sell those investment properties and give the profit to your trusted investment manager at Deton Private Wealth to invest? Well I guess that is the million-dollar question, and it is definitely one that could be argued all day, but do we really have time for that? Personally, we are not big fans of residential property as an investment, and feel that over the longer term, Equity will outperform cash and Commercial Property. Another factor that you would need to consider is if you require an income, could you break a corner of your gingerbread house off to eat if money is tight?