You can make good money on property
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| You can make good money on property |
| By Charlene Clayton of Personal Finance | www.persfin.co.za Everybody has heard of someone who has made a good investment in property. But if you think there is a secret to investing in property ... there is none, says Anton de Goede, an investment analyst at acsis. You simply need to understand the role of property as an asset class and do your homework thoroughly before you invest. For most people, their first foray into property is the purchase of their own home. But buying a house in which to live is a lifestyle decision rather than an investment decision, Anton de Goede says. De Goede was speaking at a recent meeting of the Investors’ Club which is sponsored by Personal Finance and acsis, an independent financial advice company. According to research by Absa bank, residential property in South Africa has performed well over the past three years, and house prices grew by an average of 27 percent last year. However, by July 2006, house price growth had slowed to about 14 percent. De Goede says, there is a downward trend in house prices, particularly for luxury homes. Sellers are achieving, only 60 to 70 percent of their asking prices, and homes are taking longer to sell. Houses are on the market for an average of eight to 10 weeks, according to the FNB Property Barometer. In the fourth quarter of 2004, 90 percent of properties were on the market for less than six weeks. The increase in interest rates has slowed the growth in house prices, but the recent increase is not expected to have as dramatic an effect as it did in 1984 when house prices fell, or in 1998 when house prices remained relatively static. De Goede says household debt in South Africa, as a percentage of disposable income, is at an historical high of 68 percent,which is below the 120 percent in the United States and the 150 percent in Australia. Similarly, although debt servicing costs (what you spend to repay your home loan) as a percentage of disposable income are at 7.5 percent in South Africa, this is far below the levels of 14 percent in the US and 11 percent in Australia. Apart from higher interest rates, increasing food and petrol prices will have an impact on disposable income and this will have a negative effect on the housing market, De Goede says. If you want to invest in property, De Goede says, your options are: 1 Listed property: You can invest in listed property in two ways: through property loan stocks (PLS) and/or through property unit trusts (PUTs). Loan stocks and PUTs, which are listed on the JSE, have different structures, but allow you to invest in a pool of commercial properties. Investors in loan stocks and PUTs derive income from the properties in which the loan stocks and PUTs invest. Should the properties in the portfolio held by the property loan stock company or unit trust manager appreciate or depreciate in value, it will impact on the value of the shares (units) you hold. If the properties increase in value, you will share in the capital gains made when the properties are sold by the PUT manager or property loan stock company. Investors in listed property have enjoyed sound returns on their money since 2000, De Goede says. An amount of R100 invested in the listed property sector in December 2000 would have increased to almost R484 by March this year. Since then, the sector’s return has tapered off and the R100 would have been worth about R385 at the end of July. The listed-property sector has grown greatly over the past five years, De Goede says. The market capitalisation of the real estate sector of the JSE was about R5 billion in December 2000. It reached R66 billion in July this year. There are about 30 PUTs and loan stock companies on the JSE, he says. In the same period, the number of ordinary unit trusts that invest in PUTs and PLS’s, has grown from four to 19. De Goede says the aim of investing in listed property is to: Obtain a steady stream of income; and Earn a profit through capital gains (when you sell the investment in the property). De Goede says while listed property produces a stable income, the capital returns can be erratic. The way in which property trades relative to long bonds (government bonds, such as the R157, that have long terms to maturity) influences the capital component of the total return that investors earn from listed property, he says. If the yield of listed property relative to long bonds increases, capital losses are likely from listed property. The opposite is also true; that profits can be made from listed property if the yield of listed property relative to that of long bonds, decreases. De Goede predicts an eight to 10 percent income return and a two to five percent capital return from listed property over the next year. He says the advantages of investing in listed property are: It serves as a hedge against inflation over the long term because rentals usually increase by inflation each year; It reduces risk in your overall investment portfolio; It provides a link to the equity market because you invest directly in the stock market. Also, with listed property there is the potential for income growth (similar to shares in which you may get dividend growth); It is similar to bonds in that it is an income-paying investment; It provides for a constant cash flow. The factors that have positively affected listed property over the past few years include: The halving of retirement fund tax (18 percent to nine percent) has made listed property a more attractive investment for pension funds; Investors’ confidence in the South African economy; A sustainable consumer boom; The current period of structurally lower interest rates; Increased participation in listed property by black economic empowerment groups; The consolidation of the sector from many smaller entities to fewer, larger and more sustainable entities which add liquidity (allowing investors to buy and sell shares more easily). Factors that can negatively affect listed property include: A decline in the global equity markets; A slump in the global economy; A sudden change in value of the rand relative to global currencies and its impact on inflation and interest rates; An increase in emerging market risk premiums which would drive bond yields up; An irrational sell-off of investments by investors who have previously invested too exuberantly. 2 Buy-To-let property: Buy-to-let property is property which is bought by investors with the purpose of letting it out. According to Standard Bank, the number of people on its home loan books who own two properties increased by 95 percent from 28 922 in 2000 to 56 456 in 2004. Owners of three or more properties increased by 150 percent from 16 875 in 2000 to 50 582 in 2004. But indications from the FNB Property Barometer are that the popularity of buy-to-let properties is decreasing. The proportion of buy-to-let property as a percentage of all property purchases decreased from 28 percent in 2004, to 20 percent in the second quarter of 2006. De Goede says the reasons are that rental yields are low – around five percent compared with about 10 to 12 percent three years ago. Also, the rise in property values means that landlords are not receiving enough rental income to fully cover their loans. Factors that affect the income yield of a buy-to-let property are: Maintenance costs; The financial health of the body corporate; The ratio of owner occupiers to tenants: 70 percent of a complex should be occupied by owners. The amount sought in levies and whether there is need to raise special levies. The rules of conduct for the block or complex. If the rules are not enforced, it could have a negative impact on the property value. Will you be relying on only one tenant or does the property lend itself to more than one tenant; as in the case of a house with a separate garden flat which can be let to a second tenant. Having more than one tenant reduces your risk of not receiving rental. Factors that influence the capital return of a buy-to-let property are: The location of the property; The price of similar properties. You also need to be aware that tenants have rights under the Prevention of Illegal Eviction from Unlawful and Occupation of Land Act; as well under the Rental Housing Act. 3 Commercial property: A direct investment in commercial property involves buying into retail, office or industrial property. This market is dominated by professional investors. The market prices of these properties are based on income and income growth potential. The lease dynamics of commercial property are different to those affecting residential property. The factors that affect the valuation of commercial property, include: Historical financial information (of former leases and rentals charged); Tenant profile – there is more risk of renting to someone running a biltong shop than to a blue-chip company. You need to consider the market rentals within the specific area and sector of the property, and what real rental growth you can expect. The lease-expiry profile is important because you do not want to buy into a property in which all the leases expire at about the same time. Vacancies in terms of the type of property and area should be considered. It is more risky buying into a property where many similar properties are standing empty without tenants. Take note of the operating expense ratios. These will tell you if the property is expensive to maintain. Commercial property has been a good investment over the past five years, De Goede says. Property values have increased well, the growth in rentals has also been good and vacancy rates are at historical lows. For example, Catalyst Fund Managers say you would have payed R55 per 10 000 square metre for industrial property in Airport Industria in the Western Cape five years ago. Today, tenants pay R400 per 10 000 square metre. Commercial property is valued by what is known as a capitalisation rate (cap) – the value paid for the next year’s income stream. This rate is calculated by dividing the prospective annual income by the property value. The lower the cap rate, the higher the value of the property and vice versa. The net operating income is an important consideration. This is the amount of income, after operational expenses. With commercial property, you also have to consider whether the potential capital risk is worth the cap rate. 4 Warrants and futures on property securities: Just as there are warrants and futures on equities, you will find these derivative instruments also exist on property shares. Warrants and futures are derivatives which are traded either on the JSE or on the South African Futures Exchange. A warrant, gives you the right, but does not place an obligation on you, to buy a specific security at an agreed price at a specific time in the future. A future is similar except that you are obliged to buy the security. So, not only do you have the right but also the obligation to buy the shares. Derivatives are very risky investments because your exposure to the underlying share is amplified. In other words, your gains are much better than gains made on the underlying shares. But, on the other hand, your losses are far greater than the losses you would incur on the underlying shares. Other property investments There are other ways in which you can invest in property. These include: Short- and long-term renovation switches. You can buy a property, renovate it and place it back on the market over the short or the long term. Property syndications ,which work on the same principle as property unit trusts, but they are not listed and they are not regulated. Fractional leisure ownership, which gives you usage of the property as well as ownership rights and a share of the rental income if you do not use the time allocated to you for your own use; Sectional-title hotel units which enable you to buy a unit in a hotel which is placed at the disposal of a hotel-management company. You earn income from the letting of your unit. Special development projects of large companies, such as Moreland, the property development arm of the Tongaat group of companies or Heartland, a division of ACI. Even the JSE’s alternative exchange, Alt X, has a number of property listings. Conclusion De Goede says all the property investment options that he discussed are available offshore as well. There are also property investments that are not yet available in South Africa. De Goede says it is important to diversify your property investments across regions and property types to significantly improve your risk/return payoff. The importance of doing detailed analysis before investing in any type of property investment is crucial, he says. And, you need to consider the impact of tax on your property investments. |
