How to be a landlord

May 1, 2004

By Charlene Clayton of www.persfin.co.za

Residential property as an investment has the potential for yielding stable, inflation-linked returns, but unlike other investments, it requires a hands-on approach. We look into the pluses and problems of becoming a landlord.

The stereotype of a landlord is a wealthy property baron who own scores of buildings, or – as in a Dickens novel – a slippery character who collects exorbitant rentals on neglected properties from cowed tenants with nowhere else to turn.

But these images do not reflect the reality of the buy-to-let property market in South Africa. Ask around, and you are likely to discover that a friend or colleague is playing landlord on the side in an effort to preserve his or her capital and earn additional income. With interest rates at their lowest level since 1986, property investments have become a lot more affordable for ordinary South Africans.

Property is a good way to diversify your investments, and unlike shares, property provides you with an income as well as a capital gain – if you invest wisely, of course.

However, unless you are a hands-on person, property is not your best choice of investment. Instead, you should consider alternatives, such as fixed interest unit trust funds (a bond or a money market fund), to provide you with a hassle-free income.

You don’t have to wait until you have paid off the mortgage bond on your home before you invest in another property. But no matter what type of investment you are considering, you should have sufficient income to pay for your lifestyle needs before you use the surplus cash to build your wealth.

One of the advantages of investing in property, compared with other assets, is that banks are generally willing to lend you the money. And, as long as you can afford the repayments and have a good credit record, you might even qualify for a 100 percent loan, although it is not always a good idea to borrow so much. Some banks, such as Nedbank, have loan products tailored to property investors.

Thanks to the Rental Housing Act Act of 1999, the potential for landlords to exploit tenants has been greatly reduced.

Then again, there are stories of landlords falling victim to unscrupulous tenants, who refuse to pay or to move out, and who trash the property into the bargain. Tenants are a risk, but you can eliminate many potential problems if you follow a rigorous selection process.

Rands and sense
Geoff Els, the head of external relationships at Nedbank Homeloans, says potential property investors should remember that property is not a liquid investment. Should you need the money, share investments can be sold within 48 hours, but the turnaround time on a property transfer is at least three months.

The prospects of getting a good return on your investment improve the higher the deposit you pay on the property and the less you have to borrow as a percentage of the purchase price.

For instance, if you put down no deposit and borrow R100 000 at an interest rate of 16 percent over 20 years, the repayments will be about R1 400 a month. But if you put down a deposit of R20 000, the repayments will be about R1 100 a month; and if you put down R60 000, the repayments will be about R500.

Gearing
Borrowing money to invest in an income-producing asset, such as property, is called gearing. For example, 100 percent gearing means borrowing the full amount required to buy a property, while 50 percent gearing means borrowing half the amount.

By borrowing money to invest, Els says, you get a return on your own money and on the funds you have borrowed. Gearing magnifies your returns, but conversely, it can magnify your losses if you buy the wrong property. The concept of gearing can be explained by comparing the performance of a 10 percent deposit (R30 000) on a R300 000 property, with an investment of R300 000 in a savings account.

If the property’s value increases by 10 percent, you gain R30 000. This is a return of 100 percent on your R30 000 deposit. If the R300 000 in the savings account gains 10 percent in interest, your return is only 10 percent. Although in both cases you gained R30 000, the property investment cost you R30 000, while you had to invest R300 000 in the savings account to get the same return.

Rental returns
The question that should be uppermost in your mind when you buy a property to let is whether or not the rental you can reasonably expect to receive will be sufficient to cover the mortgage bond.

As the rental increases over time, and assuming interest rates remain the same, the rental will be sufficient to cover your bond repayments. Should interest rates decline, you will be able to cover the loan repayments faster, but the converse is also true.

The best way to ensure you do not have to "feed" the mortgage bond out of your own pocket each month to meet the repayments, is to put down a sizeable deposit. It is unlikely that the rental alone will be sufficient to cover your repayments if you take out a 100 percent loan.

The size of the deposit will depend on various factors, including the amount you are borrowing, the interest rate and the rental that you can reasonably expect to get for the property.

Click here for a graph that demonstrates the relationship between loan repayments, the size of the deposit and rental income, using an example of a property bought for R350 000. It is assumed that the property was bought with a loan of between zero and 100 percent taken out over 20 years at an interest rate of 11 percent a year (one percent off the prime lending rate). It is also assumed that the monthly rental is one percent of the purchase price – R3 500 a month. Your aim when buying to rent is to achieve a position where the rental covers your mortgagae bond repayments as well as the levies or other monthly expenses associated with owning a property. With interest rates at their present, relatively low levels, you need to put down a deposit of just over three percent, or R10 914, on the loan of R350 000 for the monthly rental to cover the loan repayments, but not your expenses. The example does not take levies or other costs into account, because of the considerable variation in levies.

What can go wrong
Els says the main risks with buying a property to rent it out are:

Not receiving rent, perhaps for months, while you are between tenants;

Having to reduce the rent, possibly due to a significant increase in the supply of rental accommodation in the area in which your property is situated, or because the property is in a poor condition;

Unexpectedly high maintenance costs;

An increase in interest rates, resulting in higher bond repayments; and

Tenants who pay late or do not pay at all.

Els says you should have sufficient reserves to pay for unexpected expenses and to cover periods when the property is not rented out.

As a rule of thumb, you should set aside a reserve equal to three to six months of your budgeted expenses on the property.

Types of ownership
There are essentially two ways of owning property: freehold and sectional title. A freehold property is usually registered in your own name and you can manage it as you wish, within the limits set by municipal by-laws. You are responsible for maintaining and improving the property.

With sectional title, you are the owner of your residential unit (a flat or a townhouse), and you share in the ownership of the common property, such as the garden, swimming pool and security arrangements. You are responsible for maintaining the inside of your flat or townhouse as well as any outside areas, such as a garden, that may be for your exclusive use.

You have to pay a monthly levy to meet the running costs of the common property. The administration and maintenance of the block of flats or townhouse complex is the responsibility of a body corporate, which consists of trustees elected by the owners.

Managing your property
You have two choices when it comes to managing your property: doing it yourself or buying the services of a professional managing or letting agent.

Going the do-it-yourself route means that you have to find a suitable tenant, draw up a lease, collect the rent, and pay the levies (if the property is sectional title) and other costs. Your tenant will contact you – perhaps at inconvenient times – about maintenance and repairs, such as burst geysers and broken locks.

If you do not want to manage the property yourself, you can employ the services of either a management company or a letting agent.

Full management services include:

Comprehensive advice about letting before and during a tenancy;

Advertising for a tenant;

Selecting a tenant, which includes checking references and credit records;

Drawing up the lease;

Collecting the rent;

Inspecting the property;

Managing repairs; and

Serving notice on a tenant.

You can expect to pay between 10 and 12 percent of the total rental (excluding VAT) for a full management service. The fee is payable monthly, from the time a tenant is found until the lease expires.

A letting-only service charges about eight percent (excluding VAT) of the rental for the entire lease period to find you a tenant. This fee is payable upfront. So, for example, if the rental is R3 000 a month and the lease is for one year, the total rental will be R36 000 (R3 000 x 12 months). If the letting agent’s fee is eight percent, you would pay the agent about R3 300 once he or she has signed up a tenant.

Finding a suitable tenant
Els says finding a suitable tenant is a priority, because this determines whether or not you will receive an income and your property will be properly looked after. He goes so far as to say that it is better to settle for a reliable tenant at a lower rental than to sign up a defaulting tenant who can (supposedly) afford a higher rental.

Neville Schaefer, the chief executive of Trafalgar Property & Financial Services, which manages and lets over 70 000 residential units countrywide, agrees with Els that finding a reliable tenant is crucial to the long-term viability of your property investment.

It is essential that you obtain traceable references from prospective tenants, Schaefer says. Good tenants are not reluctant to supply references from their family and former landlords.

The tenant must where possible give you a reference from a previous landlord. This enables you to check things such as whether or not the tenant paid the rent on time, respected the property and gave the agreed to notice period. A tenant who failed to give the correct notice once will do it again, Schaefer says.

It is also important to obtain a potential tenant’s present physical address. A person who has a poor tenancy record is likely to give a post office box number and not a full physical address. You should ask for a certified copy of the applicant’s identity document or permanent residence permit and passport.

A prospective tenant should be able to provide proof that he or she has been in steady employment for at least three years. A simple way of ascertaining whether or not a tenant can afford the rental you are asking is to ascertain whether he or she earns a minimum of three times the rental.

Ask a prospective tenant for a copy of his or her latest salary slip and verify the information by contacting the employer. Self-employed applicants should be asked to produce their bank statements for the past three months.

It is also wise to check a potential tenant’s credit rating, because a bad credit rating inevitably means rental arrears. You, as an individual, cannot ask a credit bureau for another person’s credit rating. However, you can ask a prospective tenant to obtain his or her own rating from a credit bureau – it costs about R70 – and to give you a copy of the bureau’s report.

Most landlords prefer to prohibit sub-letting in their leases, but you should also use your common sense to avoid being caught. If, for example, the prospective tenant is applying for a flat in Durban but works in Pietermaritzburg, it is unlikely that he or she will be travelling that distance daily.

The lease should specify the number of occupants permitted in the unit. It is a good idea to obtain the full details of all the occupants, not just the prospective lessee. You should also find out how many children the applicant has; even if they live with a different parent in another part of the country, they may move in during school holidays and over weekends.

Follow these steps and you should be relatively safe, Schaefer says. But you should contact a professional letting agent if you are uncertain about how to select the right tenant. The letting fee could save you a lot of money in the long run, Schaefer says.

What the law says
A lease should record the terms and conditions under which your property will be let.

Although it is not necessary for a lease to be in writing, a written agreement will minimise the potential for misunderstandings and disputes to arise between you and your tenant.

The Rental Housing Act states that a landlord is required to put a lease in writing if a tenant asks him or her to do so.

You can obtain a standard lease agreement from a letting agent, a stationer or the Estate Agency Affairs Board. The board’s offices are at Dunkeld Crescent, North East Block Building, corner of Albury Road and Jan Smuts Avenue, Hyde Park, Gauteng. Telephone (011) 880 9994 or fax (011) 880 9954.

When it comes to deciding how much rent to charge, a rough rule of thumb is one percent of the property’s value. But supply and demand will influence the actual amount.

Landlords should familiarise themselves with the Rental Housing Act and the provincial regulations that govern the relationship between you and your tenant.

Among other things, the Act prohibits a landlord from discriminating on such grounds as race, gender and disability when advertising for a tenant, protects a tenant’s right to privacy and sets out terms which a lease is deemed to contain. In terms of the Act:

A landlord must give a tenant written receipts for all payments.

A landlord must invest a tenant’s deposit in an interest-bearing account.

If requested to do so, a landlord must provide a tenant with proof of the costs of repairs deducted from the deposit.

A landlord must attach a copy of the house rules of the property to the lease agreement for the tenant.

A landlord and tenant must jointly inspect the property, both at the start and at the end of a lease, to ascertain any defects or damage. If the landlord fails to inspect the property at the end of the lease, he or she is deemed to have accepted that the property is in a good state and the landlord loses all further claims against the tenant for the cost of repairs.

The landlord must refund the deposit and interest to the tenant within seven days of the end of the lease if no money is to be deducted for the cost of repairs. If money is to be deducted for the costs of repairs, the deposit and interest on it must be refunded within 14 days of the termination of the lease, after deducting the reasonable cost of repairing damage to the property by the tenant.

Should a tenant fail to respond to a landlord’s request for an inspection at the end of a lease, the landlord may use the deposit and interest earned on it for repairs and must pay the balance to the tenant within 21 days of expiry of the lease.

The Rental Housing Act also provides for tribunals to be established to resolve disputes that arise between landlords and tenants.

What a lease should contain
Hugh Jackson, a property attorney and director at law firm Cliffe Dekker, says your lease may not contain provisions that are contrary to the Rental Housing Act. You should take the following into account when drawing up a lease:

All parties to the agreement must be clearly identified and must be legally able to sign a contract.

If you are letting the property to more than one person, it is best to contract with both tenants jointly, and to specify that both tenants are jointly and severally liable under the lease. This will allow you to proceed against each individual in the event of a dispute.

The rental must be clearly specified in rands.

Specify when the rental is to be paid. Most leases state that the rental is to be paid monthly in advance.

A lease may run for a fixed term or an indefinite period – the latter is known as a open lease. A notice period must be specified in the case of an open lease. A fixed period lease should specify the dates on which the tenancy starts and ends. Allow for a notice period – say, two months – that will give you sufficient time to advertise the property and find a new tenant.

If the lease period is longer than a year, consider including a rent escalation clause. The increase can be either a percentage of the first year’s rent or you can stipulate an actual amount.

A lease is subject to stamp duty as set out in the Stamp Duties Act. The duty is 20 cents for every R100 of rental for a lease of less than five years. The stamp duty must be paid to the Receiver of Revenue within 21 days of the lease being signed. You cannot use the lease in court proceedings unless the stamp duty has been paid. Generally, the tenant pays the stamp duty, although it is the landlord’s responsibility to see that it is done. The penalty for failing to pay stamp duty is up to three times the required duty.

A lease must clearly set out the respective obligations of the landlord and the tenant regarding maintenance and repairs to the property and the payment of related costs and charges.

The lease must set out the procedure to be followed should either the landlord or the tenant default on the terms and conditions of the agreement.

The conditions of the lease may be changed provided the landlord and the tenant agree to it.

As the owner of the property, you have certain rights and obligations and it is worth including these in the lease agreement, Jackson says. These rights and obligations include:

You must ensure that the property is handed over to the tenant in a reasonable condition.

You must give your tenant undisturbed use of the property. You may inspect the property from time to time provided you give the tenant adequate notice of your intention to do so.

You may restrict the number of people who may occupy the property.

You have a duty to maintain the premises in good condition. The tenant is entitled to pay a reduced rental if any defect or damage makes it impossible for the tenant to get full use of the property.

You cannot end the lease if you sell the property. You must inform the buyer that a lease is in place.

Your tenant is obliged to:

Pay the rent according to the agreement;

Use the property solely for the purpose for which it has been let and not for any unlawful purpose;

Take good care of the property and be responsible for any damage caused during his or her tenancy;

Continue the lease even if you sell the property;

Maintain the garden, look after the swimming pool and change the light bulbs; and

Hand over the property to you when the lease comes to an end.

PROCEED WITH CAUTION
Declining interest rates have been something of a setback for the budding buy-to-let investment market.

You need to take a long-term view before you plunge into a property investment, and remember that the bigger your deposit, the more flexible you can be with the rental you charge.

Neville Schaefer, the chief executive of national residential property group Trafalgar Property and Financial Services, says buy-to-let investors are facing falling rents, rising prices and the danger of too many properties being developed in parts of South Africa’s main cities.

But, Schaefer says, the buy-to-let boom is certainly not over – the market is just undergoing a series of healthy adjustments. This is not time to leave the market, but to become smarter, he says.

With interest rates at their lowest point in many years – making property ownership more affordable – tenants are turning to buying their own properties, and rentals are declining as a result of the downturn in demand. In the hardest-hit areas, the large letting agencies say landlords are having to drop their rentals substantially to attract tenants.

But, as Jacques du Toit, a senior economist at Absa, points out, there is still a shortage of housing in South Africa as a whole, and therefore a high demand. There will always be people who cannot afford to buy a house, especially when property prices are increasing relatively sharply, as is currently the case.

According to Absa’s research, house prices increased on average by 20 percent in nominal terms (not taking account of inflation) between January and October last year. People who cannot afford to buy will continue to rent, and there are always young people entering the housing market who tend to rent until their incomes have risen enough, or they are sufficiently settled, to justify buying.

Commentators say the rush by tenants to buy their own homes is limited. The rental market is expected to strengthen when interest rates bottom out and begin the inevitable upward climb – predicted to occur in the second half of 2004 or by early 2005.

Schaefer says buy-to-let investing is a worldwide phenomenon brought about by changes to pension funds, the disappearance of jobs-for-life and investors becoming more financially sophisticated. In this environment, investors want to become the masters of their own financial destiny and residential property is the easiest and most affordable way for them to achieve this.

Although rentals are falling across the country, the rate at which property prices are rising is still low in some areas – and these also happen to be the areas where over-development is unlikely to occur. So investors should look beyond the normal investment areas, such as Sandton and Cape Town’s Atlantic Seaboard, Schaefer says.

"The first rule of buy-to-let investing is to take a long-term view – 10 years or more. The second is to concentrate on cash flow rather than capital growth," Schaefer says.

"Taking the 'long view' could mean buying in prime areas that may be experiencing over-development, but structuring your purchase so you can survive the next few years on low-income returns. Rents will recover and these areas will produce excellent income over time. But you should also realise that South Africa is going into a low-inflation, low-yield period that is the death knell of double-digit income returns. South Africa is likely to get closer to Australia, where six percent yield is considered okay," Schaefer says.

The oversupply of rental accommodation that some parts of Cape Town and Johannesburg are experiencing is healthy, he says, because it results in supply adjusting as easily as demand. This, in turn, means that the rate at which property prices are rising is moderating to single-digits each year.

"This will be good for everybody. A few small bubbles bursting early in the boom will delay the onset of a major bubble that could lead to serious financial losses for many investors," Schaefer says.

Research the rental market in the area in which you are considering investing, and do your sums thoroughly.

HOW TO FIND THE RIGHT PROPERTY
You should take the following factors into account before you buy a property for investment purposes:

Buy close to home. A rented property needs attention, so it makes sense to live close enough to be able to deal with maintenance and other problems without incurring unnecessary stress. Ideally, you should live within a 20-minute drive of your investment. You can appoint a manager to look after the property on your behalf, but this will add to your costs, and it is unlikely that someone else will attend to problems with the same speed and interest as you. Another reason for not living far away from your property investment is that you may not see the subtle changes taking place in the neighbourhood that could affect the value of your investment – for better or for worse.

Buy with your head, not your heart. When you buy to invest, you are not looking for a property in which you will live, but one that is likely to give you the best return for your money. Thus your first consideration is not whether you fall in love with the property – although it is quite possible to like a property that is also a good investment.

Educate yourself. Unlike the share market, the property market does not have a stock exchange to help you determine what constitutes a fair value for your investment. Many factors – such as interest rates, supply and demand, population movements, commercial developments in the suburb – influence the value of a property investment. Learn all you can about the segment in which your property falls, such as the student market, corporate rentals or townhouses and flats. This will ensure that you are in a position to buy and sell and rent on an informed basis. Visit a number of properties of the type you are interested in before you buy, and make a habit of doing the rounds after you’ve bought so that you stay in touch with market values. Also brush up your knowledge by reading the property and finance sections of newspapers and other publications.

Rental income is the priority. You should aim to find a property that has the potential to earn a sound rental income, rather than one that could deliver a quick capital gain from a short-term rise in the property market. Generally, if you have borrowed substantially to buy a property, you will have to use your own money to cover a shortfall in the bond repayments and other costs – such as insurance, maintenance, repairs and levies – until your rent increases sufficiently to cover these costs. Pay attention to the cash flow to make sure your investment will break even sooner rather than later.

Focus on the long term. As with most investments, your property needs time to grow in value. If you want to own more than one property, it will take time to build up a portfolio and you should be prepared to sit out any downswings in the property market. Also bear in mind that downswings present buying opportunities because property prices will be lower.

With acknowledgements to the Nedbank website and the Financial Mail.

EVICTION LAW TO BE CHANGED
Landlords and banks were up in arms in 2002 after the Supreme Court of Appeal ruled that the Prevention of Illegal Eviction from and Unlawful Occupation of Land Act of 1998, which regulates the process of evicting so-called "unlawful occupiers", applies not only to squatters, but also to tenants and home loan defaulters who refused to vacate residential properties.

In terms of the ruling, landlords do not have the right to evict defaulting tenants from their property without a court order.

Obtaining an eviction order which meets the requirements of the Act could take months and cost thousands of rands, while the culprit continues to live on the premises rent-free, possibly running up huge water and electricity bills. In terms of municipal by-laws, owners of rental properties are liable for the electricity and water bills incurred on their properties.

The good news, however, is that the government has stepped in, and in August 2003 approved a bill amending the legislation to exclude three categories of occupants, including tenants, from its protection. These amendments must still go through the parliamentary process and, at the time of going to press, had not yet become law.

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