Deur Andró Griessel, 21 June 2016
JOHANNESBURG – In this investment column, Andró Griessel, managing director of ProVérte Wealth and Risk Management, answers a reader’s question about his property exposure.
Q: I am 28 years old and own four properties.
A: R900 000 (prime + 0.5%) – primary residence (still owe R880 000)
B: R450 000 (prime – 2%) – rental income of R8 500 (still owe R430 000)
C: R320 000 (prime + 3%) – rental income of R3 300 (still owe R260 000)
D: R300 000 (prime + 2.5%) – rental income of R3 300 (still owe R140 000)
I have invested about R100 000 in Satrix products (mainly Divi) and recently sold all my direct share holdings. I have R50 000 invested in the db x-trackers MSCI USA Index ETF and MSCI World Index ETF within a tax-free savings account wrapper and one Kruger coin of roughly R20 000.
I am also saving money in a savings account at 7% interest. This is for a new car and the maintenance of my current vehicle.
Since interest rates have risen quite sharply, I currently pour all my savings into the loans with the highest interest rates (C & D), but I am somewhat concerned about this strategy. If I pay it towards my loans, Sars will come knocking as my rental profit will increase, but if I use it to pay off my primary residence, I won’t really be saving or investing.
I am considering borrowing against the other properties to buy another investment property. This will provide me with a substantial deposit and the rental income will be enough to pay the monthly mortgage installment, but I am not sure whether this is the best strategy as my exposure to property will be very high and it seems that the interest rate outlook is unfavourable.
Moneyweb has published a number of articles about listed property. Would a listed property investment be a better idea? Should I diversify?
Finally, if I do decide to buy another unit, what should I keep in mind and which areas could offer attractive capital growth in the long run?
A: At face value, four properties at the age of 28 is quite impressive. You may also feel happy about the fact that the asset side of your balance sheet is sitting pretty at above R2 million. Unfortunately the liability side is at R1.7 million and it is this side of the equation that is causing you some discomfort. Cash flow and liquidity are the two things that can catch you off guard. You will do well not to keep “gearing up” until you have built up a larger liquid portfolio (in shares, unit trusts etc.).
Your portfolio is also very overweight local low-cost property, which should offer high rental yields but relatively poor capital growth (except if these properties are in the Cape Town area). I’m not sure if C and D for example are in the same complex but if they are this would increase your risk further. I would suggest you take a look at your actual return (after ALL costs) on especially C and D and make a decision about the merits of keeping them both. Diversification per se is not necessary, it’s just important that you consider risk and prospective return. If you are confident that you will be getting the best return from these properties and you don’t put yourself in harms way in terms of cash flow you can continue. From what I’ve seen and the calculations we are making regularly I wouldn’t personally be building a portfolio of these properties.
I agree with your tax observations, but remember that there is something like negative gearing. At 13% interest it would be interesting to see what this does to your return on investment numbers. You want your asset to grow at a faster pace than your cost of capital.
With regards to your comments about your primary residence, it is a cost of capital question. If the rate is too high (especially when there is no income tax benefit) I would want to pay it off as soon as possible. In this case I wouldn’t though. You should back yourself to grow money at a faster rate somewhere else. I also see in practice that once houses are paid off or nearly paid off people start looking out for a nicer house because they can use the capital as a deposit. They therefore end up escalating their lifestyle, sometimes to the detriment of their investment and retirement planning.
Don’t forget the risks associated with buying another property. The probability of two or three of the tenants not paying you at the same time in the current economic climate is quite high. Even if you just lose B’s rental you are under water with regards to cash flow. Add to this attorney costs to get people out etc. and you can find yourself in a sticky situation very quickly. You are young. There is no need to be impatient.
Listed property was the best performing local asset class over the past decade. It is unfortunate that everyone wants to talk about this now when more and more companies are coming to market. Think about what this means. These are businessmen who are listing their property portfolios to sell it to the public who are now all eager to buy these at arguably inflated prices. Although I would generally prefer the listed commercial version rather than the type of properties you currently have I think you might have missed this boat. Personally I think there is still some good value in global listed property.
If you do decide to buy another property, considerations will obviously depend on what you are looking for but I will tend to go for high capital growth (sought after high quality areas) rather than high income yields (low quality and generally deteriorating areas). The latter lull you into a false sense of security that your co-payment is little and that you can buy a lot of these, but the lurking risks are high. I’d rather take a 5% net yield (read dividend in stock terms) that I can grow consistently with 8% per annum. This seems to be happening here in Cape Town. I am not sure about the situation in the north.
* Andró Griessel is ’n gesertifiseerde finansiële beplanner en besturende direkteur van ProVérte Wealth & Risk Management. Volg hom op Twitter by @Andro720911. Hy skryf tweeweekliks vir Sake.