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Are you investing yourself broke through property

by , 25 August 2016
Are you investing yourself broke through property
I was recently at a property auction. The developer of a complex had been liquidated and was left with 7 apartments that needed to be sold on auction.

Before the auction these properties were advertised for around R560,000. And there was not much interest in them.

Considering they could fetch around R5,200 in rental per month I hoped to pick one or two up for a bargain at the auction…
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Much to my surprise – the auction turned into a price war!
Property ‘investors’ were clamouring for these properties and bid prices up sky-high. At the end, one of the properties I was interested in went for R558,600 – practically the same price as the pre-auction listing!
I remember being at an auction where another one of these properties sold for R325,000 just two years ago. But since then rental values have gone up by around 12% - with levies up around 30%.
On the R558,600 property the buyer will need to pay R1,249 in levies and R607 in rates and taxes. Before you put a tenant in – you need to do some work to the apartment. You spend R30,000 to fix cracks in the walls, a water leak at the window, fixing tiles that lifted up and repainting the place.
The apartment will probably fetch R5,200 rent. If the buyer is very lucky he’d be able to perhaps get R5,600. At this stage I’ve found the bulk of these apartments let for R5,000 a month.
This is how buy to let becomes buy to regret
So on the property purchased at this auction, the buyer will pay R1,856 a month in levies and taxes.

Income will be R5,200 for argument’s sake.

Now let’s say this ‘property investor’ bought the property with a 10% deposit, 20-year loan at prime interest. The investor will sit with R20,103 negative cash flow in year one.

I don’t expect year two would look much better… Firstly – I expect interest rates to go up by 0.5% next year. Now let’s say rental increases 11.5% to R5,800 (which is a stretch) and rates and taxes increase the same percentage. The year two negative cash flow would be R17,615!
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By year three you’d have to pay in another R10,400. So that’s an investment of R48,118 + a deposit of R55,860 and R30,000 in repairs to equal a total of R133,978 invested and you still don’t make money from the monthly rental.
If you sold the property at this point, and its value grew by 20% to R670,000 - of this, you pay 5% to the estate agent as commission. You then pay back your bank loan and end up with R157,902. But wait… You invested R133,978 over the same time. So that means only R23,924 is profit…
Your return on investment is 23% over three years. That’s equal to an annual return of around 7.15%.
The scariest part of this equation is that I’m giving the investor benefit of the doubt – that rental will escalate more than it has in the past three years and that rates and levies will escalate less. Even more unlikely – interest rates will remain close to where they are, for three years.
But what if the investor bought the entire property cash? Would the returns look better?
Not much…
In fact – if you bought this place cash your year one return would be 7.18%. Because levies and rates go up faster than rental, that return won’t improve much in year two.
The investor would score a bit when he sells though.
The fact of the matter is that a return of 7.15% a year is way too low to take the risk of investing in property.
In fact, the Investec Prime Save Savings account currently offers 7.23% interest per year, the Allan Gray Money Market Fund also delivered 7.1% in the past year. And these returns are practically guaranteed.
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Don’t invest yourself broke through property – a simple calculation can save you thousands!
Many financial commentators will tell you that property is a bad investment and you’re doomed to low returns like this.
That’s simply not true.
What is true, is that many property investors go into deals blindly without doing simple math beforehand.
My back-of-the-matchbox calculation to ensure you buy a decent investment property is simple.
Take monthly rent, subtract levies, rates and taxes and times this by 12.
Divide this figure by the property selling price and multiply by 100.
So in this example – rent is R5,200. Levies R1249 and rates R607. So you get R3,344. Times twelve you get R40,128.
The property selling price was R558,600. Divide R40,128 by R558,500 and multiply by 100 and you get 7.18%.
You ideally want the answer to be 10% or higher. Any lower than 10% and you’re buying a property that won’t make you money. And you’d be better off putting cash into the bank at the end of the day…
I know that it is possible to get 10% or higher. But it's time consuming. One out of 50 to one out of 100 properties you look at will give you these figures in our current market. If you’re not prepared to go to this trouble – rather look at putting your money into another investment class altogether.
Here’s to unleashing real value,

Francois Joubert
Editor, Red Hot Penny Shares
P.S. If you want to discover another unique way to start a rental property business with zero cash down, click here...

Are you investing yourself broke through property
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