I often hear people talk about investing in a buy to rent property. It’s the “you just can’t go wrong” investment. In fact, people are so quick to jump into this type of investment without fully understanding the consequences.
I’m a firm believer in owning properties that you rent out as it can be a great investment, but it’s really not something to just get into without doing any proper research! If your friends’ cousin tells you about a great business opportunity you would probably be quite sceptical. If the same person tells you about investing in property though, chances are good you’ll listen intently and possibly even take their advice. Why are people so attracted to property when it can be equally (or even more) risky than the cousins business opportunity?
We’re taught from a young age that owning a property is one of the most important financial steps you can take. There is lots of hype about property and somehow property transcends most peoples logic.
Here are just 6 myths about buy to rent property investments:-
Myth 1 – You can never go wrong with buy to rent property
Let’s get this one out the way. You can go wrong, and people do all the time! Just look in your local newspaper or online at property foreclosures & bank auctions. You will find literally thousands of “investments” that went wrong. There are obviously circumstances around each one, but don’t believe people that say “you can never go wrong”; you can!
Myth 2 – You can’t work out the growth on your money
Buying to rent property involves many expenses and lots of variables that can influence the growth of your money. The amount of money you borrow, interest rate, number of periods, forecasted growth of the area, initial rental income, inflation, forecasted inflation, taxes, legal costs, legal entity taxes, etc….
It is because of all of these things that people say you can’t really work out the growth on your money and they rather “go with the flow” assuming that their money is in fact growing.
A great value to calculate is the Internal Rate of Return (IRR). Being able to calculate this for a property will empower you to actually compare properties based on a single number. Do some research on this and you will find several free tools that will do this for you (although these are generally limited in the parameters they take into account). There are also some paid-for sites and software that do amazing things! The software costs are minimal compared to buying a property and knowing what the IRR is will enable to confidently decide whether it is worth it or not.
You could for example buy an overpriced apartment and rent it out with an IRR of 6%, or get a smaller apartment in a less-afluent area but with an IRR of 28%. Knowing the IRR is what investing is all about!
Myth 3 – Property investments will always outperform Unit Trusts or Shares
This is simply not true but in order to find out you need to calculate the IRR as explained above. You can calculate the IRR of your Unit Trust or ETF in Excel (or perhaps your financial advisor can assist). Whether you do the calculations or not, it is a myth that property will always do better than other investments.
Myth 4 – You should invest in an expensive property
They say you should invest in expensive property because people who can afford higher rentals will look after your place better. This is something I have often heard! Apparently the higher the rent you pay, the more likely you are to look after the property. This myth is baseless!
People are strange and unpredictable – don’t make assumptions about people based on what amount of rental they are willing to pay.
Myth 5 – It’s impossible to buy a place where the income will immediately exceeds your expenses
My friends roll their eyes at me when I say that I want my income to exceed my expenses from day one. To most people it’s acceptable (and quite normal) to only break-even after 3 – 5 years. In fact, I’ve heard that it’s simply not possible for the rental income to cover expenses right from the beginning. Again (as with all myths), it’s simply not true.
Take a look at this example (I have just guessed the values).
A R 2-million apartment in Cape Town city centre will have an approximate installment of R20,000 p.m. with monthly levies of at least R1,500. The rental income would probably be R12,000 – R14,000 and thus a loss of R7,500 – R9,500.
A similar sized apartment in Strand (50km outside of Cape Town) will cost R500,000 with an installments of around R5,000 and a monthly levy of around R700. Rental income will be between R4,500 – R5,500 and thus it is very possible to have a positive cashflow right from the beginning.
Myth 6 – It doesn’t matter which legal entity you use
You could buy a property in your personal capacity, jointly with your spouse, in a business, trust or other legal entity.
The entity in which you buy a property however makes a huge difference! Tax on income made, expenses that can be claimed for tax purposes, taxes when you sell and what happens with the asset after you die. Also, what happens if you can no longer pay the monthly installment, and how will this affect your overall financial setup?
Everyone’s situation is different and this aspect of property investment requires thorough research and a good understanding of all options and the pro’s and con’s of each. A financial advisor should be able to assist but it’s possibly even better to find a successful property investor who will share their knowledge (either as a paid session or via a seminar or course). It’s worth spending time and money upfront before investing!
Bonus Myth – You must buy a property in a trust
Buying a property in a trust is a big decision and can certainly have some great advantages. But, there are also downsides to this and it’s really something to discuss with a qualified trust specialist who understands your intentions with the investment and who can explain the implications. Have a look at why you would consider buying a property in a trust.
Conclusion
Investing in a buy to rent property can really be a great investment, but it can be complicated and risky and it is absolutely necessary to research, read books, attend courses and spend money on your own personal education regarding this investment class! Don’t follow the crowds just for the sake of it.
Want to see a breakdown of your monthly instalments? Try the HOME LOAN CALCULATOR.