Property vs a diversified investment portfolio: Let’s talk tax and returns

I often speak with investors who are eager to diversify their income streams and assets – which is fantastic. Diversification is a powerful tool for building long-term financial resilience and stability.

That being said, not every strategy suits every stage your financial journey. What made perfect sense when you were starting out may no longer serve you as effectively down the road. With that in mind, let’s gently unpack this topic a little further, especially around property and how things can shift over time.

We’ll unpack some of the mindsets around choosing between a diversified investment approach and investing in fixed income (brick-and-mortar, not listed property). We’ll also compare the compounding returns from various asset classes and the various investment vehicles, versus the capital growth on property and rental income.

At PSG Wealth, our philosophy centres around diversification. This means spreading your investments across asset classes: cash, bonds, listed property, and both local and global equities. We also work with a range of portfolio managers to ensure that you benefit from the best expertise available, both locally and abroad.

Here’s where the property conversation gets interesting.

Before diving into any investment – property included – it’s crucial to ask yourself: What am I hoping to achieve? Only with a clear objective in mind can you determine whether the return on investment (ROI) aligns with your broader financial goals.

Advantages of investing in property during the portfolio-building stage:

• You can leverage (borrow money to acquire the asset).
• It offers the potential for a second income stream.

However, as you progress through different stages of wealth creation, the very same property strategy can begin to feel more like a liability than an asset.

A few considerations around fixed property investment:

• Your primary residence isn’t really an asset, in investment terms. If you live in the property, it isn’t generating income, even though yes, it may appreciate over time.
• What’s your true ROI on a rental property? Don’t forget to factor in ongoing costs like inflation, municipal rates and taxes, levies, advertising for tenants, maintenance, and realistic rental increases (which may not keep up with inflation).
• Analyse all costs that are associated with this asset class, as this is not merely a purchase price but will include legal fees to the conveyancing attorney handling the transfer and transfer duties. You should also factor in capital gains tax (CGT) payable on the sale of the asset – only your primary residence has the benefit of a R2 million exclusion, other properties will not.
• The tax implications can be steep on rental income earned: pay as you earn (PAYE). Rental income is subject to income tax, which can bump you into a higher tax bracket when considered with other sources of income.
• Lack of liquidity and no guarantee of 100% occupancy rate are also factors. It might be that your property is popular during summer months but more difficult to secure tenants in winter. If you happen to have a tenant who a does not pay their rent consistently, this can become difficult and expensive to navigate.

It is important to bear in mind that property lacks liquidity. This means if you suddenly need access to capital, you can’t just sell a house overnight.

Over time, I’ve seen many clients reach a point where their property investments weigh heavier than expected, which raises some of the following concerns:

• Rental income is added to your total taxable income, which can have a significant impact, particularly in retirement when every rand counts.
• Selling property can be a slow process and prices aren’t guaranteed.
• Compared to a well-diversified investment portfolio, your ROI on property may fall short. A diversified portfolio, for example, could reasonably aim for 10% annual growth, compounding year on year. CGT on these investments is capped at 18%, which is often much ‘kinder’ than the income tax rates applied to rental income.

A balanced investment strategy also offers flexibility: you can dial down interest-bearing assets (which attract income tax), increase equity exposure (growth assets), and significantly minimise tax implications as CGT is only payable on the sale of the asset. This approach keeps your portfolio liquid.

Many regard property as a “safe haven” in retirement, but it’s essential to consider the net returns and tax implications. That passive rental income can come with hidden costs, both financial and in terms of time and management. When it comes to estate planning, this asset also needs to be planned for very well, as it can become quite complicated for beneficiaries – especially if the asset is not held within a private company (Pty) or trust, which might exclude it from the estate.

A diversified, professionally managed investment portfolio can offer greater efficiency, improved after-tax returns, and much more flexibility, particularly in retirement when peace of mind is paramount.

Property can be a valuable component of your wealth-building toolkit, but it’s not a one-size-fits-all solution. As your financial needs evolve, your strategy should too. That’s why it’s so important to revisit your plan regularly, consider all your options and be open to adjusting course.

The more informed your decisions, the more empowered you are to achieve your goals – on your terms. Working with a knowledgeable and trusted adviser is key to making this possible.