If there is one thing that South Africans like more than watching sport and having a braai, it is the irrevocable belief that investing in property (with the focus on residential property) is the stairway to financial heaven. Even when the numbers (on average) tell a completely different story.
“The math is simple, you buy the property for R1m in year 0ne, earn rental income on the property while the tenants pay your bond on your behalf, and you sell the property in year 10 for R2m.” We all were probably part of a conversation before where this pearl of financial wisdom was shared. And dare you challenge a property-investing guru around the braai.
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Allow the figures to bust the myth
Before we crunch the numbers on this one, let’s fall with the door in the house – there is a lot more to the sound advice referred to above. In short, investing in property (residential mostly) comes with the following challenges and hidden costs:
- Transfer costs on the purchase of the property;
- Rates and property taxes;
- Levies;
- Maintenance and upkeep of the property;
- Fluctuating interest rates;
- Illiquid investments;
- Bad tenants;
- Load shedding (at the time of writing this was upped to stage 4 from the initial stage 2 load shedding initially announced); and
- Lack of services from municipalities (water and sanitation and maintenance of roads).
I know by now there are already some readers fuming, claiming they have reached financial freedom by ploughing their capital into property investments. This may well be the case, but for the purpose of this article, we will be working with averages across the board, over a period of roughly 10 years.
The stats don’t lie
In South Africa, buying a property should be considered a lifestyle decision over an investment decision. Especially in the southern parts of the country. You guessed it – the Western Cape.
The Western Cape might be one of a handful of regions in South Africa where property investments in the last five to 10 years reaped any rewards. That is again with the focus on residential property. Structural factors as mentioned above, and the deterioration of small to bigger towns and recently even cities across the north of South Africa, have caused residential property prices to stagnate and even collapse during the last 10 years.
Below is a clear indication of the stats indicating the destruction of residential property prices across the board in South Africa.
Of course, there will be outliers in the results, with individuals occasionally managing to successfully invest in residential property. The graph above is an average statistical figure.
The results are in
Let’s look at the performance of a hypothetical R1 million invested in the following investments over a 10-year period:
SA residential property: R1 million invested in the local residential property market 10 years ago, would have left you with about R800 000 in pocket today, reflecting a -20% destruction of your capital over the last 10 years. This is excluding any additional property-related costs, such as property transfer costs, maintenance, insurance etc.
Emerging markets property: R1 million invested in emerging markets residential property 10 years ago, would have left you with R1.16 million in pocket today.
US residential property: R1 million invested in the US residential property markets 10 years ago would have returned you about R1.67 million today.
Property vs indexes/financial markets?
JSE: Even though the local stock market has been underperforming global markets as well over a 10-year period, a R1 million investment on the JSE would also have been a far better investment, returning you R1.54 million in today’s terms.
S&P 500: If you have decided to externalise your assets offshore and invest a R1 million on the S&P 500 10 years ago, you would have had R3.2 million in capital today (222% growth in dollar terms). If you further take the depreciation of the rand/dollar into account and invested the R1 million at an exchange rate of R8.50/dollar in 2012 and cashed out your investment today at R14.50/d ollar, your capital would have inflated to R5.6 million. Furthermore, you would have excluded all the interim costs associated with owning a property as previously mentioned. Your investment was 100% liquid over the 10-year period as well, and not a single wall had to be painted or a single geyser had to be replaced.
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From bad to worse
The chart above only shows the depreciation in the physical value of the asset. This excludes all property-related costs which go hand-in-hand with owning a residential property. Not only did your capital depreciate at a rate of knots, but there are certain fixed and unavoidable costs in owning a property. This puts you even further out of pocket in real terms.
The FNB Property Barometer also clearly indicated that one of the main reasons for property sales in the northern region of South Africa was mainly due to security and safety concerns following the riots in July last year.
The protection of private property in South Africa is at an all-time low, and this drives market sentiment in the property sector into the ground. Investors are reluctant to put their capital where the safety of their assets can not be protected to a certain extent.
Another scapegoat for property owners selling their beloved homes is the increase in administered prices, which mainly refers to electricity and municipal related costs. These costs have shot through the roof in the last decade.
Administered price changes are far more volatile than the rest and increase faster as well, affecting property investments directly. See below: Administered prices vs headline CPI
Proceed with caution
The purpose of this article is not to prove individuals who successfully invested in property wrong, because there most certainly are a lot of investors who have done so over the years. It is aimed at busting the basic property investment myth, and clearly exposes all the other relevant factors that need to be considered when choosing property as an asset class for your capital.
There is far more to consider when investing in property than the mere price you pay, and the rental income derived from this investment. If the math adds up too easily, you can almost certainly know that you might be missing something somewhere.
Each investor in the property market has their own specific method of analysis of whether a certain property might be a prudent investment. The list of calculations (and how to tweak these calculations) are never-ending and stretches beyond the scope of this article.
Be extremely sure of the mechanics of your calculations when investigating a property as an investment asset. Be familiar with the different ‘drivers/variables’ of the calculation and how any changes (upwards or downwards) in any of these variables may influence your investment. Interest rates, purchase price, payment term and additional payments are all big inter-changeable factors that can determine whether your property investment will have the desired results.
The selection of asset classes is the cornerstone of any investment strategy. It is highly advisable to consult with an experienced, qualified advisor to select the asset classes that will deliver the best results suited to your specific needs and financial goals.