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I recently ran a survey on social media to understand what asset classes people invest in. The majority of women prefer property to investments such as unit trusts or exchange-traded funds, which are market related. One of the reasons people, especially women, invest in property is that they believe it is less risky than market-related investments. They feel that property is tangible, they can see it, touch it and they understand how it works.
While property can be a viable investment, it is incorrect to believe that an investment property is less risky than a diversified portfolio of shares. It is also not a passive income. It requires a lot of management.
The risks of leverage
The premise of investment property is that you get someone else to pay the mortgage for you. You only put down a deposit and, over time, the tenants pay off this lucrative asset.
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The reality is that many investors discover a serious shortfall. Through our Money Makeover Challenge each year, we see people struggling financially due to their investment property. They cannot rent the property for what they expected, or they didn’t run the numbers and include things such as levies and maintenance in their figures. When there are interest rate spikes, as experienced over the last two years, many of those investments become a financial nightmare, with rising mortgage repayments. There are also the risks of tenants not paying, dealing with difficult tenants or maintenance issues. This does not make it a passive investment. You need to run it as a business and be prepared to do the work.
Lack of diversification
Another risk factor with property is the lack of diversification. When you buy a property, it is in one street, one neighbourhood, one town, one province in a small country at the bottom of Africa. You are certainly not diversifying your risks – you are concentrating them.
If you compare that with investing in a unit trust or exchange-traded fund – for as little as R500 a month you diversify across the world and can be invested in up to 1 000 large companies globally. The added benefit is that you do not have to do anything. You don’t have to manage tenants, there is no mortgage to pay and over time, you can build up a portfolio where you are earning dividend income. Investing in shares is not just about capital growth. When you invest in shares, the CEO and all the employees of that company are going to work for you.
Perceived risk: Value vs liquidity
One of the arguments people have for the idea that property is a safer investment than shares is because the price of shares can go down. You could invest in the market and there could be a market crash, and you could lose money. But that is because we know the value of shares every second. These are continuously priced based on a willing buyer and willing seller every second of the day. Any losses you see are only “paper” losses. These only become real losses if you sell.
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If you had to price a property every day, based on a willing buyer, there would be many times when it would be worth zero – because you need a willing buyer. Anyone who has been trying to sell in Johannesburg recently can attest to this.
This raises the other point, namely that property is not liquid. You cannot exit a property investment easily and you do not want to be in a position where you are a forced seller. You need to make sure you have enough liquidity in the rest of your investments so that you are never forced to sell.
Costs of property investing
Buying and selling property is expensive. People often forget the transaction fees – for example, to buy a R1 million property, you would pay around R67 000 in costs. When selling you would need to pay an estate agent commission. There are also holding costs which include things such as insurance and maintenance.
In comparison, the costs to invest in an exchange-traded fund are negligible. There are usually no upfront costs and a maximum fee of 1% a year.
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To conclude, property can be a great investment, especially if you are able to get someone else to pay for your R1 million investment. Once the mortgage is paid you have rental income. But it is not passive, and it is not low risk, and it is certainly not diversified. Make sure you know what you are doing.
Calculate your numbers properly to understand whether you can afford it – be very aware of the levies that come with purchasing in a sectional title. Always work on a worst-case scenario. Calculate your rental income on a maximum of ten months a year – assume that for two months you do not have a tenant. Have a buffer fund that can cover the rental if you do not have a tenant or to undertake repairs and maintenance. Be prepared to screen and manage tenants or use a management agency. Alternatively, you could just invest every month into a unit trust or exchange-traded fund and leave it to grow.
