Your property investment is probably not as good as you think

South Africans like to own property. For many reasons, most of us like the security of owning a physical asset that we can see and touch.

This is true to the extent that many South Africans believe with a great deal of certainty that property will always be a good investment. There have been many discussions around the braai about how property is the only sure way to make money.

I recently experienced how strong this belief can be when a friend and her husband bought a new investment property in Cape Town. They were very excited about having found a flat and secured a bond and were talking about how they were going to furnish it for prospective tenants.

However, when I asked them what their expected return on their investment would be, they had no idea. They hadn’t even considered the question.

It hadn’t occurred to them to find out what the monthly rental was for similar flats in the area, and had not thought to calculate whether the return would be higher if their property was furnished or unfurnished. Neither had they looked at how property prices had been behaving in that suburb over the last few years.

All they were sure of was that property was a good investment. The details, they seemed to imagine, would take care of themselves.

This may be something of an exceptional example but I have nevertheless had a number of discussions with people who have ‘invested’ in property, and I always like to ask what the return on their investment is. Few are ever able to give a proper answer.

Even fewer are willing to talk about the relative risk in owning such a property, and whether the reward is enough to compensate them for it. The emotional appeal of owning tangible property often overrides the objective assessment of how much of their investment portfolio they are placing in a single asset. And almost nobody considers the opportunity cost of investing their money in that property rather than putting it somewhere else.

I am not trying to make an argument that property is never a good investment. It can be an excellent one, but only if it is done properly and managed like a business.

That means doing thorough research, identifying the right area to buy in and which types of properties are in demand. It means understanding what rental you can realistically charge and knowing exactly what the expected return should be. It means keeping very clear records of all income and expenditure and, ideally, building a diversified portfolio of properties so that you have numerous income streams.

If you are not willing to put in that effort, however, then you may be taking on a very high risk investment. And you need to ask yourself if it’s really worth it.

This is because you could take the same money and invest it in a listed property fund, where you may not be getting a flat or corner shop you can call your own, but over the long term you are still getting real estate returns.

While in the short term listed property prices are more volatile, in the long term the correlation between direct property returns and listed returns is very high. In other words, you are probably not losing anything by investing in listed vehicles.

Of course when you buy property directly you are able to leverage it by borrowing money from the bank, and that is one of the reasons why property can be a great investment. But if you aren’t managing that leverage carefully, aren’t you just taking on more risk?

This is a side to the equation that many people who invest in property seem to entirely overlook. They do not consider what the relative risk is of what they are taking on.

The reality is that people like tangible assets. This is not just true for South Africa, but also places like the UK, where the buy-to-let market is huge. There are lots of people who like to buy something that they can walk past and see and know that they own something.

There is not necessarily anything wrong with that. But if you sit down and calmly think about the relative risk and return between one single asset with one single tenant, versus owning a fund with dozens of companies, thousands of properties and tens of thousands of tenants across divergent sectors and cities, is that flat really such a great investment?

 

Source: MoneyWeb