If you’re considering property investment, it’s easy to feel overwhelmed by the number of income, tax and liability strategies. Furthermore, you have several choices. These include short term rental (Airbnb), long term rentals of flats and homes. YOu can also rent out rooms as student accommodation. But what is your strategy? Are you buying it for capital gain or cash flow? And what is the strategy behind each one?
Common Property Investment Strategies
Cash Flow Properties
Cash flow properties are properties that generate regular income from rentals. These properties typically have a high rent-to-purchase price ratio. The rent you collect can cover most or all of your monthly home loan repayment. These properties are often smaller and located in more affordable areas.
Traditionally, cash flow properties profitability is calculated by the 1% rental factor rule. This means a flat of R 400 000 should have a rental income of R 4 000 per month. However, I’ve found that a 1% rental factor after rates, taxes and levies have been deducted is a better measurement.
For example, I know someone who discovered that a solar farm will be built in the Northern Cape. He bought properties in the closest town for almost nothing. He is renting them out to foreign contractors at exorbitant amounts.
Case Study:
I own a two-bedroom flat. The flat cost me R 360 000, and the rent was R 4 700 per month. After rates, taxes and levies, I had a 1% rental factor. I used the rental income to cover my home loan and other costs. Each month, I broke even. This allowed me to focus on other investments. Meanwhile, the property continued to pay for itself.
Capital Gain Properties
Capital gain properties are often located in higher-end neighbourhoods. These properties typically have a lower rent-to-purchase price ratio (<0.8% rental factor). As you benefit from the appreciation in value, you would often hold them for a long period of time.
Having a shortfall, you will need to pay in every month. You have the following options:
- Pay in the shortfall between your rental income and expenses (rates, levies, taxes, home loan repayment)
- Put down a large deposit to break even
When buying capital gain properties, you need to have secret knowledge – something that no one else knows.
For example, you might buy a house in an upmarket area for R 1 million. However, the rent is only R 8 000 per month. The rent may not cover your loan repayments. However, the property could appreciate in value over time. This could make it a profitable long-term investment.
Case Study:
I have a friend who bought a property for R 1.3 million in Garsfontein in Pretoria East. With the development of Menlyn Maine, he was able to sell it five years later at a hefty profit!
Understanding Market Trends
With a record low interest rate of 3.50% in July of 2020, people were buying properties like crazy. This was the effect of the COVID-19 pandemic. However, in the years that followed, interest rates kept rising. As of 2024, the market is still flooded with the post-COVID properties.
Although not yet at 1998 highs of 23.99%, it is important to keep interest rates in mind and a property emergency fund in case.
How do you decide where to buy a property?
Property owners need to understand macroeconomic trends. These include supply and demand, government policy, and strategic tax breaks for uplifting certain areas. Your decision is influenced by microeconomic factors. These include a change in an area’s demographic. They also involve their needs for certain amenities.
Is Rental Property Investment risky?
Every investment carries some level of risk, and property is no different. With little liquidity, you need to make sure you buy a good property in the right area. YOu are able to prepare for other challenges such as horrible tenants or loss of income.
- Landlord Insurance:
Protect yourself from financial loss due to tenant defaults. Guard against damage or loss of rental income by taking out comprehensive landlord insurance. This can save you a lot of money in the long run. - Tenant Screening:
Always do a background check on potential tenants. This should include a credit check, previous landlord references, and confirmation of employment. This helps reduce the risk of tenant defaults or late payments.
Property Investment vs. Other Investment Types
Rental property investments are just one tool in your toolbox of diversification. Other investments can also be profitable. However, property uses other people’s money. Investments such as REITs (Real Estate Investment Trusts) or EasyProperties are also options. Exchange traded funds (ETFs) also allow for diversification into stocks and bonds. Note that the above all give you exposure to the stock market, but offer more liquidity.
Property Strategy Considerations
The property investment triangle is tax, income and liability – choose two.
For cash flow properties, you generally will pay more income tax on rental income. Capital gain properties are only profitably much later in the repayment term, meaning you might save on income tax.
When you sell any property, you will be liable for capital gains tax. There is a R2mil exception for your primary residence. There are some property tax breaks. Examples include Section 13sex, Section 13quin, and 13quat. These can bring down your tax burden.
Cash flow properties tend to be income generating, whereas capital gain doesn’t generate recurring income.
Liability has to do with legal structures and limited liability. This topic is complex. I suggest looking into the article ‘Should I buy my property in a company, trust or my own name?’
Ready to Take the Next Step?
Property investment can be highly rewarding, but it requires careful planning and strategy. If you’re ready to start your property investment journey or if you need advice on refining your strategy, I offer one-on-one consultations.
Feel free to contact me for a paid consultation where we can discuss your goals, investment strategies, and how to best manage your property portfolio.
