I think you’ll all agree with me that residential property is a good investment. The best proof of this is probably your own private home provided you bought in the right area.

According to surveys carried out by the banks, people live in a house for an average of seven years before selling it to buy another one. The chances of you selling your house after a seven year period and receiving less money than what you paid for it in the first place are very remote.

I dislike averages as these speak in broad strokes however I have used them here to highlight my point. According to House Prices SA, the average growth on residential property over the past 20 years (1993 to 2013) has been in the region of 11.28% per annum. It’s been a lot higher in certain sectors, but let’s stick to 11.28% and do a simple calculation. A house that costed R400,000 seven years ago would today sell for R845,000. At first glance that seems to be a good investment, but is it a good investment to buy houses and rent them out just because there is a probable capital appreciation? We have to look further to evaluate whether this is in fact a good investment.

At first glance, I say that it probably is, but in the current market we know that rentals are low and house prices are high. In other words, if you pay R845,000 for a house and only receive R5,000 rental per month you would not even make your bond payment notwithstanding your other property expenses. At this point the investment is no longer looking like such a great investment event hough initially we thought there was such a favourable capital growth. We also know that there are plenty of other investment instruments that seem more sensible and attractive at this point, lets investigate further.

The reality is that before one determines whether a property is a good investment or not there are numerous conditions and measurables that should be assessed and evaluated. It is also a discipline to never purchase an investment property on our emotions.

The rental income and monthly cash position plays a decisive role, but the calculation to determine capital growth must also be considered along with its costs and taxes if the property is sold at some point.

A mistake that many investors also make is to assume that the property actually costs R845,000. Well, it does on paper but not as per our cash flow which we use to calculate the Internal Rate of Return (IRR), Why? Because we’re using the banks money to buy the property. In fact, if you are lucky enough to be a premium bank client you can probably buy this house with a 100% bond from your bank and they may even capitalize your transfer duty and legal costs associated with the purchase. The internal rate of return is rated as the best performance measure for property investments.

At R5,000 rental, the investment will have a negative monthly net cash flow; the shortfall can be as much as R50,000 in the first year. Some may look at this shortfall as the investment amount. Not the R846,000, Why? Because the R846,000 was paid to the seller by the bank.

Let’s now look at the capital growth on the house over the next 12 months. At 11.28% that gives us R95,000. The cash flow investment was a maximum of just R50,000. This means that the return on the investment from a capital perspective was R45,000, WOW !!! The R45,000 will also be included in our Internal Rate of Return calculation (IRR), calculation. For some reason some investment managers will not make this calculation when they calculate their property return on investment, they will tell you that the property’s capital rate of growth is not guaranteed. That’s true, but then again equities can be far more volatile than residential property.

Another interesting angle to property is we pay capital gains to SARS, stamp duty to the deeds office and property rates to the local council. We can then assume that government has a direct interest in the price of your property increasing; we could then say that residential property investments are government-backed investments, would you not agree?

History shows us that residential property has always grown positively over the medium term, with far less volatility in growth than the stock market. Residential property is also far more stable than commercial property. The reason for this is that residential property is one of man’s three basic needs; the three are food, clothing and shelter. An investment in any of these will probably have a greater chance of success, because it won’t be dependent on the various economic factors. Regardless of what the economy does, you still need a house (the shelter). Please remember that an entry-level house is more of a basic need than a luxury house, and so entry-level properties will generally perform better than luxury properties.

Right, so an entry-level house is a necessity for the astute investor; but how can we be sure that there will be cash flow and capital growth? The first and greatest fundamental reason is that the planet is only as big as it is. Our land is limited, but the population is increasing daily; so the supply is limited and the demand rises. In simple economics if demand is greater than supply, there is only one way for the price and values to go: UP !! Another very important reason for the good performance of entry-level property in South Africa is that we have the fastest growing middle-class in the world.

When investing in residential property it is important:

  1. To target the right location;
  2. To understand your seller’s reasons for selling;
  3. To negotiate the best deal possible;
  4. To know your upfront costs;
  5. To accurately estimate your monthly cash flows;
  6. To conservatively determine your annual capital growth;
  7. To do your due diligence on the property;
  8. To understand the importance of using the bank’s money and
  9. Understand when to use a private company to invest.

In conclusion, the decision to invest in a property or not should be assessed professionally by the right team with the right skills.