What is a good property market and who gets to decide? One of the biggest questions at dinner parties, in the press and in this article is the current state of the property market. Apparently it’s all gone bad since the ‘crash’ in 2008. But as the old English proverb states, one man’s meat is another man’s poison.
Robert Kiyosaki, best selling author of numerous books on the subject of real estate investment, wrote about the influence that his ‘rich dad’ (in fact his friend’s father) had over him in his formative years, and how he had learned many lessons from him about creating wealth from property.
I thought I would share a story about an uncle of mine, let’s call him Keith, who was very good at accumulating wealth even though he was from humble beginnings and had limited formal education. Through the years that I watched Keith build a modest empire he never used a computer or read a newspaper, but relied on paper, a jar of pencils and a calculator to make decisions. If those tools could not guide him on a deal he would stay away, and it worked for him. His shortcomings were, in retrospect, one of the reasons why he was successful. He was not clouded with a noise of unnecessary information.
The buy-to-let phenomenon
So let’s look at buy-to-let today through Keith’s eyes. Developers produced more stock than the market could absorb, so there is still surplus stock of new built (maintenance-free) houses, townhouses and flats available, many directly from the developer at 2007 prices, including VAT (so no transfer duty). The previous interest rate cycle has put the average over-indebted South African household under significant financial distress, sprinkling the market with desperate sellers, pressured by the banks to sell at a loss or face repossession. At the same time interest rates are at their lowest since 1973, so cost of capital is cheaper than it has been for nearly 40 years. There are more tenants in the market as a result of tighter lending criteria by the banks and first time buyers are less able to move to becoming home owners. Finally, rentals are firming. To an investor, this looks like the perfect opportunity. I know what Keith would do. But in this world of information and data, investors seem to be staying out of this ‘bad’ market. According to the fourth quarter FNB Estate Agent Buy-to-Let survey, buy-to-let buying was only 7% of overall transactions in the period, down from over 25% at the peak of the ‘good’ market in 2004.
Of every four buyers in early 2004, at least one was buying for investment purposes. Consider the amount of supply of units that came onto the market for rental. Fundamentals matter in real estate investment more than anything. Real estate is simple, there are fewer variables and cycles happen more gently. You should not consider investing in residential property as a short-term investment, buy well, don’t over-gear, hold and don’t worry about the cycles.
Ask me if it’s a good time for residential real estate investment and I will stick my neck out and say yes — it always is. Don’t listen to the noise.
- Starting is easy if you have a stable job, a history of bank statements, and savings for costs and a deposit.
- Buy property with a good yield. There are good properties for sale at yields of as much as 10% in year one, so it is possible to buy cash flow positive. Be prepared to sacrifice capital growth for higher yields or find a happy medium.
- Gearing (bank finance) is vital and increases your net return, but do not over-extend, or you will be forced to sell when you should be buying.
- Buy low maintenance property — new is good, but strong body corporates may surprise you with low levies. Check the state of the body corporate finances if sectional title.
- Fit pay-as-you-go electricity meters to avoid tenant arrears.
- Buy where the tenants are, near places of work.
- Have a plan to deal with errant tenants and maintenance, or find a good managing agent to do it for you.
- Investing in buy-to-let property is a long-term game, don’t expect immediate returns.
- Buy property and never sell it. Refinance it if necessary.
Rent Or Own? The Risks And Rewards Of Commercial Property Ownership
Here’s what you should be thinking about if you’ve decided it’s time to invest in your own property, instead of paying off someone else’s asset with your monthly rental bill.
As a business owner, there are many options open to you when it comes to office space. Depending on the size of your business and whether you just need offices or a manufacturing or storage space, you can choose to rent offices in a co-working space, rent an entire floor or building, or purchase a commercial property that suits your needs.
If you haven’t considered property ownership before, here’s what you should know to get started — and how to determine if property ownership is right for you.
1. Keep your operational business and property portfolio separate from one another
“Many business owners who own their premises have two separate companies,” explains Suraj Lallchand, director at Fedgroup Ventures, a division of Fedgroup. “The first is the original company that actually runs the operations, and the second is a ‘prop co’ that owns the property.”
The reasons for this are simple: There are tax benefits, it opens a second income stream, and it keeps the two entities separate, allowing the business owner to one day sell the business while maintaining the property portfolio they have built up. In many cases, if the business is sold but remains in the premises, as the property owner they will continue to draw rental fees from the business.
For example, when Gil Oved and Ran Neu-Ner sold their business, The Creative Counsel, to international conglomerate Publicis in 2015, the deal didn’t include their building, which they own and from which the business still operates.
“We still own the building separately,” explains Gil. “Publicis Group are not in the business of property ownership, and the two businesses are entirely separate. You should always keep your property portfolio separate. If and when you sell your business, the buyer would probably not want a building as well. Furthermore, when you sell the business, you get to keep the building and hopefully get the new buyer to assume the lease agreement. Passive income is what we all aspire to.”
“It’s a simple process,” explains Suraj. “You would put the property into the prop co, take a loan against the property, and charge rent to the operations company. This then becomes a taxable deduction for the operational company, and the interest you pay on the loan for the building is deductible for the prop co. As a result, you bring your taxable income down to a minimal amount. We see many companies that would rather purchase their own properties and take the tax deductions than continue to rent.” There’s a growth avenue as well. If your business outgrows your current property, you can purchase another property through the prop co and lease the previous building to someone else. In this way, many business owners slowly build up their commercial and industrial property portfolios.
If you haven’t outgrown the first property but have paid off the loan, there’s an incentive to continue building your portfolio as well. “Once the first property is paid off, you can bond it again, purchase a second property, and continue to benefit from the tax deductions on the interest you pay on that loan,” explains Suraj.
The key to owning your own commercial property is whether or not the operations company can afford the rental and has strong prospects for the future. “If you can’t occupy the building and you don’t find a tenant, the prop co will end up defaulting on its loan and losing the property,” he adds. “We always do our due diligence on the borrower and the property in question,” agrees Rick de Sousa, Head of Commercial Property Finance at Fedgroup. “The security we are lending against is determined by the value of the property as well as the owner’s ability to service the loan. If the owner of the business is purchasing the property, then the business’s stability and projected income is an important factor for us to consider.”
2. Take an objective view of the property you’re looking to purchase
According to Rob Fenner, National Director of Corporate Solutions at JLL, which provides experienced commercial property and investment management services for corporations and investors, many business owners decide to purchase a property because they no longer want to pay rent to someone else. “The irritation that owners feel paying off someone else’s asset is emotional. Choosing to purchase a property based on emotions instead of for financial or business reasons is a mistake,” he says. “You need to carefully consider all the factors around purchasing property before pulling the trigger.”
Rick agrees and believes that subjective decisions around purchasing commercial properties are a key reason why a business owner could end up investing in the wrong property. “Business owners don’t always look at property objectively,” he says.
“One of the most common scenarios we see is the business owner who has been renting for years, and now wants to purchase the property from their landlord. The problem is that they’ve already invested so much into the building that they’re stuck. They think the property is worth more than it is, and the landlord knows the business is anchored there, which works to their advantage because it drives up the price. In these cases, objectivity becomes a problem.”
Rick’s advice is straightforward. Instead of just making an offer to your landlord, consider the pros and cons of the property you’re in and why you want to purchase it. “You obviously ended up in that property for a reason and that’s why you want to buy it, but that could be more of an emotional attachment than a strong economic or business reason to stay where you are,” he says.
“If you’re looking to buy, take everything into account. You have a market you’ve captured, and you have to be close to that market in terms of your supply chain and distribution, but consider other buildings in the vicinity and look at them objectively. There might be a much better option available.”
Over and above which property to purchase is the overriding question of whether you should be investing in property at all. “Investing capital in your premises is something a business should look at only if they believe that the capital is of better use in the commercial property market than invested in whatever their core competency is,” says Rob. “Whether this is the case is a function of where the commercial real estate market is likely to go, and how much disposable income they have on their balance sheet.”
“We made the decision to move away from renting office space and to build our own premises for two key reasons,” explains Gil. “The nature of our business means that we have very specific requirements. We wanted a place big enough that all the various entities within the group could be housed in a single location. This meant we needed large warehousing facilities, but because we entertain clients, we also needed our offices to be in a convenient location for them to visit. Large warehousing facilities generally don’t exist in upmarket areas. We needed to build what we wanted.
“The second reason was a purely commercial one. We’ve always had the philosophy that to grow our wealth we need to keep things in the ‘micro economy’ — when the rental is paid to the landlord, who also happens to be the shareholder of the business, that’s wealth creation at its utmost.
“However, even though we knew exactly why we were making the decision, it was still a risk. We decided to back ourselves, but it’s not a decision to be taken lightly. The outcome for us has been positive, but in hindsight, a smaller outlay to begin with would probably have been a more prudent approach.”
3. Get as much information on the property and the area as possible
What many first-time property buyers don’t realise is how much information is available to them. “There is no excuse for not having the information you need when considering a property or area,” says Rick. “As a layman, I can sign up on sites like Lightstone Property, pay my R70 and have a full view of the area I’m looking at, property values and a history of commercial businesses in that suburb.”
Fedgroup always recommends that serious property buyers use the services of valuers. “There’s a lot publicly available, but professional valuation firms have so much more data. When the valuation comes back we get a deep understanding of the property. It takes into account macro-economic factors, the area, suburb trends, national trends, and a thousand other data points, including capitalisation rate to yields on the rent, average vacancy rates, the highest rates you can get in that area, average rates you get, price per square metre — anything and everything you need to determine whether this is a good investment or not. The more information you have, the more you’re de-risking the purchase.
“If a buyer wants a loan on the property, they’re going to need a valuation anyway, and that’s done on risk — it’s necessary for the application, whether the loan is granted or not — so why not get it done upfront? This one report is everything you need. You can then determine if you’re looking at the right property, or if there’s something better in the area. What’s a R10 000 valuation compared to over-spending by R2 million? The key to buying property is to always have as much information available as possible. Too many people walk onto a premises, fall in love and purchase — without looking at the business case. Business owners should take a leaf out of the playbook of property owners whose sole focus is their property portfolio. They’re never subjective. Properties are their business — not premises they will occupy themselves. It’s this fact that often skews the purchase for business owners.
“One of our clients who is purely in the business of investing in properties was recently reviewing a boutique hotel in the Cape. He loved it and thought the valuation of R40 million was reasonable. Our valuation was R33 million, but there was an operational hotel and vineyard on the property, and he accepted the premium based on that benefit.
“What he didn’t know was that 20km down the road a big conglomerate was selling their hotel. It was ten times the size for the same amount of money. From a pure investment perspective, this was the better deal, with a much bigger return. If he wanted to purchase the boutique hotel to live on the estate and run it, that would be a different discussion — but he’s an investor, and the valuation gave him the vital information he needed to make the most informed decision on where to buy.”
This is even more important for business owners whose core focus isn’t property investments. “Taking advice from a trusted consultant is critical,” says Rob. “Many CEOs and CFOs aren’t experts in the field, and yet they need to make decisions that will result in a large capital outlay and subsequent servicing of an even larger loan. Get expert advice. Commercial property brokers, valuators and property finance companies can give you insights that you don’t have. Many real estate consultants in our market are highly skilled and more like management consultants than property brokers. Forming a relationship with one of these individuals can make sure your real estate decisions are backed by strong metrics and not done on a whim.”
4. Determine if the time is right to buy
According to Rick, there is a completely different level of responsibility involved when you purchase premises compared to rent. “It’s a good example of risk and return,” he says. “Your risks increase, and it becomes your responsibility to ensure the building is maintained, rates and taxes are being paid, security, insurance, health and safety — you no longer have a landlord taking care of any of these things — but the returns should be commensurate with that risk.”
Rick’s advice is that you ensure the yield of the property makes sense. “Property has proven to outperform inflation. It’s generally in the high teens. In addition, commercial property is pretty predictable when it comes to rentals as well. You can bank on a yearly increase of 6% to 8%. This all aligns with whether the property is well managed though, and if you’re the landlord and the tenant, whether your business can continue to pay the rentals for the foreseeable future.”
“Before you consider whether to buy, you need to take multiple factors into account,” adds Suraj. “There’s work involved in owning a property — is it worth it for you?”
Gil agrees. When he and his business partner, Ran, built their property, it took three times longer than expected. “There is a great upside in the long run but building and owning a building can also be a massive distraction from the business itself,” he explains. “It’s also a massive long-term commitment and cyclicality in businesses is variable, whereas paying rent is stable and escalating in a predictable way annually. With a rental agreement you may only be in for three to five years. When you own, you commit for much longer.”
It’s this factor that Suraj believes prospective buyers should pay particular attention to. “You need to consider your five- to ten-year plan,” he advises. “For example, if you know you’re growing, it might be better to rent until you need a bigger property.” He also warns that cash flow is critical. “Pay attention to interest rates,” he says. “As interest rates go down, it makes more sense to buy. But what happens if the interest rates go up? This could put a huge cash flow strain on the operations company. Do you have enough cash flow to handle an increase in interest rates? Consider the worst-case scenario before making any decisions.”
“These are long-term decisions,” agrees Rick. “If you know you’re going to grow, now might not be the time to buy — stay renting. You also need to find the right place with a long-term view of where it’s going. You could choose an up-and-coming area or an already established area — but either way, location is important. This is another area where valuation experts are critical because they don’t only look at the property, but the entire area. Either way though, if you do choose to buy, the returns you get from the business (or from a tenant) need to exceed the bond rate. You must be making more than 10% in profit for this to make sense. Otherwise you just slowly erode your business.”
5. Consider other revenue streams property ownership could bring
Once you own a building, there are a number of smart ways to monetise the property. “These are negligible when you’re considering buying, but after you’ve bought the property, you can be smart about how you use it,” says Rick.
“There are many ways you can bring additional revenue streams into the business through the property,” adds Suraj. “We offer a grid-tied solar opportunity, for example, that allows commercial and industrial property owners to monetise their roof space. You can also rent out any unused space, particularly if you’ve bought a bigger property than you need to accommodate future growth.”
“You can also reach out to cell-phone providers — do they need a tower in the area? Would they like to erect it on your property? Are you well positioned to offer billboard advertising, or building wraps?
“There are a lot of different things you can bring together. This is often what investors do better than business owners who only have one property — their premises. Investors are in the game of looking for income streams, and because they’re in the business of buying and managing properties, they get good at it.”
FEDGROUP’S PROPERTY FINANCE SOLUTIONS
The Commercial Property Finance division of Fedgroup has been operating for almost 30 years. It’s a participation bond fund, which means a pool of investors invest in the fund, and business owners and property investors can secure bonds from the fund to purchase commercial and industrial properties.
“We’re able to offer attractive interest rates to our investors,” says Rick. “Our rates are in the top three in South Africa. A minimum investment is R5 000, so our entry points are low, with a five-year
From a property owner’s perspective, Fedgroup’s terms are flexible. “We can lend up to 75% of the asset value,” says Rick. “We also give interest-only terms. This means you can choose to only pay the interest, and once the business has grown and your revenues have increased, you can elect to start paying capital, or you can continue to only pay your interest and see returns once the property has appreciated and is sold. Those returns can then be invested in the next property.”
Over and above the flexible terms and the fact that Fedgroup does not prescribe how funds are allocated once the loan has been granted, Rick believes their clients benefit from the property experience of the division’s team and partners. “We can talk property with them, which is extremely valuable when making such a big decision.”
5 Property Myths That Are Holding Investors Back
Property investment can be a viable (and profitable) prospect for anyone, but to take advantage of its many opportunities, we need to dispel a few common myths.
Bring up the topic of property investment, and you’ll likely hear any number of opinions on why you can’t – or shouldn’t – get involved. The industry in South Africa has developed a reputation for being difficult to break into, and this reputation has held many a potential property investor back.
Over the course of my own 13+ years investing in property, however, it’s become increasingly apparent that most of the so-called “barriers to entry” are nothing more than myths and misconceptions. Property investment can be a viable (and profitable) prospect for anyone, but to take advantage of its many opportunities, we need to dispel a few common myths.
Myth 1: You need to be rich to invest in property
Most people assume that you need to be rich to get into the property game. In reality, there are several ways to launch a property portfolio without putting up so much as a cent of your own money.
One of the more popular options is to partner with investors who are money rich, but time poor, and don’t have the skill or inclination to implement their own property projects. They can be friends, family or total strangers – you’d be surprised at how many people are waiting for the right opportunity to put their money to work.
If you have done your research, found a legitimately promising project and packaged it appropriately, access to capital is never out of reach.
Myth 2: All debt is bad debt
If you, like me, were brought up to believe that any debt is bad debt, the idea that borrowing money can be a good thing may feel counterintuitive. When it comes to property, however, bank financing is actually a very powerful tool that can make us money much faster than we would ever be able to on our own.
Think of it this way: If you have R1 million in cash, you can buy R1 million’s worth of property, or you can use the same money to pay a 10% deposit on a R10 million bond. The latter incurs debt, but gives you ten times the buying power for the same capital investment. It’s a strategy exclusive to property, known as gearing, and can be extremely profitable when leveraged intelligently.
Myth 3: A bad credit score makes investing impossible
If you’re looking to get bank financing, a good credit score is essential, but as we’ve already pointed out, banks aren’t the only way to finance property investments.
With the right deal on the table, supported by sound financial projections, investors have as many as 10 alternative options for securing capital – none of which typically require a credit check. For the sake of brevity, we won’t go into details on those options here – suffice to say tools like bridging finance and legislation like the Alienation of Land Act offer opportunities that are frequently overlooked by prospective investors.
Myth 4: Property is a long-term investment
The traditional approach to property investment is to buy at market value, use rental income to supplement bond repayments, and hope for long-term appreciation. While this is a legitimate strategy, it does take many years to realise a profit, and who wants to wait years before their investment delivers any rewards?
Contrary to popular belief, property can be cash-flow positive from day one. You just need make sure your rental income covers all your expenses with a little profit left over. That may sound like a tall order (and is nearly impossible to achieve when buying at market value), but is perfectly doable when you start investigating purchases through alternative channels.
Private sales, auctions, bank repossessions and fixer-uppers all offer the potential for near-immediate returns. You just need to know how to recognise an opportunity, and crunch the numbers before pulling the trigger.
Myth 5: There are no good opportunities left
The thing about the property market is that it’s constantly shifting. Opportunities may not stay the same forever, but they are always out there. The easiest way to cash in on them is to establish your own investment strategy (playing off your interests and strengths) and then take that strategy to a market where it taps into local demand.
Whether you’re flipping houses, building security estates or growing a rental portfolio, there is always going to somewhere that needs what you’ve got. Go to that area, become a local expert, and then buy your property. You’ll be amazed at how many opportunities are out there when you take the time to really look.
The Rise of Mobile House Hunting
Over the past decade the property business has become increasingly digital and today property hunters are turning to technology to help them buy a home.
In the world of entrepreneurship and small business learning more about additional ways to supplement your income is a savvy choice.
Property can offer investors two potential new sources of income, either through letting the property out to tenants an ensuring a steady income, or alternatively, buying property and selling for a profit.
Learn more about the nature of property investments and discover how the digital age has changed the way in which property is bought.
Discover how the internet has changed buying property in a modern age, from the rise of online property shopping to the evolving role of digital media in the property market.
Today 9 in 10 of home buyers searched online during their home buying process, and property buying searches on Google.com have grown 253% over the past 4 years.
Buying for investment can be a minefield, and indirect property investment is an ideal option for many.
With a property fund, a professional manager collects money from many investors, then invests the money directly in property or in property shares, which can be the ideal scenario for an entrepreneur.
Over the past decade the property business has become increasingly digital and today property hunters are turning to technology to help them buy a home.
This infographic from All Finance Tax looks at the nature of investing in property, and how the internet has changed the way in which we look for property.
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