Should You Buy That House?
Shaun le Roux is a portfolio manager at Alphen Asset Management and in an article published by Realestateweb, he poses the big question pervading the minds of many smaller investors: is residential property really a great long-term investment?
Many South Africans, along with their American counterparts up until some time last year, appear to have an unshakeable belief that residential property is a great investment. In fact, when it comes to paying rent to a landlord so that he can afford to pay off his bond, there seems to be a determined attitude to rather own property and put savings towards your own bond. This begs the question whether this tendency to own rather than rent and invest the difference elsewhere is always appropriate?
The answer is generally dependent on a number of factors. For instance, timing would have a profound impact from a capital appreciation perspective – if you entered the residential property market in 2002 then a house can make a great investment. However, the sad reality is that most of the time it doesn’t. For most property owners, a house is bound to be the largest financial investment that they will ever make and is deemed a key factor in their overall net worth.
There are many financial planners who choose to exclude a client’s residential property from the list of assets in order to determine the level of savings and asset allocation necessary to meet their financial needs. The prevailing view seems to be that you never know what price you will achieve when you decide to sell, especially in light of a market that is prone to ‘wild swings in confidence’. More often than not, a large percentage of the value realized would have to be used to discharge debt.
Even so, there are plenty of smart operators so to speak that habitually earn profit from an extensive knowledge of the relative value of specific properties and because the market is not liquid, pricing can be extremely inefficient. This skill is not really something attributable to the average homeowner though.
When it comes to residential property outperforming as an investment class, there are several factors working against it. First of all, the transaction costs on a sale or purchase, which include transfer duties, estate agent fees, conveyancing charges and high selling costs. In comparison, transaction costs in a liquid market trading in securities like equities or bonds are but a fraction of this.
Second, the home that you reside in does not generally produce an income. As any investment expert will tell you, the holy grail when it comes to investing is the power of compounding. Of course, some may argue that paying off the bond on a house allows the investor to benefit from this power by virtue of the fact that the outstanding debt steadily decreases. However, a house is really a depreciating asset, as the value of bricks and mortar falls in real terms over time. To add to this, the average house, especially an older one tends to require a significant input of cash for annual maintenance.
Le Roux goes on to say that investing in a growth asset like equities or income yielding investment property has far more long-term advantages. Mark Seymour (Alphen Angle) discussed the South African equity market and said that an annualized real return of about 9.5% has been achieved over the past 50 years.
If the returns achieved on the price index of the SA equity market are compared with the ABSA House Price Index over the past 40 years then the JSE has been a vastly superior investment to average houses and this is before even taking into account the re-investment of dividends. This superior return on growth assets comes from the ability of sound investments to generate returns in excess of inflation and the opportunity to re-invest and compound these returns into new growth options. In the case of equities, the excess capital distributed to shareholders in the form of dividends is tax-free.
To top it off, bond repayments have to be made out of disposable after-tax income and a monthly contribution to a retirement plan sees the first 15% of before-tax income directed to such a savings plan enjoying considerable tax benefits. A retirement plan that is started early that has high allocation to growth assets is likely to be the most important investment that the average investor will ever make. When retirement arrives, they will still require a home to live in, but they will also need to draw an income from somewhere to meet their monthly expenditure.
The advice is not all doom and gloom when it comes to investing in residential property though. Le Roux believes that the strongest case to be made for residential property is the manner in which a bond acts as a vehicle for forced saving. The savings rate in South Africa is currently abysmal with many consumers surviving on credit and living beyond their means. Monthly bond repayments do enforce a degree of saving, but at the same time, this is weighed heavily in favour of the bank and at the expense of the homeowner, particularly in the first few years after taking out a bond as the repayments go towards paying off interest and not capital.
There is another argument in favour of residential property that posits property values as underpinned and supported in the long-term by the fact land is a scarce and finite resource. This is particularly true in areas where there is high demand, such as cities or on the coast. However, le Roux argues once again that while the value of land is bound to appreciate and so inspire investment, it is still a non-income yielding property. The average man in the street may not be so fortunate as that who called the market right or picked the next Plettenberg Bay.
While le Roux’s comments may not have a profound impact on the trend towards owning property rather than renting in South Africa, he does has a valid point. Perhaps the best piece of advice when owning or planning to invest in a home is to ensure that you do the maths correctly. You shouldn’t be living beyond your means and you should be meeting your retirement objectives with your existing savings levels and investment portfolio.
The information in this article is courtesy of Shaun le Roux (“Residential property: a great long-term investment?” Realestateweb, 2 September 2008).
Buy or sell property in South Africa.
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Before you invest in any type of bond, it is important to know how bonds work. Bonds can be complicated to understand at first since there are many types of bonds and therefore many rules. It is also more important to understand how bonds work when you invest in bonds because people usually invest in bonds for the interest payments as well as redemption value which are something in the future. While when a stock goes down in value you know you are losing money, when a bond goes down in value, you may not be losing money but if you understand perfectly how your bonds work.
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