10 Apr 2014
The most recent FNB-TPN Residential Property Yield Review, produced by FNB Home Loans and TPN (Tenant Profile Network), notes that residential property yields have started to increase on the back of rental stock shortages driving rental inflation, which will be accelerated by interest rate increases.
To truly understand the returns on investment on a buy-to-let property, the capital growth must also be factored in, and this capital growth must be calculated correctly, on the investor's actual out-of-pocket investment, not on the value of the property.
The National Gross Average Yield on residential property was estimated at 9.18 percent by the third quarter of 2013, raising the attractiveness of residential property as an investment.
According to Dr Koos du Toit, CEO of P3 Investment Group, a nine percent yield may not seem exciting, but investors should bear in mind that this is only the yield on the rental income. He says to truly understand the returns on investment on a buy-to-let property, the capital growth must also be factored in, and this capital growth must be calculated correctly, on the investor's actual out-of-pocket investment, not on the value of the property.
In addition, he says buy-to-let property is a low risk investment, and this must be taken into account in the consideration between yield vs risk.
Dr du Toit explains that the returns on residential property consist of two elements: an ongoing, passive, inflation-linked monthly income and capital growth on the value of the property. He says if residential property yields are nine percent and the average capital growth nationally is around eight percent, then a buy-to-let property will yield an average combined return of 17 percent.
Bear in mind, however, that these are national averages and in many areas, both rental yields and the capital growth are higher, he says.
"But there is yet another reason why buy-to-let property investment returns can be nothing short of spectacular: buy-to-let property allows property investors to gear their investments. Gearing makes a massive impact on the return on investment."
In simple terms, if you buy R500 000 worth of listed property shares, you need to invest R500 000 in after-tax cash. However, if you acquire a R500 000 income-generating residential buy-to-let property, you can obtain a 100 percent mortgage or home loan, which means you need no lump sum investment. Of course, the bond would have to be repaid each month but, remember, the property is generating a monthly income, which will cover most of the bond repayment amount.
If one takes a R500 000 property as an example, requiring a R50 000 deposit (the actual out-of-pocket investment made) and one assumes a R4 000 per month rental income, 10 percent interest rate, eight percent capital growth and eight percent inflation of costs and annual rental, the returns are as follows:
Annual capital growth (R500 000 x 8 percent) = R40 000
Rental income (R4 000 x 12 = R48 000) - not included as covers bond
Total Returns = R40 000
Deposit = R50 000-
Bond repayments (R4 000 x 12 = R48 000) not included as covered by rental
Interest, levies + taxes and other costs not covered by rental income = R16 000-
Total Out-of-pocket investment = R66 000-
Total return on R66 000 investment = 60 percent
Annual capital growth (R540 000 x 8 percent) = R43 200
Rental income (R4 320 x 12 = R51 840) - not included as covers bond
Total Returns = R43 200
Bond repayments (R4 000 x 12 = R48 000) - not included as covered by rental
Interest, levies + taxes and other costs not covered by rental income = R16 850-
Total Out-of-pocket investment = R16 850-
Total return on R16 850 invested = 256 percent
Of course, next year and each year thereafter, these returns on investment will grow because capital growth is compounded each year and, as the rental increases every year, the out-of-pocket investment per year continues to diminish. After a few years, the rental income exceeds the bond repayments and the other costs, which then adds rental income to the capital growth in the returns section, and eliminates the out-of-pocket investment, and the result is truly spectacular returns on investment.
Investors must also consider the yield vs risk, as with any investment, there are some inherent risks involved in investing in a buy-to-let property. However, unlike the many risks traditional investments entail, most of the risks in property investment can be managed and mitigated, if not eliminated, through tried-and-tested risk management strategies the investor can implement easily and cost-effectively.
Du Toit says while residential property yields are improving, smart investors should consider the total returns generated by a buy-to-let property, and consider these in the context of the low risk this investment alternative entails.
He says achieving such stellar returns on such a low risk investment requires little more than a willingness to investigate time-honoured and proven strategies to acquire brick-and-mortar rental properties without investing your own hard-earned money, to produce both an ongoing, inflation-linked rental income and ongoing capital growth, which translates into returns that are remarkable when compared to traditional asset classes.