Author Topic: Can buying a property in a high interest environment make sense?  (Read 2193 times)

Ipodius

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I live in South Africa, and I am aiming to live a frugal, early retirement life. I'm considering investing in a rental property (and I am in the process of selling a previous investment property).

The situation in SA is very different to the US - for one, interest rates are much higher (9% is the current prime rate, an all time low. My current mortgage is at 8.25%, I'll probably only get 8.6 or 8.7% on my next mortgage). However, inflation is also a lot higher, so that obviously impacts the interest rate.

Renters generally have much lower standards and requirements in the US - it's not at all the norm for a property to be newly painted, have new carpets, etc when being rented. Added to this, the nature of our buildings mean that maintenance (especially on rental apartments) is much lower than in the US. We don't have central HVAC, and tenants bring their own appliances. In most apartments, the only two electrical appliances are the oven/stove and the geyser (water heater).

Obviously all the above mean that the normal rules (half the rent for maintenance, etc) that you apply for a US property can't be applied to an SA property. To give you some figures, I'm considering buying the following:

Bachelor flat, selling price R330 000. Owner will take an offer of R315 000, so my total cost of buying would be about R325 000. The flat currently attracts a R3500 rental income a month, and is in a great rental area  - walking distance to the two of the biggest Universities in the country, walking distance to the head office of the national broadcaster, many other employers close by. I've seen other units in the complex go for R3800, and rental inflation is about 8% a year, so I would expect to get a higher rent when the current tenant moves out.  Costs would be R600 Levy (essentially HOA / condo fees for the building) and R150 rates and taxes. Electricity would be paid by the tenant (pre-paid), water is included in the levy.

So the maths works out as follows:
    R3500 (rental)
 - R2631.69 (20 year 90% mortgage at 9%)
 - R750 (levy and rates)
= R118

(These are pessimistic guesses - hopefully I would get 8.5%, and a higher rental once the current tenant is up for renewal in 3 months time. I also might be able to get a 100% mortgage from day one, which would mean I would be putting in money every month, but would have nothing down).

So it's cash flow neutral, rather than positive. Based on my maintenance experience with my previous unit, and what I've heard from other landlords, I am looking at about R1000 to R1500 a month in expenses. I would manage the unit myself, which would obviously be "unpaid work" but would not result in high costs. For my previous unit, I've never had it empty, and I've had to visit it less than once a year - this may just be luck thus far! So let be pessimistic and say I would lose R5k in the first year, and that I make that back in year two and three. 

Obviously, as a US investment I'd look at this and say "not a chance". However, when it comes to the property options in SA, it's one of the best I've found. There are positive cash flow properties, but they are generally in significantly worse areas. And once I take into account the need to hire a company to manage the unit (I would not take the safety risk of doing it myself), their returns are not that much better than this unit.

I feel like this will be a good investment in the medium term - with very little down now (R32 500) I'll own a property in a decent part of the city that taking into account rental inflation, will cover the losses from the first year by the end of the third year. By that point I'll be able to refinance and take out my initial investment, and leave the property to slowly pay itself off and appreciate, and could then refinance to unlock value as it appreciates.

Am I fooling myself to think this is a good idea?

illy5603

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Re: Can buying a property in a high interest environment make sense?
« Reply #1 on: May 22, 2012, 09:22:35 AM »
Unless math is somehow different in South Africa, no, I would not do this deal. Why add another hassle to your life for so little return?

Also you keep mentioning how pessimistic you are, actually, I think you are being optimistic regarding the maintenance costs. You still have a roof, walls, ceilings, electrical wire, plumbing etc. Trust me, "appliances" are the least of our maintenance worries.

The HOA levy would also make me want to shy away from the deal.

Ipodius

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Re: Can buying a property in a high interest environment make sense?
« Reply #2 on: May 23, 2012, 03:21:41 AM »
Thanks for the response, I appreciate it.

In terms of maintenance, it's hard to judge. The body corporate (who the levy is paid to) are responsible for  maintenance external to the unit - so that's the structural aspects of the building covered (roof, walls, ceiling - well, the ceiling is a concrete slab - foundations, etc). Beyond that, they also pay for insurance on the building - so a lot of the levy fee is really money being paid into a maintenance pool.

Internal plumbing and electrics would be to my account. The building was converted from an office building to a residential complex 7 years ago, and I would get an electrical compliance certificate and plumbing certificate on purchase. So the risk there (in the short run) is minimal, but obviously over the long run their will be maintenance. I've increased my maintenance estimate to R3000. To give you an idea, on my current unit I've spent less than R2000 over 5 years on maintenance - in general, because these buildings are 100% brick and concrete, and because the body corporate covers the external maintenance, costs are low. Talking to other owners (I'm a trustee on the body corporate, so have a lot of interaction with them) 9 out of 10 people have had similarly low maintenance costs in my current building.

Obviously, I'm looking at this in a speculative way, to a certain degree - it's not at all a cash flow positive from day one property. I guess what makes me feel like it's worthwhile is the 5 year projection, making the following estimates:

1. Rental increases of 5% a year. Thus far, for this complex the increases over the last 5 years have been 7% annually (based on hard facts). Rental inflation for the country as a whole is 6.6% and expected to stay high going forward - a new law was passed in 2007 that has made it a lot harder for individuals to get bank financing for properties, so the rental market has boomed since then.

2. Increases in the levy and rates & taxes of 5% annually. Thus far, they've been much lower than this both for this property, and the current property that I own.

3. I've assumed the property will be empty 1 month of the year.

4. Putting down a bigger, 26% deposit (R84500)

Projecting forward over five years, my annual cash flow would be as follows:

Year 1: +R544
Year 2: +R2019
Year 3: +R3567
Year 4: +R5193
Year 5: +R6901

Total: R18226

The balance on my Mortgage would be R213 340 after 5 years, so I would have paid down R33 032 on the mortgage

So essentially, the five year return would be R18226 (Cash flow) + R27 160 (principal paid down on Mortgage) on my investment of R84500 (first year's loss + original capital). Which is a more than 8.9% annual return, assuming no appreciation on the property. But more importantly, I would own a property that's generating cash flow every year, and that would require almost no extra effort or money in the future (I could pay a managing agent and still make a profit at that point).

Risks I see:

- Huge drop in rental demand, leading to a drop in rent, or a stagnation of rental increases
- Increase in interest rates.
- The area declining in a big way, negatively impacting rentals and the value of the property.
- Maintenance being a lot higher than I expect
- Tenant delinquency rates being a lot higher than I expect

illy5603

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Re: Can buying a property in a high interest environment make sense?
« Reply #3 on: May 23, 2012, 10:44:31 AM »
I still see two issues.

One you are willing to throw more money in cash down to make the numbers work. If they don't work, they don't work. Putting up a larger down payment might make it cash flow positive but your return on your entire investment gets smaller. In short, there are probably better places for your money than in a down payment.

The other one is that you are still speculating. Speculating is gambling not investing. I would recommend looking for something that has several positives that beat out the negatives even in worst case scenarios.
 
I ended up buying two rentals half way across the USA because it was one of the places where the numbers actually worked. My local market looks a lot like what you are describing in your area, so I moved on.


Ipodius

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Re: Can buying a property in a high interest environment make sense?
« Reply #4 on: May 28, 2012, 03:16:03 AM »
Yeah, it definitely is speculation. Unfortunately, all real-estate opportunities that are available to me in SA fall into speculation to a greater or lesser extent. So I guess the decision I need to make is if I want to avoid real-estate completely, or do some speculation :)

My current feeling is to try and purchase something similar to the apartment mentioned above, but re-possessed (SA version of foreclosed) property so that it costs me R50 to R100k less. Still won't be a great investment by USA standard, but I feel like it would be worth it for my situation - will give me some exposure to property, I'll learn a lot, and I'll have to give up very little in return to do so.

Thanks for the feedback!