If there’s one thing South Africans love more than watching sports and having a braai, it’s the irrevocable belief that investing in real estate (with an emphasis on residential real estate) is the stairway to financial heaven. Even when the numbers (on average) tell a completely different story.
“The math is simple, you buy the property for R1m in the first year, earn rental income on the property while the tenants pay your deposit on your behalf, and you sell the property in the 10th year for R2m.” We’ve all probably been in a conversation before where this pearl of financial wisdom has been shared. And dare you challenge a real estate investment guru around the braai.
Let the numbers bust the myth
Before we crunch the numbers on this one, let’s get to the house door – there’s a lot more to the savvy tips mentioned above. In short, investing in (mainly residential) real estate comes with the following challenges and hidden costs:
- Transfer fees when buying the property;
- Rates and property taxes;
- Specimens ;
- Property maintenance and upkeep;
- Fluctuating interest rates;
- Illiquid investments;
- Bad tenants;
- Shedding (at the time of writing, this has been upgraded to Stage 4 from the initial Stage 2 of Shedding originally announced); and
- Lack of municipal services (water and sanitation and road maintenance).
I know now that there are already readers who are fuming, claiming that they have achieved financial freedom by investing their capital in real estate investments. This may be the case, but for the purposes of this article, we will work with averages at all levels, over a period of approximately 10 years.
The stats don’t lie
In South Africa, buying a property should be seen as a lifestyle decision rather than an investment decision. Especially in the south of the country. You guessed it – the Western Cape.
The Western Cape may be one of the few areas in South Africa where real estate investments over the past five to ten years have reaped rewards. This is again with the focus on residential real estate. The structural factors mentioned above and the deterioration from small to large towns and even recently towns in northern South Africa have caused residential property prices to stagnate and even crash over the past 10 years.
Below is a clear indication of the statistics indicating the destruction of residential property prices across the board in South Africa.
Of course, there will be outliers in the results, with individuals sometimes managing to successfully invest in residential real estate. The graph above is an average statistical figure.
The results are in
Let’s look at the performance of a hypothetical R1 million invested in the following investments over a 10 year period:
Residential Property SA: 1 million rand invested in the local residential real estate market 10 years ago, would have left you around 800,000 rand in your pocket today, reflecting a -20% destruction of your capital over the last 10 years. This excludes all additional costs related to the property, such as transfer of ownership costs, maintenance, insurance, etc.
Emerging Markets Ownership: A million rand invested in residential property in emerging markets 10 years ago would have left you with 1.16 million rand in your pocket today.
US residential property: One million rand invested in US residential real estate markets 10 years ago would have earned you around 1.67 million rand today.
Real estate vs indices/financial markets?
JSE: Even though the local stock market has also underperformed global markets over a 10-year period, an investment of R1m in the JSE would also have been a much better investment, earning you R1.54m in current terms. .
S&P500: If you had decided to outsource your assets abroad and invest 1 million rand in the S&P 500 10 years ago, you would have had 3.2 million rand of capital today (growth of 222 % in dollars). If you take into account the depreciation of the rand/dollar and invest the million rand at an exchange rate of 8.50 rand/dollar in 2012 and cash out your investment today at 14.50 rand/dollar, your capital would have inflated at R5.6 million. Additionally, you would have excluded all interim costs associated with owning a property as mentioned earlier. Your investment was also 100% liquid over the 10 year period, and not a single wall had to be painted or a single geyser had to be replaced.
Worse and worse
The graph above only shows the depreciation of the physical value of the asset. This excludes all of the property-related costs that go along with owning residential property. Not only has your capital depreciated at a rate of knots, but there are certain fixed and unavoidable costs associated with owning a property. This puts you even further out of pocket in real terms.
The FNB Property Barometer also made it clear that a major reason for property sales in the northern region of South Africa was primarily due to security and safety concerns following the riots in July last year. .
Protection of private property in South Africa is at an all time low, which is shaking market sentiment in the real estate sector. Investors are reluctant to place their capital where the security of their assets cannot be protected to some degree.
Another scapegoat for property owners selling their beloved homes is rising administered prices, which primarily refers to electricity and municipal costs. These costs have skyrocketed over the past decade.
Administered price changes are much more volatile than others and also rise faster, directly affecting real estate investments. See below: administered prices vs overall CPI
Proceed with caution
The purpose of this article is not to prove individuals who have successfully invested in real estate wrong, as there are certainly plenty of investors who have done so over the years. It aims to bust the basic myth of real estate investing and clearly lays out all the other relevant factors that need to be considered when choosing real estate as an asset class for your capital.
There is much more to consider when investing in real estate than just the price you pay and the rental income earned from that investment. If the calculations add up too easily, you can almost certainly tell that you might be missing something somewhere.
Every investor in the real estate market has their own specific method of analyzing whether a certain property might be a prudent investment. The list of calculations (and how to modify those calculations) is endless and beyond the scope of this article.
Be extremely sure of the mechanics of your calculations when investigating a property as investment asset. Familiarize yourself with the different “drivers/variables” of the calculation and how any change (up or down) in any of these variables can affect your investment. Interest rates, purchase price, payment term, and additional payments are all important interchangeable factors that can determine whether your real estate investment will have the desired results.
The selection of asset classes is the cornerstone of any investment strategy. You are strongly advised to consult an experienced and qualified advisor to select the asset classes that will deliver the best results tailored to your specific needs and financial goals.