Does it make financial sense to enjoy living in an upmarket rental apartment and not buy it?

“It’s common knowledge that you will pay a lot less to rent a house or apartment valued at R1 million compared to what you would pay if you were to buy that same property,” says De Waal.

“Why burden and trap yourself to buy a property when you can enjoy the freedom of a rental property and get more value for your money?” asks Meyer de Waal, owner of My Bond Fitness, a property conveyancing attorney and also an exhibitor at the upcoming Property Buyer Show in April in Cape Town

De Waal takes an in-depth look into this question as to which is the better investment.

“It’s common knowledge that you will pay a lot less to rent a house or apartment valued at R1 million compared to what you would pay if you were to buy that same property,” says De Waal.

“I did some calculations, looking at a 5-year, a 10-year and a 20-year and longer view, and my perception changed several times before finally landing on the answer.”

Here’s how he went about it:

1. The devil is in the details

If you rent a property valued at R1 million, De Waal says you can expect to pay a rental of between R6 500 and R8 000 per month for that property. If you buy a property of R1 million, you can expect to pay back the bank R9 321 per month if you were lucky enough to negotiate a home loan interest rate of 9.5 %, close to the current prime home loan rate.

“However, chances are you ended up with something a little higher. If your interest rate is a mere 2 % higher at 11.5%, you can expect to pay back the bank R10 664 per month,” says De Waal.

“Not a lot per month you may think, but the 2% extra adds up to 32% more over the duration of a 20-year repayment. That’s almost R320 000 more to pay back your bond.”

“Now consider if you buy a property of R1 million and rent it out, you will collect R90 000 rental income in the first year. Your tenant will pay you R7 500 per month, and the rent ought to increase by 10 % each year.

As a tenant, you usually do not have any responsibility to pay additional expenses like rates, taxes, insurance and levies. However, if you own your own place, De Waal says you can easily add another R2 000 to R2 300 per month to cover these expenses over and above your home loan repayment.

“Now is where it gets tricky with the numbers. If we add all the payments of a homeowner together in one year, the R1 million property could end up costing you R111 856 in annual bond repayments (R1 million x 9.25 % x 20 years) and an extra R27 000 for the ‘additional expenses’,” says De Waal.

“This leaves you with an annual total payment of R138 856.”

Now, if you were to rent the same property for R7 500 per month, De Waal says your only expense would be the R90 000 in rent for that same year.

“A homeowner will then pay a staggering R48 856 more compared to a tenant in year one,” he says.

De Waal says there is some hope for the homeowner – the tenant might have to pay less, but will enjoy no capital growth as all his money is helping the landlord pay off his bond.

If the property value grows at 8% per year, the homeowner’s investment will increase in value by R80 000, leaving the property worth R1.08 million after one year. On a growth basis, the property owner will be R58 856 out of pocket.

“The best returns with owning a property are usually achieved over a longer term of ownership, but I did some calculations on what would be the returns, should the owner decide to sell after year one,” says De Waal.

De Waal says if you buy a property of R1 million, you can expect to pay back the bank R9 321 per month if you were lucky enough to negotiate a home loan interest rate of 9.5 %, close to the previous prime home loan rate – now 10.5%

“If the property is sold after that period, the seller will have to pay the estate agent a sales commission. Estate agent’s commissions are usually 5% (plus VAT) and can go as high as 7% (plus VAT) of the purchase price. If the property is sold for R1.08 million, with the 5% commission (plus VAT) of R61 560 payable to the agent, the property owner would be left with a ‘cash in hand’ profit of R18 440 on the sale alone.”

However, De Waal says the owner has to take into account the bond and other property expenses of R111 856, which leaves the owner making a significant loss on the investment.

It appears not to make any financial sense to sell the property within a year, unless a much higher sales price can be achieved. The tenant, if he follows sound advice, can invest the difference he pays compared to what he would have paid if he owned a property and be in a much better cash-flow situation.

2. Will it stay the same?

The tenant’s rent usually increases each year from between 8% to 10%, meaning that after five years the rent will be R111 856 per year (calculated on an average increase of 9% annual increase), and the tenant would have paid a total of R538 624 in rent over that five year period.

“When looking at the homeowner over the same period of time, if no major interest rate hike was introduced or if the homeowner fixed his interest rate with the bank (keeping home loan repayments the same), we can see if investing was worthwhile,” says De Waal.

“Let’s assume a 12% escalation for rates, taxes, levies, insurance and maintenance expenses per year, leaving the homeowner to pay R175 339 for these expenses and R559 279 to the bank towards the home loan after five years. The total expenses of the homeowner will sit at R734 617 and must be set off against potential 8% compounded growth of the property over the same five-year period.”

With this growth, De Waal says the property will increase in value from R1 million to R1 469 328. This leaves the homeowner out of pocket to the tune of R265 289 as his capital growth is R469 328 and his expenses R734 617.

If the property is to be sold, and an agent is paid, the loss will increase even more as the estate agent must be paid. After five years, only +/- R84 000 capital of the initial R1 million home loan would be repaid.

“Over a period of 10 years, if the growth stays the same and rates, taxes etc. increase at a similar rate, the homeowner will pay R1 602 902 towards the home loan and other related expenses. By the same time, with an 8% capital increase every year, the value would now be R2 158 925,” says De Waal.

“Only now would the owner be in a positive position due to a larger portion of the capital of the home loan would be repaid, at the 10-year mark the outstanding capital on the bond ought to be R756 959 from the original R1 million home loan.”

The tenant, facing a 10 % rental escalation each year, would have paid in total R2 219 602 rental over 10 years. If the tenant had the discipline each month to save the difference between his rental paid and bond and other expenses, he would have an investment in his bank account.

“After 20 years, the home loan ought to be paid off, and with a steady capital growth of 8%, the property will be valued at R4 660 950. The expenses towards bond repayments and rates, taxes, levies and maintenance amount to R4 225 762. It is a nominal profit, but at least the bond is paid off and, if the property is sold, the cash value will be R4 660 950 (less agent’s commission),” says De Waal.

“This does look like a ‘break-even’ situation, but compared to the tenant who paid rent of R4 944 160 over the past 20 years and has only his savings to show (if it was invested wisely and if invested at all), the homeowner does seem to be sitting pretty with a property paid up in full, no future rental costs and a potential sale if he so chooses.”

So, does it make sense to invest in property or is it just a forced savings plan?

The abovementioned scenario is calculated if a homeowner is to pay off his own residential home loan with no outside help like rental income.

“It appears to be around even with the rental paid over such time and can be regarded as a ‘forced savings’ structure, as you end up with close to the same money that you invested,” says De Waal.

“In fact, many investment gurus will advise you that it is not a good idea to buy your own home, rather rent and invest the extra money that you will have each month and enjoy better investment growth.”

What is not considered by these ‘gurus’ and considered for the abovementioned scenario is the fact that the property owner enjoyed the occupation of his own home.

“If he did not have his own home, he would have had to pay rental somewhere else. If we do the calculation again and work on rental of R7 500 that the owner would have paid for another property, he would have been R4 944 160 out of pocket after 20 years,” says De Waal.

“Add the R4 944 160 to the property value of R4 660 967, then the investment all of a sudden has a better ‘ring’ to it.”

Investing in a second buy-to-let property

“To improve your return on investment, get a tenant to help you fund your investment,” says De Waal.

“Now consider if you buy a property of R1 million and rent it out, you will collect R90 000 rental income in the first year. Your tenant will pay you R7 500 per month, and the rent ought to increase with 10% each year.”

De Waal says this means you will only need to contribute the shortfall until the rental escalation per year catches up with the shortfall.

In the first year, after payment of the home loan of R111 853 and the rates, taxes etc. of R24 000, it will leave a shortfall of R45 852.

Based on the same percentages, he says it ought to take a few years to break even, considering no major increase in interest rates.

“Looking at these calculations, investing in property remains a good and solid investment,” says De Waal.