Buy vs Rent? It depends on when you’ll sell
Increasingly South Africans are asking themselves: “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?”
Meyer de Waal, owner of My Bond Fitness and property conveyancing attorney, who will be exhibiting at the upcoming Property Buyer Show, takes an in-depth look at whether it makes financial sense to enjoy living in an upmarket rental apartment and not buy it.
“I did some calculations – looking at a 5 year, a 10 year and then a 20 year and longer view – and my perception changed several times before finally landing on the answer. Here’s how I went about it.”
The devil is in the details
If you rent a property valued at R1m, you can expect to pay between R6,500 and R8,000.00 per month rental for that property. If you buy a property of R1m, 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 R10,664.00 per month. 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!
The “hidden” extras: 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 you can easily add another R2,000 to R2,300 per month to cover for these expenses over and above your home loan repayment.
If we add all the payments of a homeowner together in one year, the R1m property could end up costing you R111,856 in annual bond repayments and an additional R27,000 for the extras. 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 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.
The homeowner’s silver lining: The tenant might have to pay less but will enjoy no capital growth; 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 with R80,000, leaving the property to be worth R1,08m after one year. On a growth basis, the property owner will be R58,856 out of pocket.
Selling after year one
“The best returns with owning a property is usually achieved over a longer term of ownership, but I did some calculations,” says de Waal. “What would be the returns, should the owner decide to sell after year one?”
If the property is sold after that period, the seller will have to pay the estate agent a sales commission. Commissions of estate agents are usually 5% (plus VAT) and can go as high as 7% (plus VAT) of the purchase price. If the property is sold for R1,08m, with the 5% (plus VAT) 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, 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 would have paid, compared to what he would have paid if he owned a property, and be in a much better cash-flow situation.
What if the homeowner sells in year five?
The tenant’s rent usually increases each year between 8 – 10 %, meaning that after 5 years the rent will be R111,856 per year (calculated on an average annual increase of 9%) and the tenant would have paid a total of R538,624 in rent over that 5 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.
Let’s assume a 12 % escalation for rates, taxes, levies, insurance and maintenance expenses per year, leaving the home owner to pay R175,339 for these expenses and R559,279 to the bank towards the home loan after 5 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 5 year period.
With this growth the property will increase in value from R1m to R1,47m. 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 agent is paid, the loss will increase even more as the estate agent must be paid. After 5 years, only +/- R84,000 capital of the initial R1m 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 R1,6m towards the home loan and “other related expenses”. By the same time, with an 8% capital increase every year, the value would now be R2,16m.
Only now would the owner be in a positive position due to a larger portion of the capital of the home loan having been repaid – at the 10 year mark the outstanding capital on the bond ought to be R756,959, from the original R1m home loan.
The tenant, facing a 10% rental escalation each year would have paid in total R2,22m 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.
What if the owner sells once the bond has been paid off?
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 R4,66m. The expenses towards bond repayments and rates, taxes, levies and maintenance amounts to R4,23m. It is a nominal profit, but at least the bond is paid off and, if the property is sold, the cash value will be R4,66m (less agents commission).
This does look like a “break-even” situation, but compared to the tenant who paid rent of R4,9m 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.
Investing in a second property – Buy to let.
To improve your return on investment, get a tenant to help you fund your investment. Now consider if you buy a property of R1m 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. 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, it ought to take a few years to break even, assuming no major increase in interest rates.