A tenant paying rent will soon start doing the calculations: Over 20 years of paying a rental of R10,000 per month, which escalates every year by 10%, will cost a tenant around R5,491,435.
And this is not the exception, either. A young adult who starts working at 20 years old may only be in a financial position to purchase their first home at 40 years old – this is, after all, the average age of the first-time home buyer in South Africa.
If a home loan is paid off over the same period of time, it would leave the homeowner with a paid off property valued at a few million rand.
“Many tenants feel they are trapped renting forever due to the high hurdles to enter the property market,” says Meyer de Waal, a property attorney and market innovator. “They do not realise that the longer they wait, the more difficult it becomes to get their foot through the property ownership door.
“It is, however, common knowledge that you will pay a lot less to rent a house or apartment valued at R1m compared to what you would pay if you were to buy that same property.”
So why buy?
“Initially, many people may think, ‘why should I burden and trap myself by buying a property when I can enjoy the freedom of a rental property and get more value for my money?’. But a few years later when they struggle to buy a property due to escalating property prices, they may doubt their decision to remain a tenant for too long a time,” says de Waal.
De Waal takes an in-depth look into this question as to which is the better investment. And his findings may surprise you.
“I did some calculations looking at a five-year, a 10-year and a 20-year and longer view, and my perception changed several times before finally landing on the answer,” he says.
Here’s how he went about it
If you rent a property valued at R1m, 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 R1m, you can expect to pay 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 of 10%.
“Chances are, however, that you ended up with a higher interest rate,” he says. “If your interest rate is a mere 2% higher at 11.5%, you can expect to pay the bank R10,664 per month.
“Not a lot per month, you may think, but the extra 2% adds up to 32% more over the duration of a 20-year repayment. That’s almost R320,000 more to pay back on your bond.
“Now consider if you buy a property of R1m and rent it out. You will collect R90,000 rental income in the first year if your tenant pays you R7,500 per month and the rent increases by 10% a 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,” he says. “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 (R1 million x 9.25% x 20 years) and an extra R27,000 for the additional expenses.
“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 (excluding utilities costs) would be the R90,000 in rent for that same year.
“A homeowner will then pay +/- R48,856 more compared to a tenant in year one,” he says. “There is, however, some hope for the homeowner: while the tenant might have to pay less, they will enjoy no capital growth as all their 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 R1,08m 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 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 of 10%.
“If the property is sold after one year, the seller will have to pay the estate agent’s commission,” he says. “Estate agents’ 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 R1,08m, 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 with a significant loss on their 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, or if one manages to buy the property at a very good price and below market value. 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.
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 annual average increase of 9%), 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 R1m 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 are R734,617.
If the property is to be sold, and an agent is paid, the loss will be even greater. After five years, only +/- R84,000 capital of the initial R1m home loan would have been 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. In the same amount of time, with an annual 8% capital growth, 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 being 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 a total of R2,219,602 in 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% per year, the property will be valued at R4,660,950,” says de Waal. “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).
“This does look like a ‘break-even’ situation, but compared to the tenant who paid rent of R5,491,435 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 off in full, no future rental costs and a potential sale if he so chooses.”
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 more or less 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; to 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.
Finance is now available to help you escape the rental trap. Why not rent and get yourself ready to buy at the same time?
“The Rent2buy product we developed some 11 years ago received a new facelift when we introduced a financial product to unlock the deadlock between renting vs buying,” says de Waal, noting that finance is available for home buyers and property investors in the price range of R400,000 to R1,8m for property in the Cape Town Metro or in Gauteng.
A small escalation is added to the purchase price and then the price is frozen for the Rent2buy tenant for the next 24 months.
A deposit from as little as 3% or 5% to 7% can get your foot in the door to buy your own Rent2buy property using the finance option.
Read more about the Rent2buy Finance product, click here
“Many home buyers are not aware that they have access to a subsidy called FLISP, made available by government to first-time buyers,” says de Waal. “The FLISP subsidy can also be used as a deposit to purchase a property or applied to cover transfer and bond registration costs.”
To get access to such a subsidy, an applicant must be a South African citizen or a permanent resident, and be a first-time homeowner with dependents, must have an approved mortgage bond and earn less than R15,000 per month. For more information go to www.flisp.co.za
To register and get started on your Rent2buy journey, click here