What is the maximum exposure to residential property you should have?
1. How do you think investment properties such as buy to let properties fit into a portfolio?
In an ideal world, a perfect investment gives you a consistently high rate of return year after year with very low risk.
With interest rates in SA having reached their lowest in 50 years, there has been some renewed interest in buying residential property for investment purposes, and many investors see this as the perfect investment for generating an alternative income stream.
When building an investment portfolio, however, we need to remind ourselves that perfect investments don’t exist in the real world – asset classes that skyrocket one year can plunge the next. (Just look at SA listed property returns over the last few years).
Equities tend to be volatile over short time periods but have the most potential for growth in the long term, while so-called “low-risk” investments have low rates of return, frequently not even keeping pace with inflation. High-income investments are not without the risk of permanent capital loss either.
Even the buy-to-let residential market slumped as a result of Covid and its aftermath, with tenants defaulting on rent, and landlords having to reduce rentals or cancel increases in order to keep tenants. In KwaZulu-Natal, property prices fell following the recent riots.
With this in mind, and on the assumption that your portfolio is well-diversified across asset classes, fund managers and investment styles, both locally and offshore, then adding an investment property could provide you with a consistent income stream and capital growth over time.
From a risk perspective in your portfolio, residential property has an advantage in that it has a low correlation to equities and bonds – it is a lagging economic indicator, with prices reacting well after the rest of the economy.
Buy-to-let property does not come without pitfalls, and you need to do your homework carefully. This becomes even more critical if you consider buying property offshore.
2. Would properties in the UK or US represent a diversification of a residential property-focused portfolio?
Before you consider buying investment properties, either in SA or elsewhere, you need to understand the amount of work involved. Wherever you buy, you will need to be comfortable with investing either your money or your time.
If considering property overseas, it would demand more of both, and there would be a few additional points to consider:
- To ensure you don’t overpay for prospective property, you would need to get a realistic idea of market-related rentals in the country and area that you select. You would need to spend some time researching this, being careful of companies that offer guaranteed rental returns – these are often built into the purchase price.
- Managing the property: You would need to do some research into the developers (if applicable), agents and the company that you would be working with offshore to ensure that they are trustworthy.
You would need a reputable rental agent to manage the property, screen and manage tenants, attend to maintenance and so on. Managing a property is admin-intensive.
- Financing: Even with enough funds available offshore to buy a property for cash, it generally makes sense to make use of financing, particularly in a low-interest environment such as the UK or US. You would need to arrange a mortgage as a non-resident, which would be a more complicated process.
- Costs: You would need to have a good understanding of all the ongoing and future costs, including maintenance, as well as agency fees.
- Tenant risks: There could be periods of time when you do not have a tenant. As in SA, you would need to ensure that you have sufficient resources to cover the bond repayment and monthly costs – levies, rates, insurance and so on. However, this comes with the added challenge that you could potentially be covering these costs, in foreign currency, with SA rands.
- Tax implications: You would need to consult with a tax practitioner there to register you as a non-resident landlord, and to assist with the tax reporting to the relevant authorities.
As an SA tax resident, you are subject to tax on your worldwide income, and you would need to report any overseas rental income to Sars in your SA tax returns. You would claim a tax credit for tax deducted overseas in terms of the relevant Double Taxation Agreement.
- Estate Planning: To avoid potential delays in the winding up of your estate, you would need to have a separate offshore will drafted in respect of a property that you own overseas. You would also need to plan for inheritance tax that may be payable in that country.
While buying a property overseas would give diversification against SA specific risk, you would still be in an illiquid asset class. You would also need to weigh up the added complexities.
If you are looking to diversify offshore, you should also be considering other asset classes, in the same way as you would do with your SA portfolio, which would provide you with global exposure.
3. What is the maximum exposure to residential property you would suggest?
This will depend on your individual circumstances, overall assets and lifestyle objectives. Essentially though, you’ve hit the nail on the head about not having all your eggs in one basket.
If you have the money, expertise and time to deal with property maintenance, tenant selection and the capital to cover purchase costs, investing in a buy-to-let property can provide a hedge against inflation that delivers a steady income once the bond has been paid off.
If you don’t have a long time horizon, such as if you are already approaching retirement, then you need to consider whether you would own the property for long enough to recoup the transfer fees and other purchase costs.
Investing in the buy-to-let market isn’t for everyone. Property is an illiquid asset, meaning that it takes time to sell, and finding a buyer is a more difficult and lengthy exercise than selling bonds, shares or a unit trust investment.
By spreading your total investment portfolio over a wide range of asset classes, including investment property, you should outperform any single asset class over a long period of time (and yes, this applies to Bitcoin too, for those who might be wondering).
In determining how much exposure you should have to residential property – as with all aspects of your financial planning – you should consult with an independent certified financial planning professional who will advise you based on your unique circumstances.
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