The decision to invest in a rental property must be carefully considered. In addition to the costs associated with owning a rental property, there are a number of risk factors that investment property owners should be aware of. For those looking to navigate the rental real estate space, here’s a comprehensive guide to what it entails.
Access link: If you are financing your rental property with a mortgage, consider asking for ease of access. If you have paid extra money into your home loan beyond the required minimum repayments, there is easy access to allow you to withdraw the extra funds at a later stage. Keep in mind that any excess money paid into your bond will have the effect of reducing interest and therefore increasing your net returns.
Annual rent increases: As for annual rent increases, you will no doubt want to make sure that these increases keep pace with annual inflation. While there are risks associated with having bad tenants, keep in mind that there are also risks associated with having good tenants. Many landlords, reluctant to accept market-related rent increases for fear of driving out good tenants, have cut their losses by maintaining below-market rents.
Obligation creator: If you are financing your rental property, consider using a bond originator to find you the home loan on the most favorable terms. A bond originator will help you prepare a single application which will then be submitted to multiple banks on your behalf. They will help you fix your credit score, gather all the necessary documents, get pre-qualified and get the best interest rate from the banks you apply to.
Commission: The seller of the property is responsible for paying the real estate agent’s commission. According to Ooba, the standard commission rate for estate agents in South Africa is 9.75%, although this is often negotiated.
Capital gains tax: If your rental property is a secondary property, keep in mind that there may be CGT consequences when realizing the property. Assuming the value of your rental property appreciates over time, you will be liable for CGT on the full gain, subject to a rebate of R40,000, after which 40% of the gain will be included in your taxable income for the year in which the property is sold.
Diversification: If you’re considering buying a rental property, it’s important to keep in mind that lack of diversity is an investment risk. As an investment, a single rental property is considered a concentrated asset that requires heightened risk awareness. If you intend to own rental property, consider spreading your risk by investing in other asset classes or investment structures such as a portfolio of unit trusts.
Forced sale: Keep in mind that real estate is an illiquid investment. The buying and selling process is usually long, which can create liquidity problems if you need your money urgently. If you are forced to sell your investment property to access your capital, you may have to settle for a price below its market value.
Gear: Gearing involves borrowing money from a bank to finance the purchase of your investment property. As such, investment property is one of the only asset classes you can fund with borrowed capital. Borrowing money to buy a property allows you to build wealth over time as the value of the asset appreciates and the amount of the deposit decreases due to the use of the rental income earned to reduce the deposit.
Home loan: Negotiating the most favorable terms possible for your home loan from the start is the key to your long-term returns on investment. Your credit score is an important factor in determining the interest rate offered to you by the bank. If you are considering investing in real estate, take all necessary steps to boost your credit score to increase your chances of being offered a better interest rate.
Insurance: When buying a property, you will need to factor insurance costs into your budget. If you have a mortgage on the property, it is likely that your bank will insist that you have suitable bond cover to secure the loan. Your bank will also likely insist that you have building and contents insurance to protect property and existing structures from fire, flood and other natural disasters.
Interest rate: If you have financed your property with a home loan, fluctuations in interest rates can impact your bond repayments and, therefore, your bottom line. A rise in interest rates can affect your monthly cash flow.
Common possession: If you and a partner or friend intend to purchase an investment property jointly, be sure to have the appropriate legal agreements in place to protect your interests. Co-ownership comes with a unique set of challenges, so it’s essential to make sure your agreement clearly outlines who is responsible for what costs, when the properties will be sold, and a strategy if a partner wishes to opt out. arrangement.
Owner: To ensure that there is no confusion between you and the tenants as to what is the landlord’s obligations, be sure to specify your obligations in your tenancy agreement.
Maintenance: Property maintenance is generally ongoing although maintenance requirements may fluctuate from month to month. As such, it is wise to budget around 0.5-1.0% of the property value per year to keep the property in good condition.
Net rental income: As an investor, calculating the actual return on your investment will be important to you so that you can determine whether the investment is generating a profit or not.
Ongoing charges: It’s important to calculate the ongoing costs of owning a rental property, as you’ll want to make sure these costs don’t eat away at your profits. These costs could include water and electricity, Wifi, armed response, levies, gardening and cleaning services, etc.
Passive income: Once you have repaid your deposit, the net rental income you receive – less taxes, insurance and maintenance – will be classified as passive income and is taxable.
Rental agent: If you intend to outsource the management of your property to a rental real estate agent, be sure to factor these costs into your budget. Typically, rental real estate agents charge an upfront advertising and placement fee of around 8% of the lease value, as well as ongoing management fees of around 8% of the monthly rental amount.
Rental insurance: Landlords of rental properties can limit tenants’ vacancy risk by purchasing rental insurance, although this type of coverage is usually expensive. There are a few insurance companies that offer risk coverage covering three months’ rental, limited legal fees, and property damage.
Rates and taxes: The rates and taxes on your rental property will depend on the property’s municipal assessment which, in turn, is based on market value. Each municipality sets its own rates which depend on the use of the property and the geographical location, so be sure to ask your estate agent for these figures.
Saturated market: Rental property markets fluctuate and as a property investor you need to be prepared for times when the rental market is saturated. In a saturated market, you may find it difficult to raise your rent to keep up with annual inflation as this may drive out good tenants. Be sure to factor these eventualities and risks into your planning.
Tenants: The quality of your tenants can have a huge impact on your profits, so it’s important to consider them carefully. Disruptive, overly demanding or contentious tenants can make your job as a landlord unpleasant and costly, so put measures in place to ensure you consider them carefully.
Transaction costs: Buying and selling real estate is expensive, largely due to high transaction costs which include bond issuance and registration fees, transfer taxes and deed office fees. As such, it is important that you are prepared to take a long-term view of your investment.
Initial costs: Be sure to do the math when it comes to any upfront costs you might face, such as connection fees, alarm installations, renovations, carpeting, painting or landscaping, to to name a few.
Unforeseen costs: Budgeting for unexpected costs can be tricky, but it’s important to assume that you will face unexpected costs at some point. As a guide, consider keeping one month’s worth of rental in accessible savings to cover unforeseen costs such as insurance deductibles, costs not covered by insurance, thatch repairs, pool leaks and other expenses associated with running a home.
Vacancy risk: All investments carry varying degrees of risk, and real estate is no exception. The risk of tenant vacancy is real and must be taken into account in your planning. Most investment property owners assume half a month per year of occupancy for rental risk.