Buying vs renting your first property: What’s best?

BOITUMELO NTSOKO: Welcome to the Money Rules Podcast. I am Boitumelo Ntsoko. The merits of investing in property are well known. The youth are often advised to purchase a home before even buying a car. But is rushing into this asset class a better idea than directing those funds towards other investments?

If you are considering whether to buy or to rent, then stay tuned. Franske Neiteler, who is a chartered financial analyst at PSG Wealth Pretoria-East, joins us on this episode to help us weigh the pros and cons of both investing in property and renting, as well as looking at where your funds can best be directed if you choose to go the renting route. Welcome, Franske.

FRANSKE NEITELER: Good day, Tumi. Thanks for the opportunity and welcome to everybody listening.

BOITUMELO NTSOKO: Could you please give us a quick rundown of what the pros and cons of renting are?

FRANSKE NEITELER: One of the most important questions to ask yourself before deciding to buy or rent is what your long-term plan in terms of housing requirements is. Are you starting off with a new employer or have you found your dream job, and you want to nestle in?

If you’re not one hundred percent sure of your long-term plans, renting can be a more suitable choice. It will afford you the freedom to move without incurring large fixed costs or expenses should the need arise. When renting, you have the added advantage of not being liable for the maintenance of the property. This can help with budgeting and save time by not being burdened with costly repairs. Money saved by renting could be allocated to a long-term savings vehicle to complement your savings pool.

In many cases, renting will be a smaller monthly expense than the monthly expenses incurred when buying a property. These typically include expenses such as interest on your home loan, municipal rates, building insurance and levies.

In the case that the excess monthly cash flows can be saved in an alternative investment vehicle, it will add diversification to your overall investment portfolio. Ideally these costs should be compared when you want to determine the advantage you might gain by renting rather than buying.

Some of the downsides to renting include a rental inflation on an annual basis, as well as not having the privilege to customise a property to suit you or your family’s individual needs.

BOITUMELO NTSOKO: And what would be the advantages and disadvantages of buying a home?

FRANSKE NEITELER: Basically, Tumi, if you have indeed determined that you want to buy a home, it’s again very important, as with all investment decisions, to first determine what your long-term plan would be.

Do you want to buy this property to occupy for the long term, or do you plan to move after a few years? Is the property going to be suitable for your family needs over the long term, or are you keen to manage a rental after you have moved on? Some major advantages include the ability to modify or build your home according to your specific needs, as well as fixed bond payments over the term bearing unchanged interest rates.

When buying a home you also acquire an asset which could appreciate in value over time. This will however be dependent on your purchase price and general property trends in your area of interest. When looking back at the FNB House Price Index for South Africa over the last five years, one has barely seen a 4% annualised growth rate. This is in comparison with inflation rates closer to 5% per annum.

An added advantage for small business owners or entrepreneurs is the access to capital down the line once the property value has increased and the original mortgage has been paid in full – or in part. By re-advancing your mortgage, you can gain access to cheap capital, which could help to expand the small business at an opportune time.

There are however some downsides. Concentration risk is one of the larger risks you face. When buying a property, a portion of your mortgage will be allocated to capital. In essence, a portion of your monthly savings will be allocated to paying off your mortgage. Owning a single asset with a large value holds concentration risk. There’s always the off-chance that you buy in a deteriorating neighbourhood, or general property value trends do not work in your favour. In this case, it’s always important to remember that diversification by acquiring other asset classes as part of your long-term savings plan is crucial.

Some other downside risks include unforeseen maintenance costs and large fixed costs when acquiring a property.

BOITUMELO NTSOKO: Franske, you just touched on the costs. So when deciding between these options, what are those cost considerations you should factor in?

FRANSKE NEITELER: Yes, there are several costs to consider when renting. One must consider your deposit, as well as contract admin fees charged by the estate agent. Other than that, you must determine how your electricity will be charged, and who is liable for the water account. Typically in some instances, the owner pays the water account included in the levies already paid, while in others the tenant is liable.

When choosing to buy, one has to be aware of the large fixed costs while acquiring the property. These typically include your deposit, bond registration costs, transfer costs, transfer duty, as well as agent’s commission when you decide to sell the property. Buying a property also has running costs that need to be taken into account. Property rates and taxes, building insurance, and levies when the property is in a complex, are examples of some.

BOITUMELO NTSOKO: Besides costs, what are other factors you need to take into account?

FRANSKE NEITELER: There are several others. Of these, I think the most important one is the price paid for the specific property. You should not just assume that the listing price is a market-relevant price; some market research is definitely warranted.

So basically, to determine a fair price and a good starting point, request a property valuation report from your selling agent or any transfer attorney. This will allow you to compare your price to pay versus recent sales in the same area or complex.

These reports usually also show selling price trends for historic sales comparisons. A good measure is to compare the price per square metre, taking into account the condition of the comparable properties, as well as the land size and outbuildings.

BOITUMELO NTSOKO: If you decide to buy, how much do you budget for a deposit, as well as the associated cost of purchasing a property?

FRANSKE NEITELER: When purchasing a property your fixed costs will form a large part of your expenses, and these play a major role in the decision-making.

Ideally, when you decide to buy, you should aim to keep the property for a long period, to avoid incurring the large fixed costs and having to sell again within a few years. Bond registration costs, transfer costs, and transfer duty could easily amount to 8-10% of the purchase value of the property in question.

Depending on your loan profile, banks could grant you a larger than 100% home loan, which could cover many of these costs. Alternatively, you will have to save beforehand to ensure that you have sufficient liquid funds for these costs.

A deposit is not always required, but the bank will weigh up your credibility and will give you an offer accordingly.

A good suggestion is to get pre-approval from the bank, which will help to indicate your affordability and how much in additional funds you will require for the additional costs involved.

Your affordability is calculated by considering your personal or total household income, as well as other existing debt obligations.

One also has to be wary of agent’s commission when selling the property. These costs could easily range between 5% and 8% of the property value. When taking into account your acquiring costs, the fixed costs, as mentioned earlier, as well as [other] costs, could be as much as 18% of the property value.

[So] be sure that when you buy you have a long-term plan in place. It could take many years of capital growth to cover these expenses and even reach break-even on the property considered.

BOITUMELO NTSOKO: Franske, where would you recommend someone save for these costs? In what kind of vehicle?

FRANSKE NEITELER: If you have determined that you want to buy, and from your affordability screening with a bank determine that you need to make provision for these costs, it would be sensible to save in some kind of savings account or a unit trust, typically unit trusts classified under the Asisa [Association for Savings and Investment SA] interest-bearing or income sector. You would ideally want to invest it in a vehicle which is quite liquid, so you can withdraw the funds and use them at short notice, and also with little to no capital volatility.

BOITUMELO NTSOKO: Would it be better for someone to defer purchasing a property and focus more on building up their investments?

FRANSKE NEITELER: Yes, Tumi, that’s a very important question and I think it’s asked by a lot of investors, young and old alike. It’s always difficult to get an exact comparison. I think many comparisons have been done between buying a property and renting and saving in a suitable investment vehicle; the conventional wisdom of not paying someone else’s bond does not always hold if you have the discipline to save your excess cash flow or lump sum while renting.

In the end, doing a calculation to determine a winner between these two options involves a whole lot of assumptions of which two are most important.

Basically, the capital-growth assumptions on the property as well as the investment will greatly influence the outcome of these kinds of calculations. Yet it is important to determine where your resource or advice or expertise lies, and decide accordingly.

If you decide to rent and save, it is important to have the discipline to stick to the savings plan whereas, if you have bought the home, you will be forced [to stick to paying] your monthly premium on your home loan.

As mentioned earlier, renting and saving will offer the added benefit of diversification in comparison to a property which will in the end be a large concentrated asset in your savings pool.

Also, investments you make earlier in your life will most likely contribute the largest portion of your total lifetime savings, due to the longer timeframe leaving considerable room for compounding [in] these early-life investments.

If you decide to buy, make sure you have a long-term plan so you don’t end up having to sell the property over a short period of time. It’s also important to ensure that you get as much advice as possible to ensure that you pick the correct property or investment vehicle to allow for maximum capital growth over your investment term.

BOITUMELO NTSOKO: For those who decide to go this route, where would be a good place for a novice to start investing?

FRANSKE NEITELER: Typically, if you would save the excess money saved by going the rental route, you would look for a suitable asset class which will give you maximum capital growth over the long term, and then one would typically look no further than the equity market. Historically equities have outperformed inflation over most periods.

Depending on your need to either contribute monthly or via a lump sum, you can consider something like a suitable high-equity unit trust, or even an equity portfolio.

It’s just always important to remember to get proven advice to ensure that you pick the correct vehicle to suit your specific needs.

BOITUMELO NTSOKO: Thank you so much, Franske. That was Franske Neiteler, who is a chartered financial analyst at PSG Wealth Pretoria-East.