The case for buying real estate
As a kid, I read rich dad poor dad (affiliate) written by Robert Kiyosaki. It was a good read, but the whole book (and probably a lot of the subsequent books as well) can be summarized in one concept. You need to spend the extra money you have every month, on investments that constantly bring in additional money. It’s a simple concept, and it snowballs once you get the process going because of the effect of compound interest. One of the very first ways I identified to achieve this is with the help of real estate. It took me a year and two months to save the deposit for my first property. When I bought the property, it was literally my entire net worth, which looking back was idiotic.
Real estate just made sense. It was an investment 23-year-old me could understand. I imagined a future where I had 20 paid off investment properties that were rented out and I simply lived off the rental income. I ran the math and it looked legit. The profit from the first property would pay off the second until everything was paid off, at which point I’d retire and travel the world.
The mathematics of owning real estate
Let’s look at the mathematics of owning real estate. If you bought a rental property at a cost of R800 000. You’d be able to buy a two-bedroom, two-bathroom place and depending on the location, it might even have a small garden. Rental for a property like this should run for about R7 200 a month (I made a lot of assumptions just like everyone else running the numbers).
By the end of the 20-year repayment period, you’d have real-estate worth about R3 million. In comparison, if you were to invest in shares, your investments would be worth about R2.4 million with the same input capital. This is 20% less than what you would have retired with had you invested in real estate. The comparative growth can be seen below. The REIT line starts out higher since you can invest your transfer and lawyer fees you would have paid buying real estate.
So far, so good. Let us now assume that you are retiring with property to the value of R20 million. Had you invested in shares you would have saved up about R16 million, 20% less than when investing in physical property.
Living off your properties
The property yield is about 10% (yearly income) with the property value growth about 7% per year. Typically, about 2% of the yield goes towards levies, rates and taxes and another 0.5% towards maintenance. That leaves you with an income of R1.5 million (the remaining 7.5%). However, you’ll be paying the worst tax you can be paying, income tax. You will only see about R980 000 of that money and the president considers buying another private jet (the other planes are lonely).
Let’s assume you drew your money from your share portfolio, while still requiring 7% growth. You will receive 1.5% from dividends (the typical yield of the Top 40 or International Exchange Traded Fund (ETF)). On the dividends, you will pay 20% withholding tax. In addition, you will need to sell 5.3% of your portfolio. On this, you will pay capital gains tax. The tax on the dividends and capital gains will be R103 200, leaving you an income of R984 800…