Rental property vs investing | Stacking one investment type up against the other

by Lana Visser

In this precarious investment climate it is always important to do the necessary research to determine the best strategy for you. Each person’s investment plan should be tailored to their circumstances and all aspects should be considered before investing. This is according to Lana Visser, financial planner at Fiscal Private Client Services. She looks at the pros and cons of a unit trust versus a rental property, and how both can impact your cash flow and tax return.

What to consider

  • Availability: Be thorough in your search for available properties, and once you’ve narrowed them down research the possible rental income that can be received. Benchmark this against alternative investment options such as unit trusts and other products, like Tax-Free Savings Investments or a share portfolio, etc.
  • Affordability: Know exactly what you can afford. If you don’t have a lump sum to purchase a property or to invest as a down payment, you should consider if it would be better to invest monthly or finance a property by applying for a bond.
  • Term of investment: Be clear about your goal, is this a short-term or long-term investment? If short term, a rental property may not be the best option. If longer term, then the option of a property should be compared to an investment. This possible return that can be achieved, will help you make the best decision. The investment term will then determine the level of risk that one can take and the potential growth that can be achieved.
  • Tax consequences: Different investments have different tax benefits and consequences. It is important to consult a tax advisor and understand all the tax implications before you invest your hard-earned money.
  • Liquidity: You should always consider if you will need access to your capital. Ideally, we would like to leave our investments to grow, but if there are plans to purchase a car, or renovate property, or pay school fees, then these plans should be factored into your investment decision.

Unit trust investment vs rental property

Based on the recent property reports, property value is currently growing at an average of around 4% per annum. This is the potential growth that you would receive from your rental property itself, excluding the rental income which you will receive. Note, however, that there are many factors that will influence the price of your property when sold, including location and the recent sale prices of other similar properties in the area. Alternatively, a long-term unit trust investment could achieve an annual return of 10% net of fees. This is provided that distributions are reinvested each year, which most investors do when building up their portfolio. Visser says, “You should always consider the potential growth on your investment and if it will beat inflation.”

Tax consequences

One of the advantages of a rental property is the monthly income which it provides. On the downside, adds Visser, “one should always remember that this income is taxable and if you are employed, this could put you in a higher tax bracket, which means owing more to the tax man. Note that tax is only paid on the net rental for the year, so one is able to deduct rental related expenses such as levies and rates, as well as the interest portion of your bond instalments, should you have one. If you do not have a rental agent, it is important to keep all documents as proof of these expenses. The tax on rental income is paid when submitting your tax return every year and this could cause cash flow issues if provision has not been made for this expense.”

Tax is payable on the interest portion of the distributions received from a unit trust investment. The local dividend portion paid out is an after-tax amount, which means that no tax payment is required in the investor’s hands. Visser explains, “Each individual is entitled to an annual interest exemption, which will help reduce the actual taxable interest. In addition to tax payable each year, Capital Gains Tax is payable on the “profit” made on your investment when sold. It is likely that the capital gains on the unit trust would be higher than a property and this estimate will need to be factored in when making your decision.”

The costs

Another thing to consider is the costs. For a unit trust, the applicable costs would be the Investment Management fees charged for the funds you are invested in, any platform administration fees applicable as well as the financial advisor’s fee, should you have one. When purchasing a property, there are initial costs payable, such as conveyancing attorney fees, transfer costs and bond costs, where applicable. Property maintenance costs should be considered, and it is safe to assume that a certain percentage of the rental income will need to be spent on the upkeep of your property, and more so if it happens to be an older building.

Real estate investing: factors to consider

  • What happens if you don’t have a tenant? The expenses don’t fall away if rent is no longer received. It is a mistake to assume you will have a 100% occupancy.
  • What if you have difficult tenants? Is the trouble worth the income? This could also lead to legal fees, if necessary.
  • There could be damages to your property. Even when insured, if you cannot have a tenant in your property while it is being repaired, you lose rental income.
  • Should you need access to your capital, consider a depressed market where you could struggle to sell your property. As opposed to a unit trust investment, you cannot sell a portion of it, if you only require access to some of your money.

Stock market investing: factors to consider

  • Markets could crash, resulting in losses on your investments.
  • Fund choice may be poor, which could result in lower than expected returns.
  • What other investments do you have and what are the tax consequences of it. Is your entire portfolio properly diversified and invested in a tax efficient way?

Your investment strategy should be as unique as you are

Every investment strategy has its advantages and disadvantages and determining which one is suitable, is dependent on each individual’s needs. Visser concludes, “It is always important to consider both sides of every coin before investing and make sure that you see the full picture in order to help you make the very best decision suited to your needs. It is also important to always consult the right people who can guide you. It is key to speak to a financial planner before you intend to invest.”

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