What one needs to know about real estate investment

It seems as if COVID 19 in South Africa has brought about a surge in real estate investment. This is specifically relevant in certain areas and property types and can be a great opportunity for potential investors. There are ways and means of making it happen...

In order to invest in real estate one has to be especially cognisant of certain basic considerations when evaluating a particular opportunity. Here are some initial thoughts that should assist:

• how much of your own capital (equity) do you wish to invest;
• the possibility of future capital growth in the area in which you wish to invest;
• the potential income stream that your investment can produce;
• the effect of inflation;
• the possible liquidity of your investment, i.e. how easily your investment can be converted to money;
• the possibility to leverage your capital;
• the utilisation of tax benefits;
• after-tax yield on capital invested;
• possible sources of borrowed capital;
• the best percentage to borrow in tandem with own equity investment;
• current interest rates, both nominal and effective;
• the best term for borrowing;  
• utilising the rental income to amortise your loan;
• the monthly instalment to be paid in order to repay capital and interest;
• all additional costs in the purchasing and borrowing process;

Before investing and or borrowing it is also of extreme importance to understand why real estate has value and can therefore contribute to your investment portfolio:

Real Estate has VALUE...But value is not inherent...what is inherent in property is its utility, productivity and by being an economic product:

• Utility: the potential to provide services that satisfy human needs and is the benefit which is derived from possessing a property and can be realized in 3 ways:

Ownership for own use (occupation), for cash flow (rental) and for capital growth (increase in value). The utility of a property is a function of the land as well as the improvements (physical size and form, topography, soil, services) as well as location (convenience, exposure) and its institutional attributes in terms of legal usage:

• Productivity: only if advantages outweigh disadvantages for a particular investor.

Advantages include the possibility of the provision of operating income (rental), financing (leveraging), income tax (special deductions) and capital growth.

Disadvantages that also need to be considered include operating expenses, interest on borrowed capital (mortgages) and applicable taxation.

• Economic product: means that it is not available in unlimited quantities. Scarcity and productivity imply an economic product and property is an economic product because it is productive, it is often scarce in relation to demand (demand and supply).

Value is thus definitely not inherent to a property ... it is ascribed to it by individuals and their specific needs.

Now the following can be assumed: PROPERTY possesses UTILITY in order to be PRODUCTIVE as an ECONOMIC PRODUCT and therefore has VALUE for which an investor can pay a PRICE.

The price that an investor can pay (market value) is the most economic present use of the property's future net productivity or income stream.

An investor in real estate is advised to follow a sound investment process, e.g.

1. Analyse your needs, objectives and resources

2. Determine terms of current mortgage loans or other sources of finance

3. View the selected property by doing a physical inspection

4. Determine the property's productivity

5. Consider the possibility of leveraging. (A method to increase the yield on equity. Money is borrowed at a lower rate of interest than can be earned from a project by using only own money.

5. Calculate the investment value by capitalising the first year's net normalised income

6. If a long term investment is envisaged, calculate the Net Present Value  by discounting the future net income stream over a period of time and future reversion (selling price)

7. Research the current market conditions in the particular area where the property is situated and evaluate factors that could influence value in future like economic, social and political factors

8. Make an informed decision

It is clear from the above that investing in real estate requires much research and specific knowledge. This is only the beginning!

If we can be of any assistance please contact Dawie Snyman on 084 5811622 or Pam Snyman on 082 8000867 of REDZetc Real Estate, Real Experts, who will gladly assist.