A City Press reader is a member of an investment club that would like to start buying into property. The club has accumulated about R200 000 and would like to invest in property. The club currently banks with both Absa and FNB and wants to know the best way to invest in property and how to obtain funding.
Lee Mhlongo, CEO of housing finance at FNB says that the investment club needs to consider the type of property investment they want. The club could consider either buying into a JSE-listed property fund or buying directly into a property.
“If the need is a passive incremental investment, then investing in a listed property fund, targeting the market segment(s) of interest, would be a possible consideration,” says Mhlongo, who explains that, while this means the club would not own one specific property, it would give them immediate diversification of location and property segment. It would also allow them the option of allowing a gradual build-up of property interests over time. “This would be passive investment with minimal ongoing management requirements and is generally a very liquid structure as you can sell shares anytime.”
Alternatively, the club could invest directly into property by establishing a property holding entity. “This property holding entity would then raise funding by leveraging the R200 000 on hand. The funding would then be used to acquire property as a working asset. This asset could be used as a rental property”.
The downside is that the club’s investment risk is concentrated to a single asset, single location and single income source. It also requires active management, including rental collection, utility and rates payments, and property maintenance.
“It is also difficult to trade out of because, in order to realise capital, the property would have to be sold together with associated costs,” adds Mhlongo.
If the club decides to invest in physical property, Nondumiso Ncapai, head of customer strategy and engagement at Absa, recommends that the club consult an attorney or tax consultant for the ideal structure to suit their needs and objectives. It is worth paying for professional advice before you enter into a long-term financial commitment such as property.
As a basic starting point, the club should have a memorandum of association that outlines its objectives and the intended investment property types, as well as member’s contributions.
At this stage the investment club needs to decide if it wants to be in the form of a legal entity or partnership. The funding mechanisms will be treated differently, depending on the legal entity chosen.
Ncapai says that, if the club uses a partnership approach and purchases the property as a joint home loan, each applicant of the loan is joint and severally liable. This means each loan applicant is responsible for the entire loan, and not only a portion of it. So, if one club member fails to meet their obligation, it will fall to the other members to meet those payments. All applicants will need to ensure that monthly payments are kept up to date, including all other contractual requirements, such as having a valid home owners’ insurance. They may also be required to take out life insurance to cover their portion of the joint bond.
Mhlongo says that if the club uses a legal entity, this must be a recognised borrowing entity should the investment club wish to borrow money, using the R200 000 as leverage. “Most lenders will recognise trusts, closed corporations and Pty Ltd, however, lenders may adopt different, perhaps more stringent, loan underwriting principles when compared to the usual individual loans.”
Even if purchased in a legal entity, the trustees or shareholders of the entity may still need to stand surety for the home loan and, as with any loan, the bank will consider the individual risk profiles and collective affordability from all parties to the application, irrespective of whether the application is in the name of a legal entity or joint application.
“As a bank, Absa offers preferential rates to its customers; this is, however, dependent on the customer’s individual risk profile and credit record. To arrive at the individual rate, the bank is required to perform an affordability assessment before granting credit as required by the National Credit Act.
“We will look at a number of factors when assessing the application for a home loan in their individual/joint capacity,” says Ncapai.
TIPS ON GETTING FUNDING
. DEPOSIT: An additional deposit is always recommended to reduce the loan amount, and to possibly obtain a better home loan rate. A lower home loan amount also helps to reduce the monthly loan payment, assisting in achieving a positive cash flow sooner for the investment club.
. AFFORDABILITY: Buy within your means and always be realistic, open and honest. Not being able to afford the instalment of your loan has much worse consequences than the fleeting awkwardness of being declined upfront. If your income levels fluctuate, be realistic of what you can afford, especially in those months when your higher income does not materialise.
. EXPERT ADVICE: Use the available tools and seek expert advice. There are tools available on your banking website and you can obtain expert advice from an industry specialist such as a home loans consultant, private banker or mortgage origination consultant.
. RESEARCH: Before you start the home loan application process, you may want to check that you have all your paperwork ready. Find out everything:
– What your monthly repayments will be
– How much you can save with a lump sum
– The detailed costs of a new home loan, including registration charges, transfer costs and attorney fees
. STRESS TEST: Do your affordability calculation at a higher interest rate than you expect to pay – in other words, stress-test your affordability. Using a home loan calculator, type in interest rates 1%, 2% or 3% higher than those you have been offered on your home loan.
This will give you some comfort that, even at increased interest rate levels, you are still able to make your home loan payments.
Consider the impact of an interest rate hike on your monthly instalment. If you are not comfortable to expose yourself to fluctuating interest rates, a fixed-rate option could be your solution.
Selecting the right property
According to Nondumiso Ncapai, head of customer strategy and engagement at Absa, when buying an investment property, whether by yourself or with a club, always start with a manageable property. Consider the following factors:
PROPERTY TYPE: Investigate which property type is best suited to your investment objective. Sectional title properties are in estates or complexes that are usually managed by a managing agent, which takes away the management hassle of looking after the outside of the apartment. This usually comes at a cost of a monthly levy.
VACANCY FUND: Try to ensure that you have a “vacancy fund” that would be able to support the bond repayment requirement should the property be vacant for periods when there is a change in tenants.
LOCATION: Research the suburb and area that you are looking at and ask property specialists for the growth trend of the area over the last couple of years. When considering different areas for where to purchase your home, consider the house price growth in the area.
Most estate agents will be able to provide you with a report of recent sales in the area. These reports are pulled off deeds office data.
Ideally you want to purchase in an area that has enjoyed house price growth in the past, and is expected to do so in the years to come. House price growth can never be guaranteed, but should definitely form part of your location criteria. Ask your agent or local businesses, or research the internet for future developments in the area, such as new transport links being built, a highway extension, a shopping centre being built.
RENTABLE: Invest in areas where there is an active rental market, where the expected rent for the type of property you’re purchasing can absorb the costs associated with the property: loan payments, levies, rates and taxes, and so on.