South African listed property has been the best performing asset class over the last 25 years, giving investors a return of almost 14% on average each year. But in 2018, the asset class fell over 25% amid allegations of market manipulation at the Resilient group of property companies, some company-specific governance issues at other property firms and general economic woes. While there has been some recovery in the year to date, investor concerns remain.
On the bricks-and-mortar side, things have also not been promising. Many investors who bought property in recent years have found that capital growth has not kept pace with inflation. According to FNB’s Property Barometer, house prices only grew 3.8% year on year during the first quarter of 2019, and this is before inflation is taken into account.
Property investors have also had to come to terms with much more muted adjustments to rentals. According to PayProp’s Rental Index, the average monthly rental growth rate in 2018 was a mere 3.9% year-on-year, compared to 6.4% in the prior year.
Where does this leave investors?This may have led investors to wonder if they should turn their backs on property as an investment. Here are some things to keep in mind.
Markets go through cycles
While no-one wants to be invested in a poorly performing asset class, there is no way to know what types of assets will do well in any given year in advance. Markets go up and down and selling a listed property investment when the market is down is not a good long-term strategy. You may be prone to selling your investment cheaply and buying something that has done well and that is expensive.
In a letter to clients, Paul Stewart, CEO of Bridge Fund Managers, says currently, South African equities (shares) and listed property offer the best opportunity of outperforming inflation in the long run.
And while listed property has disappointed, average yields have improved significantly.
Director of Investments at Sanlam Private Wealth Alwyn van der Merwe says while the entire property landscape is under pressure, they are selectively adding listed property shares to their portfolios again.
With the economy still under pressure, it is unlikely that the physical property market will experience meaningful growth in the near term and investors should think carefully about the percentage of their portfolio they expose to the sector. That being said, discussions about physical property investments are often quite emotional. While some investors have made good money from them, others have burnt their fingers, leading to quite a polarised view on the topic.
So what should you keep in mind?
Make sure that your exposure to listed property or physical property is in line with your investment goals and time horizon and that you don’t put all your money into a single investment or asset class. It would arguably be prudent for most investors not to exceed a 10% to 15% allocation to the listed property asset class, depending on personal circumstances.
The same is true for physical property. While there are property investors who have successfully bought various properties in the same apartment block and rented them out, keep in mind that if something goes wrong, you could have several of the same properties and no rental income.
Forced saving when you buy your own home
While the house you live in (your primary residence) will increase in value over time, most analysts would probably not consider it an investment in the strict sense as it generally doesn’t produce an income while you live in it.
But this argument may miss an important point. Buying a house can be a great way to accumulate wealth over time as it is a forced form of saving. While you can stop a monthly debit order towards an exchange-traded fund or unit trust at any time, missing a few mortgage payments will leave you out on the street. With a primary residence the trick is arguably to buy something 20% to 40% less than what you can “afford” and to pay the house in as short a period as possible.
Most people won’t pay any capital gains tax when they sell their primary residence as the first R2 million capital gain is excluded for tax purposes.
Since the primary residence does not produce a taxable income, expenses incurred with regards to the property may not be deducted for tax purposes. With buy-to-let properties that produce an income for the owner, most of the expenses incurred to generate the income may be deducted for tax purposes, including the interest on the bond.
The land question
Uncertainty about land expropriation without compensation has weighed on the broader property market, but despite concerns, there has been no indication that residential property rights are under threat.
The bottom lineProperty investments – whether listed or physical – have disappointed, but rather than reacting emotionally and selling out of the asset class, investors should keep the long-term in mind, and take the time to determine an appropriate level of exposure.