Property Funds: A Smart Investment Guide For South Africans

Investing in property funds in South Africa is a great way to enter the real estate market without the rigours of managing tenants. Property funds expose you to a diversity of assets, including residential, industrial, and retail properties. By investing in a fund, you can have stocks in different property types such as shopping malls, office blocks, and townhouses.

South Africa has several real estate funds that have dominated the unit trust space over the last ten years. Some of the country's top-performing property funds are the Absa Property Equity Fund, the Stanlib Property Income Fund, and the Prudential Enhanced SA Property Tracker Fund.

Before investing in property funds, it is important to do your research and understand the different types of investments available. It is also crucial to set clear financial goals, create a budget, and determine your risk tolerance.

Buy-to-let

Market Research

Before investing, it's crucial to understand the state of the market. South Africa's property market is currently experiencing a surge in demand, especially in the Western Cape, due to factors like the semigration of buyers to Cape Town and a growing middle class. Researching market trends and choosing promising areas with high tenant demand is essential.

Financing

Financing options are a key consideration. Investing in buy-to-let properties typically involves taking out a home loan or mortgage. It's important to compare different lending options and secure the best deal. Lenders will assess your creditworthiness and may require a deposit, which is typically around 10% of the property's purchase price.

Rental Income and Yield

Understanding the potential rental income is vital. Calculate the expected rental yield by dividing the annual rent by the property's value. Compare this with yields from other rental properties in the same area to ensure you're getting a fair deal. The rental income should ideally cover your mortgage repayments and provide a steady cash flow.

Property Type and Location

The type and location of the property are critical factors. In South Africa, one-bedroom and studio apartments have historically offered better returns than larger apartments. Focus on areas with strong resale value and consider up-and-coming neighbourhoods to maximise long-term gains.

Managing Tenants

Finding and screening the right tenants is essential to avoid issues like unreliable rent payments or property damage. Consider hiring an estate agent to manage tenant screening, rental agreements, and ongoing property management. This can save you time and reduce the risk of problematic tenants.

Legal and Financial Considerations

Be aware of the legal requirements and financial implications. Familiarise yourself with the Rental Housing Act and other relevant regulations. Understand the tax benefits of property investment in South Africa, such as tax deductions on interest, maintenance, levies, and insurance.

Long-Term Perspective

By following these steps and conducting thorough research, you can make informed decisions about investing in buy-to-let properties in South Africa.

Tax benefits

South Africa offers several tax benefits for property investors, which can significantly impact your overall investment returns. Here are the key tax advantages to consider:

No VAT on Property

There is no value-added tax (VAT) payable on property purchases in South Africa. This is a significant advantage as it reduces the overall cost of acquiring a property.

Capital Gains Tax Advantages

Capital gains refer to the profit made from selling an asset, such as property, for a higher price than the purchase price. In South Africa, capital gains are generally taxed at a lower effective rate than income tax or dividend tax. The maximum effective capital gains tax rate for individuals is 18%.

When investing in property, you benefit from a lower taxable capital gain compared to other investments. For example, if you invest R100,000 in the stock market and grow it to R1.5 million, your taxable capital gain would be R1.4 million. However, if you invest the same amount in a property worth R1 million with a 10% deposit, and the property value increases to R1.5 million, your capital gain for tax purposes would only be R500,000.

Additionally, the South African Revenue Service (SARS) allows investors to capitalise on various transaction costs, such as transfer fees, renovation expenses, and marketing costs. These costs are added to the purchase price to calculate a higher base cost when determining capital gains tax liability.

Income Tax Advantages

Property investment in South Africa is considered a business by SARS. This means that all costs incurred to produce revenue, such as interest expenses on financing, municipal rates, taxes, professional services, and marketing costs, can be deducted from your taxable income.

For example, if you purchase a R1 million investment property with a loan, your taxable income can be significantly reduced due to the interest expense on the loan. This is known as a 'tax shield' and provides a substantial tax advantage, especially in the early years of the loan when interest expenses are typically the largest.

Tax Breaks on Property Development

The South African government provides tax breaks of up to 20% for real estate developers. This incentive is designed to stimulate the economy and encourage the development of new properties.

Tax Incentives for Urban Development Zones (UDZs)

SARS has created tax incentives for investments in specific urban development zones, typically targeting dilapidated inner-city areas. These incentives often take the form of tax breaks for investing in new or renovated buildings within these designated zones. However, there are specific requirements and conditions that must be met to qualify for these incentives.

No Inheritance Tax on Property

Another advantage of investing in South African property is the absence of inheritance tax. This means that if you pass on your property to your heirs, they will not be burdened with additional tax liabilities.

Location

When it comes to investing in property, location is a key consideration. The famous saying, "location, location, location" still rings true, but other factors such as municipal logistics and future development plans also play a critical role in the decision-making process.

In South Africa, the Western Cape province, particularly Cape Town, has consistently outperformed other regions in terms of property investment. The housing market in this region has demonstrated strong performance, with house price inflation rising by over 10.35%. This makes Cape Town an attractive destination for investors seeking lucrative opportunities.

Within Cape Town, there are several areas worth considering. The Southern suburbs and Northern suburbs offer a blend of quiet living and affordable properties. Additionally, towns along the Garden Route, such as Plettenberg Bay, have experienced significant influxes, making them prime investment targets.

However, it's important to keep in mind that over-supplied areas with mass development could require you to lower your rental prices to remain competitive. Therefore, it's crucial to research property sale and rental trends before making any investment decisions.

Another factor to consider is the demand for affordable housing. With a shortage of affordable housing in South Africa, suburbs that offer a combination of affordability and convenience become sound investment choices. Areas in Johannesburg, such as Ferndale, Northwold, Winchester Hills, and Witpoortjie, fall into this category, providing comfortable living and easy access to necessary facilities.

Lastly, the impact of the COVID-19 pandemic has influenced property trends, with more people seeking remote locations and larger houses to accommodate the work-from-home lifestyle. This has resulted in a semi-migration to coastal areas, not just by retirees but also by young families and professionals. Thus, coastal towns near Cape Town and the Eastern Cape, such as Ballito, are worth considering for their quiet coastal living and proximity to urban centres.

Residential vs commercial property

The South African property market is growing, with a notable demand for residential property. However, the question of whether to invest in residential or commercial property is a complex one. Both types of property have their advantages and disadvantages, but here is a breakdown of the key differences to help you decide.

Lease Agreements

Residential lease agreements tend to be shorter, and it is generally easier to find residential tenants due to the consistent demand for housing. Even if tenants vacate, it is unlikely that a residential property will be empty for long. In contrast, it is harder to find new commercial tenants, and the building could remain vacant for extended periods.

Costs

Commercial properties incur higher tax and maintenance costs due to their larger size. However, commercial properties may suffer less wear and tear as they are typically only used during business hours. With a residential property, you may need to consider whether the money you put into the property is worth what you are earning from it. While commercial properties may have higher upfront costs, you will likely earn more from commercial tenants than from residential tenants.

Professional Relationships

Commercial relationships tend to be more business-like and courteous. Most businesses operate during standard 9-5 hours, so you are unlikely to receive night-time calls unless there is an emergency.

Eviction

In South Africa, commercial and residential evictions are governed by different legislation and rules. Commercial evictions are handled by the High Court or Magistrates Court, whereas residential evictions fall under the jurisdiction of the Land Claims Court, Magistrates Court, or High Court.

Purpose and Zoning

The purpose of a commercial property is to generate profit, while residential property is intended to accommodate people. A property with four or more units is considered commercial, and a "mixed-use building" is used for both residential and commercial purposes. If you plan to use a residential property for commercial purposes, you must check the zoning regulations and be prepared for a tax increase.

Income Potential

Commercial properties can offer greater financial rewards in the long run. The income potential of commercial properties often depends on the image of the property, which means that maintenance may not be an issue. Additionally, commercial properties have value in both the land and structure, providing earning potential regardless of the tenants.

Property funds

Advantages of Property Funds

Top-Performing Property Funds in South Africa

• Absa Property Equity Fund
• Stanlib Property Income Fund
• Prudential Enhanced SA Property Tracker Fund
• Catalyst SA Property Equity Prescient Fund
• Investment Solutions Property Equity Fund

Tips for Investing in Property Funds

When considering investing in property funds, it is important to do your research and understand the different types of funds available. Compare the fees, investment strategies, and historical performance of each fund before making a decision. Additionally, keep in mind the following:

• Diversify your portfolio: Invest in a variety of assets and property types to spread your risk.
• Understand the risks: Be aware of common risks associated with property investing, such as interest rate risk, vacancy risk, and volatility risk.
• Seek professional advice: Consult financial advisors and investment experts to ensure you make well-informed decisions.

Frequently asked questions