Real Estate Investor Magazine South Africa March 2013 | Page 36

STRATEGIES

BY JOHN ROBERTS

What Is The Return?
I

On your investment

nvestments have little meaning without a
return. Property is no different, whether
that property is the primary residence or one
of the pillars supporting the portfolio.
By def inition, the return on investment
(ROI) is a performance measure evaluating the
efficiency of an investment or comparing the
efficiency of a number of different investments.
In calculating ROI, the benefit or return is
divided by the investment cost with the result
expressed as a percentage or ratio.
The versatility and simplicity of this equation
means ROI is a popular metric - when the
investment has a negative ROI or there are
other opportunities with higher ROIs, the
investment should not be undertaken.
In short, investing R500000 into an account
that pays 7,2% interest annually (R36000),
means the ROI is 7,2%. Similarly, purchasing
a R500000 house and renting it out for R3000
per month, thus R36000 per year, translates
into an ROI of 7,2%.
Applying ROI to property can become more
complex when the investment is refinanced or a
second bond taken out. The interest rate on the
second or refinanced loan may increase and new
fees charged, both of which will reduce the ROI
when applied to the equation.
The property may also require additional
maintenance costs and taxes and an increase in
utility rates if these costs are borne by the owner
of the residential rental or commercial property.
However, these are not insurmountable
issues given a small amount of mathematical
application.
Again taking that R500000 property example,
let us assume it was a financed purchase rather
than a cash one. In that case, the buyer only
covered the costs associated with that purchase,
namely the bond, registration and transfer fees
and other sundry costs, amounting to R13600.
The bond repayments would be R5000 monthly
or R60000 in the first year.
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March 2013 SA Real Estate Investor

Coupled with the initial cost of R13600, the
investor has sunk R73600 in the first year. If
the monthly rental income was R3000, the
R36000 annual rental would be offset against
the cash flow.
The ROI would show 50% in the first year in
this simplistic calculation. Not factored into the
equation are the rates and taxes, maintenance
costs, body corporate levies if applicable, future
capital gains due on the property and the tax
incurred against the income.
However, what this equation does illustrate is
that ROI on property can be quite high when
coupled with gearing or leveraged finance.
Essentially, it means growing the investment
and maximising the ROI by playing with other
people’s money - in this case, the bank’s capital
- rather than your own.
However, a common mistake is confusing
ROI with cash flow. In this example, the cash
f low is the difference monthly or annually
between the income generated by the rentals
and the required expenditure that must come
from your pocket. The R5000 bond repayment
against the R3000 rental means the investor is
liable for another R2000 each month to cover
the investment.
That is also an opportunity cost investors must
factor into their decision-making process when
purchasing the property, as it raises the question
on whether that R24000 annual cost could be
better spent on another investment.
However, it does mean that while the ROI
on the property is 50% against the 7,2% gained

by leaving the capital in the bank, that ROI is
not immediately obvious in terms of growth in
the bank account. It will only come to fruition
many years down the line, underpinning the
reality that property is a long-term investment
commitment.
It is an element of which investors must not
lose sight when calculating that opportunity
cost.
Property is not something for which investors
enter and exit the market swiftly to make a
quick buck. The associated costs alone prohibit
that approach.
Where the ROI on property comes into its
own is as a retirement income. Purchasing those
properties early enough that they have evolved
into income-generating investments, rather
than ones eating into cash flow, paves the way
for a solid monthly rental income.
There still remains the reality that those rental
properties have an underlying appreciating
capital asset that, despite the associated costs
including capital gains tax, will offer a bulk cash
injection on liquidation.
South Africa has a key housing shortage
relative to its population and as the middleclass grows exponentially, the demand for
housing comes under increasing pressure. The
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