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| Not my apartment |
I was a little ashamed to admit that I didn't.
It's actually quite bad - I mean maybe the investment was doing really badly and I wouldn't even know it!
Poor form!
So why had I never bothered to put something together to see if my Buy To Let property investment was actually generating acceptable returns?
Don't get me wrong, I had been meaning to draw up something, I guess I was just procrastinating a little because I knew this was going to be quite a beast involving many moving parts like interest payments, accounting for the money I took out of the bond for our TFSA's, and Tax.
So you can't blame me for being a little reluctant.... Added to this was the fact that I had formed an impression that the returns may not actually be that good based on this post I did. Also, I sort of had the intention of selling the property as soon as we were settled in Centurion and/or any sort of tenant issue cropped up. (A little background as to how I ended up with this investment property in the first place - it was a side effect of our move to Centurion from Sandton. We wanted to rent in Centurion before buying, to get to know the area first, and the rental income from the Sandton apartment easily covered the rental of a bigger, ground floor place in Centurion (a result of Centurion property being way better priced than Sandton property)).
So that's the long answer as to why I wasn't tracking the property's performance.
The short answer is I was just being lazy! :)
Anyways the question I received gave me a kick up the bum, and was a reminder that I really should start evaluating this investment property properly (wow, say that fast 10 times - property properly, property properly, property....).
So I decided to dive into it...turns out it wasn't as difficult as I first imagined. It also turns out I am getting a semi decent(ish) return from the rental property at the moment, and the calculations I ran gave a fair indication of the right time to sell....
Quick side note....
I suspect I am going to get a number of requests to share the spreadsheet I used to run the below calculations. I would have no issue passing it around, but the problem is that it is a pretty specific spreadsheet which leaves out many important considerations for a more generic residential property investment. But fear not, I have you covered! I am currently working on a way more general and customisable spreadsheet which can be used to evaluate any potential residential property investment you may be considering and could also be used to track actual returns of an existing residential property investment. Once done, there will naturally be a blog post on it, and I will of course share it with everyone on the mailing list (you can join the mailing list by clicking here).
Just a heads up, this is a bit of a long post - not one for if you are in a rush. So get a cup of coffee (or shot of tequila if that's more your style) and settle in.
I think the below serves as a good case study for some of the drivers that can affect the returns of a residential property investment and how an actual residential property investment plays out.
Ok, all the housekeeping is out the way, here we go...
Initial Investment Numbers
Before diving straight into the calculations, I need to bed down the initial numbers.The first number I need is the value of the property when we started renting it out. In amongst the chaos of our move to Centurion, I never took the time to estimate this. But no worries, I got a way around it. I did a quick estimate of the value of the property at the end of 2016 - R1.2 Million. Then, using the price we paid when we bought the place towards the end of 2011 (R780k), and assuming equal growth each year, I can get an estimate what the place was worth at then end of 2015 - right before our tenant started renting.
Total growth from 2011->2016 = (R1 200 000 - R780 000)/R780 000 x 100 = 53.85%
53.85% is the total growth. So the question now becomes - what would the property price growth be for each year, that when compounded, gives you total growth of 53.85%?
For this I calculate the annualised growth over 5 years:
Total annualised growth over 5 years = (1 + 53.85%)(1/5) - 1 = 9.00%
i.e. If the property grew at 9% each year, then over 5 years the total growth would be 53.85%
So to estimate the value of the property at the end of 2015 (right before we began renting the place out):
Estimated value at end of 2015 = 2011 Value * (1+ 9%)4 = R1 101 033.66
So property value at the start is estimated at R1.1 Million.
At this point, there was roughly R660k outstanding on the Bond.
So the starting equity = R1.1Million - R660k = R440k
This was kind of like putting down a deposit of R440k on a R1.1Mil property.
Because we had already paid all the purchasing costs when we first bought the place, I do not include any other initial costs for this rental scenario.
The table below summarises the "purchase" of the property:
2015
At end 2015, the investment looked like this (basically just summarising the above):
The R440k deposit is listed as an "expense", but falls directly into the equity of the property. So a net 0. And since I put R440k into the property, the cashflow for the time period is -R440k.
2016
Now the fun starts - tenant moves in, getting some income, paying some expenses.
Income:
Starting rent was R8200 per month (R98 400 for the first year).
Expenses:
Any levies, rates, maintenance, agents commissions, insurance and tax need to be factored in. We found our tenant privately, so no agents commissions. And because it's a sectional title, the insurance is covered by the levies. During 2016 we had to make some minor repairs and do some painting - this came to R1200.
Income was pretty much in line with the running expenses and interest payments, and I estimate the tax expense around R2300 (that reminds me, I still need to do my returns!).
Our tenant was great (very grateful for this because tenant issues are a real risk with property investments) and we had no issues with payments and therefore no vacancy related expenses.
Below is a summary of the expenses for 2016:
Income was pretty much in line with the running expenses and interest payments, and I estimate the tax expense around R2300 (that reminds me, I still need to do my returns!).
Our tenant was great (very grateful for this because tenant issues are a real risk with property investments) and we had no issues with payments and therefore no vacancy related expenses.
Below is a summary of the expenses for 2016:
Property Value:
Start of 2016 = End of 2015 = R1.1 Million
End of 2016 = R1.2 Million
Growth in property value = 9.09% (This is not 9% like my previous annualised calculation because I rounded the starting value to R1.1 Million)
For 2016:
R98 400 - 112 340 = - R13 940 (i.e. the property, took money in 2016 - ideally you prefer the property to be a giver and not a taker...)
At the end of 2016 the property was worth around R1.2 Million, and there was around R640 400 outstanding on the bond. So at the end of 2016 the theoretical equity calculation looked as follows:
R1 200 000 - 640 400 = R559 600
Seems like a decent amount.... but to see what I would actually get out if I had to sell at the end of 2016 I need to factor in sales costs. For this we need some estimates on commission, and capital gains tax. The inputs for these cost estimates are summarised below:
First up I calculate the return on equity. This calculation is as follows (need to factor in the cashflow, because not all the equity growth will be due to property value increase):
Return for 2016 = (Net Profit)/(Equity At Start)
Return for 2016 = ((Equity At End)-(Equity at Start)+(Cash Flow))/(Equity At Start)
Return for 2016 = 24.01%
Not bad!
But, what if I had put this money into another investment for the year. Then I would have had to "cash out" at the start of the year, which would incur all the sales costs and possibly CGT too. To get a comparison value I calculate a return on equity if I were to sell.
Return At Sale = (Net Profit)/(Equity At Sale)
Return At Sale = ((Equity At End)-(Equity at Start)+(Cash Flow))/((Sales Price)-(Bond)-(Commissions)-(CGT))
Return At Sale = 28.67%
In other words, assuming risks were the same, I would need to find an investment that would return more than 28.67% to make it worthwhile to sell the apartment at the start of 2016 and switch over to the other investment.
Cashflow
Cash flow is simply money received from the property, less money put into the property.For 2016:
R98 400 - 112 340 = - R13 940 (i.e. the property, took money in 2016 - ideally you prefer the property to be a giver and not a taker...)
Equity
Now things start getting a little more complicated. Equity is the "value" that I would get out if the property were sold, and the bond were settled. However there is a distinction to be made between the theoretical equity, and the actual equity (which would factor in all the costs incurred on sale of the property).At the end of 2016 the property was worth around R1.2 Million, and there was around R640 400 outstanding on the bond. So at the end of 2016 the theoretical equity calculation looked as follows:
R1 200 000 - 640 400 = R559 600
Seems like a decent amount.... but to see what I would actually get out if I had to sell at the end of 2016 I need to factor in sales costs. For this we need some estimates on commission, and capital gains tax. The inputs for these cost estimates are summarised below:
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| Commissions and Tax - bleh! |
To be honest, I am not sure what estate agents commission rates are like these days - if anyone has had a recent home sale, maybe you can give some feedback on my estimated figure of 6.5% in the comments?
When I factor in the selling costs and tax, I calculated I would get R472 000 out.
2016 Returns
And now for the cool part! Time to get some percentages out of all this.First up I calculate the return on equity. This calculation is as follows (need to factor in the cashflow, because not all the equity growth will be due to property value increase):
Return for 2016 = (Net Profit)/(Equity At Start)
Return for 2016 = ((Equity At End)-(Equity at Start)+(Cash Flow))/(Equity At Start)
Return for 2016 = 24.01%
Not bad!
But, what if I had put this money into another investment for the year. Then I would have had to "cash out" at the start of the year, which would incur all the sales costs and possibly CGT too. To get a comparison value I calculate a return on equity if I were to sell.
Return At Sale = (Net Profit)/(Equity At Sale)
Return At Sale = ((Equity At End)-(Equity at Start)+(Cash Flow))/((Sales Price)-(Bond)-(Commissions)-(CGT))
Return At Sale = 28.67%
In other words, assuming risks were the same, I would need to find an investment that would return more than 28.67% to make it worthwhile to sell the apartment at the start of 2016 and switch over to the other investment.
2017
I think I covered the inner workings of the calculations in the 2016 part. So I won't bore you with all the details again for 2017 - I'll just show you the outcome.. Bear in mind some minor assumptions because the year is not done....yet.
Income
Rent went up - total income for the year = R108 000
Expenses
Rates went up, levies went up. Tax will be a little higher based on the increased income ~R6k. No maintenance costs incurred so far, but the year is not done, so I allocated R2000 for this. I am also assuming no vacancies for the year based on our excellent tenant behavior thus far - gold star for him!
Total expenses for the year = R123 174.42
Property Value
Going forward I am assuming that the property value increase will be more or less in line with longer term data. If it happens to be higher, bonus, but I am not banking on more than 6.88% a year.
This gives me an end 2017 property value estimate of R1 282 560.
Cashflow
Still sucking money = -R15 174 .42
Equity
I took around R16 000 out of this property's bond to top up my wife and my TFSA's (read more about that here). So I need to factor in that removal of equity - I get the following:
Estimated Equity at end of 2017 = R658 860
Estimated Equity After Sale = R554 094.72
2017 Returns
Return for 2017 = 12.72%
(So this now is starting to look like I should evaluate other options - especially considering that long term equity and listed property returns are around 15.28% and 16.28% respectively.
But then if I sold at the start of 2017, what return should I get in order to equal the property investment (considering the costs of the sale)?
Return at Sale = 17.72%
So that would be a little difficult to achieve. Seems it was the right decision to renew the contract with our tenant for this year.
2018 and Beyond
The 2016, and 2017 returns are based mostly on actual values (with a few low risk assumptions about the remainder of 2017). If I wanted to keep the apartment beyond 2017, I need to start making some more assumptions. I like to keep these conservative and modest (like a nun :))I assume house price growth around the long term average = 6.88% p.a.
I assume rental will increase by long term inflation = 6.28% p.a.
I assume 1 month vacancy per year
I assume maintenance of R2000/year
I assume levies and property rates increase above inflation = 10% p.a.
And then I project forward to end 2020. The result is below (with the previous years also shown.)
I am particularly interested in the Return On Equity At Sale. When this value drops to something which I could achieve in another investment, then it may be time to sell - especially if I consider the alternative to be lower risk.
Note that I calculate the return on equity for the current year, but the return on equity at sale is calculated as if I were to sell at the start of the year. My reasoning for this - I look at the future years return on equity, and if it is not satisfactory, I will sell the property at the start of that year - this will leave me with a lumpsum to invest - what return must this lumpsum generate to make the sale worthwhile?
I also include extra fancy calculations like cumulative cashflows, rental yield, average property price growth and annualised returns.
Click for larger image:
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| A big-ass table! |
Selling at the start of 2018 to invest in something else, means I would need to find something with a return of 15.99%. Going into listed property is starting to look like a good alternative, especially since, in my view, it has a lower risk profile. Tenant default still scares me, and it can get a lot worse than just a 1 month vacancy expense. So listed property is starting to look attractive...
The above is a conservative scenario, with low rental increases and high cost increases. Might be worth looking at the optimistic case too. As I had mentioned previously, our tenant has been excellent, and happily renewed for another year with a ~10% increase. I suspect he may renew again for another 10% increase, and this would give a very high probability of no vacancy in 2018.
So let's assume a 10% rental increase, no vacancy for 2018, and only a 8% increase in levies and rates (which may actually be closer to what will play out). Using these assumptions, I get a Return On Equity On Sale of 17.57% for 2018. Based on this, it seems like keeping the property in 2018 and selling at the start of 2019 may be a better plan...
So what to do, what to do....?
My Plan Going Forward
My thinking is currently as follows - naturally this is subject to change as all this rattles around in my head, but as thing stands, this is the plan:
- Should our tenant want to renew, I will accept. This has some really nice benefits such as increasing the rental income by 10%, but more importantly, significantly reduces our risk. I will then re-assess at the start of 2019. In an ideal world the tenant will keep renewing, and then one option would be to wait until the proceeds of selling the apartment would match the outstanding amount on our primary residence bond. I estimate this at around end 2019. At this point I would probably sell the apartment, and settle our bond. Totally debt free woohoo!
- Any sort of tenant issue, (including a non-renewal at the end of this year) and I will more than likely sell.
But.....
There is one other aspect to all this which is also giving me a lot to think about. I mentioned at the end of a previous post that there has been some talk of a Junior version 2.0. I am still playing around with the numbers, but should this materialise, our current budget would definitely need to "expand" somewhat. It could get toight like a toiger!
So another option that I am considering, is to sell the apartment at the end of this year. Throw the proceeds into our primary residence's bond, and then renegotiate a lower instalment with the bank. This would free up some monthly cash, which could partly be used to subsidise version 2.0, and partly to increase investment contributions and slightly fast track/make up the deficit on our Early Retirement Plan.
It's an interesting option....
A fantastic perk of this blog is that I get to throw this out to all of you awesome readers out there, and I usually get some great insights - so please let me know what you think of this challenging but hugely exciting little conundrum we find ourselves in?
Also, I am very curious if anyone else has attempted a returns calculation on their residential investment property? What was your methodology and what did your numbers look like?
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Till next time, Stay Stealthy!
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