When it comes to property investment, particularly when there is a large portfolio of buy to let properties, says Michael Bauer, managing director of IHPC estate agency, if the debt to equity ratio is high, this high risk level should be phased out over time.
Many property investment moguls’ advice would be never to pay off the bonds completely, as you need tax deductable expenses such as interest on the bond repayments. Further expenses to these properties that can be deducted are depreciation on the furniture and appliances, some renovation or improvement costs, levies paid, rates and taxes, insurance on the property, the rental agent’s commission, repairs and maintenance, legal fees and bank charges.
If the properties bought are registered in a business’ name, some of the director’s overheads are also tax deductable as well as the expenses of running that business.
Bauer gave an example of a company with multiple properties in it, run by a person who is nearing retirement age. This person now has a high net worth because of the accumulated wealth in buildings, but the problem is the risk, he said. If there is R20 million in properties but the accumulated bonds come to R19 million, there is essentially only R1 million in equity. The cash flow is generated from the rent each month and there will be very little surplus.
It does make sense to gear one property against another to accumulate wealth, but the aim should be to reduce the risk as the investor gets older, he said.
“You don’t want to pay the bonds off completely,” he said, “because you would be trying to avoid a higher tax bill, but 90% debt is also not an ideal situation, and the debt should be reduced. A moderate amount should be 50 to 60% of the bonds fully paid off.”
In the life cycle of the investor, when he is young he is willing to take a lot of risk, and the debt will be built up as he buys up properties but as the investor gets older and closer to retirement, the risk profile should decrease.
“To give an extreme example in a high risk operation,” he said, “if there is R100 000 due in bond repayments each month and 50% of the tenants don’t pay, there is suddenly R50 000 in bond repayments that become the owner’s responsibility. As a retiree or older person, I don’t think this is a wise strategy.”
“Make use of the tax deductions available but use them wisely,” said Bauer, “and consult someone with experience in the field to guide and ensure that your specific circumstances have been assessed before any advice is given.”
Property is still the best long term investment as it brings in income as well as capital growth, it is just the approach and management of it over time that needs to be dealt with caution, he said.