Buy-to-let market scored by lower rental income ratios

News > news - 07 Nov 2005
Activity in the buy-to-let market is beginning to slow down as rental incomes shrink and the residential property boom settles into quieter waters.

House price to rental income ratios are deteriorating, suggesting declining attractiveness of residential properties as investment vehicles, according to an article in Intellectual Property magazine.

Investor activity plays an important role in the property market, especially once price increases start to accelerate and even more so when prices start to fall. Says the Standard Bank: “Generally, investors are more likely than home owners to sell their property when they expect (or see) a fall in those prices. The simultaneous sell-off by investors to escape or limit capital losses aggravates the decline in property prices.

A large presence of investors therefore gives the property market more momentum and fuels the trend in house prices in either direction.

Interestingly, Standard Bank points out that the proportion of property owners who are investors (rather than owner occupants) has been rising steadily over the past four years, while a smaller proportion of properties are owned by them.

In other words, there are more investors participating in the property market but on average each of them is buying fewer properties. This could be attributable, says the bank, to a rise in the number of new entrants in this market who are buying their first investment properties.

The ever-present danger in the investment market – residential and commercial – is lack of occupancy. This coupled with downward pressure on rental is beginning to squeeze the residential market – especially in areas where speculation became almost frenzied, such as the Western Cape. This applies particularly to the flat market, other than CBD units and in suburbs around a hub, such as Century City.

Mick Joyce, MD of Pam Golding Properties’ Western Cape metro region, points out that there are now close to 3 000 development unit in the Cape Town central city, and they are starting to pay dividends for those who bought them two years ago when the trend of converting old office blocks into apartment buildings began. More and more people are realising the benefit of city living, says Joyce. “Our group is delighted with the speed at which the trend has caught on. Over the past 24 months, PGP agents have sold some R460 million in development units in the central area.”

He adds: “While originally there were concerns that too many central city buyers would be speculators, we have found that the large majority of buyers are resident in the apartments as are most of the re-sale purchasers.”

More than R12 billion has been invested in the Cape Town CBD since the year 2000. As a result, local businesses are reaping the benefits of having a sustainable residential pool in an area, which was previously deserted after office and shop closing hours.

Nevertheless, Dexter Leite, PGP’s rentals director for the region, says any potential investor should be very selective as to “what, where, and how much,?” in the present market.

“I find that many investors do not take all costs into consideration such as transfer duty, tenant requirements, rates, taxes, levies, commissions, maintenance and repairs. In the present market it is essential to do one’s sums; it is not so easy to ‘bale out’ any more.”

Erwin Rode, publisher of the Rode Report on property, warns: “It is not a good time to buy a residential unit as an additional investment if you already own a home.” He predicts that for the next five to ten years chances are slim that capital growth in the market will exceed inflation. “If you buy a flat at a net income yield of four percent while your bond interest is 10 percent you are going to finance your bond requirements out of your own pocket for a long time.”

The answer, of course, is to get better yields, but according to Dexter Leite, although specific types of rental property are still in demand, returns remain somewhere between three to five percent.

An equally important consideration for investors in the buy-to-let market is the tax angle and the key issue here, as far as SARS will apply revenue tax. You have entered into a moneymaking scheme.!

Intention, of course, is open to interpretation. But by law, it is up to you to prove your intention to the taxman, Generally speaking the longer you hold on to your unit before selling the better.

It is, however, possible to persuade the Receiver that you intention has changed. Interest rates could climb, rental income could remain static, and, faced with impending ruin you could possibly make an emotional case which will bring tears to the eyes of a caring SARS official – possibly.

Another point to consider in terms of capital gains, cautions Grant Bayne tax consultant to Smith Tabata Buchanan Boyes, is that should you rent your home and pop off to your beach cottage up the coast and then sell your home you would not be eligible for the R1m capital gain exclusion since it would not be deemed your primary residence – unless, that is, the let was for a limited period (two years).

Rental income, of course, is taxable and is added to your normal income – but against this you can deduct certain expenses, then property would still be considered your primary residence .

Where the taxpayer is carrying on a trade - in this case the letting of property – he or she is allowed to deduct ‘expenses incurred in the production of income which are not of a capital nature.’ These would include:
· Levies
· Bond interest
· Agent fees (collection of rent)
· Electricity and water
· Repairs and maintenance
· Garden/pool service.

You can’t deduct transfer duty on a residential property or legal fees for transfer of the property, the bond registration, or setting up a standard lease contact.

There is, Bayne points out, a difference between repairs and maintenance and improvements (which are not allowed since this would be capital). "Let's say you pull up a carpet to put down wood laminate flooring. If your intention were to modernise to get a better rental the cost would be capital and disallowed. If the carpet was replaced due to a geyser bursting, this would be a repair and deductible. Another example would be if you painted a room to ‘lighten it up’ and hopefully improve the rental this would be capital and the cost would not be deductible.”

In certain circumstances – and this could apply in particular to the buy-to-let-market – the owner can make use of a loss for tax purposes, setting it off against other income earned (salary), but the procedure has been ring fenced by SARS in that it will only allow the claim for three years in the last five years of assessment.

The loss would then only be allowed for offset against future profits. However, if you can prove that there are prospects of profits within a reasonable period (e.g. rent escalations) then SARS may not apply the ring fencing.

Last word from Grant Bayne: “If people in the buy-to-let market had to be honest with themselves, a large proportion have bought to try and make a short term gain. On a sale, the proceeds would be taxable on a revenue basis at their margin rate (maximum 40 percent of R270 000).”
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