Investing in residential property has fallen out of favour over the last few years. In 2003 around 25% of property purchases were for investment purposes; that figure has fallen to 8%, according to the FNB Property Barometer.

These figures are hardly surprising when one considers that property prices in real terms (adjusted for inflation price increases) have fallen by 20% since the financial crisis. Capital growth was the major driver behind property investing in the mid 2000s and now that property prices are fairly stagnant there is less opportunity for profit. Although lending costs have fallen significantly, which normally makes investing in property more attractive, the lack of capital growth is keeping investors out.

Apart from poor returns, investors are also faced with higher risks as tenants default due to worsening economic conditions. According to Tenant Profile Networks (TPN) the number of tenants in good standing fell from 85% in 2008 to 71% in 2009.

This is a reminder of how vulnerable investors are to economic changes. Although this figure has improved to around 84%, it still means that around 16% of tenants will default, and given the current economic conditions, the number of defaults could rise further  – a risk anyone considering investing in residential property needs to be aware of.

Ewald Kellerman, Head of Sales at FNB Home Loans says affordability is also affecting the demand for investment property. Since the financial crisis of 2009, banks no longer lend based on the potential rental of a unit. This is also reinforced by the National Credit Act which looks at current affordability – not potential income. Banks are also requiring higher deposits and charging higher interest rates on investment properties. Kellerman says if, however, you have an existing property that has a solid track record of rental income you could borrow against that as it would be considered as part of your regular income.

Kellerman says investors also need to realize that building up a property portfolio is not as simple as buying one property and two years later buying another. “The first property will have to be making a decent profit after repayments, maintenance and levies and that can take many years to reach,” says Kellerman.

Future prospects

While these factors have contributed to the fall in investment property, on the positive side the demand for rental properties is increasing. Young entrants cannot afford to buy property and are therefore looking to rent and as a result in certain areas the demand for rental is outstripping supply. Kellerman says this will eventually feed into higher rental rates which will make property as an investment more attractive. “We will see a property boom when net yields are equal to the bond repayments but that is not now,” says Kellerman.

Currently rental yields are too low to cover the costs of purchasing a property. According to TPN, rental yields (annual rental as a percentage of purchase price) are on average are around 8% – 9% gross. This is not sufficient to cover the cost of funding and maintaining the property – a rental property needs to generate a gross rental income (before deducting costs like levies) of around 12% a year to be viable.

Dr Koos du Toit of P3 Investment Group, which specializes in residential property investments, says there are pockets of opportunities where rental yields are in excess of 10%.

The key is to focus on entry-level flats and small townhouses which cost below R600 000. “Rental demand is extremely high on these units, they provide the best yield of about 10-12%,” says du Toit who cites as an example a townhouse in Midrand selling for R399 000 with rental income of R3800 per month.

“We find that Midrand is a lively area, especially close to the Gautrain stations. However, these kinds of properties are always in demand, almost everywhere in Gauteng” says du Toit.

What to consider when buying-to-let

Managing tenants

The whole property proposal is based on the idea that you have a tenant and that the tenant actually pays. This is an important part of managing a property portfolio and you have to spend time vetting your tenants carefully. There are many horror stories of professional squatters who use the law to avoid paying rent and you have to know how to deal with them. If you are not prepared to deal with these issues then property investing may not be for you.

Interest rates

An unexpected increase in interest rates will increase the cost of servicing the loan so you need to be prepared for it. Either opt for a fixed interest rate or build up a buffer by paying more into the mortgage than you need to so that you can absorb a rate increase.

Tax

The net income from property rental is taxable. You are able to deduct the interest on your loan as well as running costs like levies and maintenance. But remember once the property is paid off this will be a taxable income.

Maintenance

When you are working out your finances, remember to include on-going maintenance costs on your property. As the landlord you will be expected to deal with any problems like burst geyers and broken garage doors. If you are the DIY sort of person that is great, but you may want to hire someone to manage the maintenance on your behalf which will add to your costs.

Body corporates

You will most likely buy into a sectional title property like a block of flats, townhouse or clusters. All of these are run by bodies corporate who collect levies to maintain the common areas of the property. However many bodies corporate are in financial difficulty and have court orders to appoint administrators to run and administer the buildings on behalf of the owners who for various reasons, including lack of finances, have not been able to properly run and manage their complexes. You need to find out the state of the body corporate before you buy.