Investing in property can be a great investment, but be sure that you understand the risks.

I recently ran a survey on social media to understand what asset classes people invest in.

The majority of women prefer property over investments such as unit trusts or exchange-traded funds which are related to the stock market.

One of the reasons people – especially women – invest in property is that they believe it is less risky than investing in market-related investments. They feel that property is tangible; they can see it and touch it, and they understand how it works.

While property can be a viable investment, it is incorrect to believe that an investment property is less risky than a diversified portfolio of shares. It is also not a passive source of income. It requires a lot of management.

The risks of leverage

The premise of investing in property is that you get someone else to pay the mortgage for you. You just have to put down a deposit, and over time, your tenants pay off this lucrative asset.

The reality is that many investors discover a serious shortfall. Through our Money Makeover Challenge each year we see people struggling financially due to their investment property.

They find that they cannot rent the property for what they expected, or they didn’t run the numbers properly, failing to include expenses such as levies and maintenance in their figures.

When there are spikes in the interest rate, as we experienced over the last two years, many of those investments become a financial nightmare, with mortgage repayments rising.

Other issues include the risks of tenants not paying, the costs of maintenance, and dealing with difficult tenants. All of this means that investing in property is not a passive investment. You need to run it as a business and be prepared to put in the work.

Lack of diversification

Another risk factor with investing in property is lack of diversification. When you buy a property, it is in one street, one neighbourhood, one town, one province in a small country at the bottom of Africa. You are certainly not diversifying your risks – you are concentrating them.

If you compare that to investing in a unit trust or exchange-traded fund, for as little as R500 a month you can diversify your investment across the world, and you can be invested in thousands of large companies globally.

An added benefit is that you don’t have to do anything. You don’t have to manage tenants, there is no leaky roof to repair, and best of all, no mortgage to pay.

Investing in shares is not just about capital growth. Over time you can build up a portfolio where you are earning regular dividend income.

Perceived risk: value vs liquidity

One of the arguments people have for why they believe that property is a safer investment than shares is because the price of shares can go down. If there is a market crash, you could lose money due to the share price of your investment going down.

But that is because we know the price of shares every second of every day. Any “losses” you see are only losses on paper. These only become real losses if you sell.

If you had to price a property every day based on what a buyer would be willing to pay for it, there would be many times where it would be worth zero – because you need a willing buyer. Anyone who has been trying to sell in Joburg recently can attest to this.

This raises another point, namely that property is not liquid. You cannot exit a property investment easily and you do not want to be in a position where you are a forced seller. You need to make sure you have enough liquidity in the rest of your investments so that you are never forced to sell.

Costs of investing in property

Buying and selling property is expensive. People often forget the transaction fees.

For example, to buy a R1 million property, you would pay around R67 000 in costs. When selling, you would need to pay the estate agent’s commission. There are also holding costs which include things like insurance and maintenance.

If comparison, the costs to invest in a unit trust or exchange-traded fund are negligible. There are usually no upfront costs and a maximum fee of one percent a year.

Property can be a great investment, especially if you are able to get someone else to pay for your R1 million investment. Once the mortgage is paid you have rental income. But it is not passive, and it is not low risk, and it is certainly not diversified. So make sure you go into it with your eyes wide open and that you know what you are doing.

Calculate your numbers properly to understand if you can afford it. Be very aware of the levies that come with purchasing in a sectional-title complex.

Always work on a worst-case scenario. Calculate your rental income on a maximum of ten months a year – assume that for two months you do not have a tenant. Have a buffer fund that can cover the rental if you don’t have a tenant, or if you need to undertake repairs and maintenance.

Be prepared to screen and manage tenants, or factor in the cost of using a management agency.

Alternatively, you could simply invest every month into a unit trust or exchange-traded fund and leave it to grow.

This article first appeared in City Press.