Why my dream of ‘investment’ properties turned sour

First, the spoiler: it wasn’t because of the tenants. I’m not even sure how I ended up with a small rental portfolio (one and a half properties).

The first purchase, with a friend, was entirely opportunistic. A complex and area we knew well and a sudden forced seller meant this was a real “no-brainer”. It helped that the property market had cooled off after overheating in the early 2000s.

Obviously the plan was justified by the usual logic: the bank lends you the money, you have to only cover a small shortfall and once the bond is paid off, we can sit back and earn a monthly rental income.

The second property was my first house that I’d bought. I managed to pay off that bond in a ridiculously aggressive time-frame (read: Why I paid off my house 15 years early) and after deciding to upgrade to a larger house in a better area, I figured that sticking tenants into the already paid-off house would be a good idea.

Here the dream of a passive income was in full swing. These were both roughly R1 million properties and over time, the theory went, these should appreciate nicely.

Both had stable tenants who paid on time and didn’t really cause any drama. This was part of the problem.

Tenants have rights … and bargaining power

Not only do tenants have more rights than landlords, when they’re good tenants they use this fact to their advantage. And while the current environment (anaemic economic growth) means annual rental escalations of anything close to 10% are a delusion (unlike in the boom years), good tenants are able to negotiate zero increases (or token, marginal ones).

Of course they’ll try their luck. Why would a smart landlord risk replacing good tenants with unknown ones for a few extra hundred rand a month?

If negotiations are a little more aggressive from the landlord’s side, it is possible that those same good tenants will pitch a compromise. “Sure, we’ll agree to an 8% increase, but here’s a list of things we want fixed/improved/changed in the house.”

Not only does this impact your yield, but the headache of actually managing this process (with contractors, painters and the like) just isn’t worth the effort. Been there, done that.

Modest or no rent escalation, together with sharp increases in property rates, utilities and (sectional title scheme) levies has created a situation where yields are collapsing.

In both properties, it became clear over time that net yields were closer to 5% than 10%. Levies (including unrecoverable utility costs) and property rates for both these townhouses were fast approaching the R3 000-a-month mark.

Suddenly, that R8 000 in rental income looks more like R5 000 a month.

Separately, the theory of ever-appreciating property prices has been blown to pieces. In real terms, property prices have been in decline for the last decade. This means that over time, that R1 million asset is depreciating in value.

The long-term tenant in the co-owned property decided to emigrate last year, forcing us to revisit this investment. We both decided that the hack of being landlords was no longer worth it, not to mention the drama of trying to find a new tenant (the “hidden cost” of the additional 10% you give up to an agent for securing a tenant further impacts your return).

The risks have become untenable

Long term, the risks far outweigh any potential upside.

It is possible that we could have a return to the boom years (anything is possible), but it’s almost impossible to see how that happens. The increases in administered prices will not abate (something has to fund collapsing infrastructure), putting further pressure on yields.

That the law favours tenants remains a risk, as does the continued uncertainty regarding property rights. Plus, being overinvested in physical property is a problem.

Would it be smart to put the majority of your investment portfolio in one stock on one exchange? Or in one asset class? Why would you not diversify your risk? The lack of liquidity – properties take months to sell – is a further obvious issue.

None of this is new. Financial advisors, who are generally dead against the idea of buy-to-let “investing”, constantly warn about these and other risks.

Once we were rid of the co-investment, the decision to sell the other property became even easier. Those good tenants were given notice, some minor renovations were done once they vacated (more hidden costs that you don’t see when doing those yield calculations in Excel), and the house was put on the market. I accepted a signed offer to purchase the week we went into lockdown. Talk about timing!

With both properties, there was a modest “profit”, but not even enough to trigger capital gains tax. That hurt.

It’s tempting to try and convince myself that “at least I didn’t lose money”. But what about the opportunity missed in not investing that extra few thousand a month, which was funding the “shortfall” on the bonded house, elsewhere?

Even an exchange-traded fund tracking the MSCI World Index would’ve delivered nearly 14% a year over the last five years. What a miserable thought.

This article first appeared on Moneyweb and was republished with permission.

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