/ 21 September 2011

Don’t write off residential property

The Weekend Argus personal finance page carried an article on whether it is better to buy or rent property. This was prompted by research by Henno Vermaak, an analyst at PSG Asset Management, which suggests that you may be better off renting and then investing the difference between your rental and mortgage repayments into equities.

It is a compelling argument, and if you are only planning on living in a property for five years or less it makes no sense to buy once you have taken the transfer costs and agent fees into consideration.

However, I remember clearly in late 1996 a similar article in personal finance which made the argument for rental over ownership. In fact at that time it was a no-brainer and many analysts agreed that buying your own home was financial suicide. The property market had stagnated for years, interest rates were high and the stock market was offering far better returns.

It was against this backdrop that we debated whether or not to buy our first home. Our friends told us we were crazy, the sums made no sense, but emotionally I wanted a place where I could paint the walls the colour I wanted and have a garden. We made an emotional decision to buy rather than a financial one.

Eight years later we sold our home for five times the price we paid for it as the residential property market went ballistic. Our emotional decision was the best financial decision we have ever made.

Apart from a sense of déjà vu, I have noticed reports that rental yields on residential property are starting to increase. Over the last eight years rental yields fell behind as property prices soared in the early 2000s, however as property prices have fallen and affordability has forced people to rent rather than buy, we are seeing rental yields pick up which led FNB property strategist John Loos to comment in a report that “residential property’s investment attractiveness relative to other asset classes may thus be slowly on the mend”.

If you go back to the basics of investing and ignore projections and theories from talking heads, it all comes back to yield and income. If you receive a good income from an asset, it will eventually reflect in the price. As rental yields on residential property start to pick up, it will affect the capital values. The relationship between yield and price was clearly demonstrated in the mid-2000s when rental yields fell significantly as property prices overheated and then we saw the property prices fall too. Analysts will point to “macro-environments” but it really is all about how much income your asset is generating.

Where exactly we are in the cycle is not a perfect science but when people start touting rental over buying it suggests to me that some sort of bottom is near. If you want to put down roots, don’t write off becoming a homeowner.

For more Smart Money advice go to Maya on Money.