Simply ignoring property might be a disservice to clients. At the same time, many financial planners are not property experts and could feel uncomfortable making recommendations beyond generic advice, eg trying to pay down your mortgage.
There are many types of property investments to consider
To complicate matters for financial planners, clients are offered a variety of property investments. These range from their primary residence to listed property companies, unit trusts, offshore property schemes (golden visa anyone?) and many other offerings. Financial planners might be best served by offering advice based on a few fundamental principles rather than specific advice on investments outside their expertise.
Concentration risk
Diversification of investments is a sound principle and a proper diversification strategy is an excellent antidote to economic, political and stock market uncertainty. When discussing property investments with clients, it is critical to determine how much of their wealth will be tied up in their property investment(s). For most people, they must own their home. It might be correct to advise them to pay down their mortgage and build up non-property investments simultaneously to compensate for the concentration risk.
Cost of transactions and ongoing cost of ownership
It is worth highlighting the total cost of property ownership before allocating money to this asset class.
Offering a cost comparison might be helpful, for example, compare the cost of buying a property vs buying a unit trust or ETF. Property transaction costs include transfer duties, mortgage registration, agent’s commissions, etc. In addition, the cost of ownership and maintenance must be factored into any calculation, including property taxes, levies (for apartments or clusters) and maintenance (even apartments must be repainted). I have run some simulations and believe the ongoing cost of property ownership (excluding transaction costs) averages more than 2% per year. This excludes the cost of a mortgage repayment.
Complexity: syndications/fractional ownership
Many investors like property as an asset class because it is simple, easy to identify and visible. However, some product providers have created complex property structures that are not transparent, simple or easy to understand. Unfortunately, many of these structures have imploded in the past (please search Sharemax or Masterbond for two examples) and some new structures might be headed in the same direction.
One significant benefit of a listed share, ETF or unit trust is that it can be sold quickly. Still, selling your portion of a property via a syndication or fractional ownership structure is very difficult. I prefer a listed property company, property ETF or unit trust for investors who want to be part-owners of a property portfolio.
Merits of leverage
Investors often argue about the potential for outsize returns if they borrow money to invest in a property. This type of leverage is not readily available on shares, ETFs or unit trusts. This is a valid argument in favour of property. Financial planners need to remind clients that the flip side of this benefit is the potential for implosion if the investment goes wrong.
Rental income
Many investors favour property as they can earn a stable and predictable rental income from the investment. A well-chosen property with a reliable tenant can provide a steady and increasing rental income. In an ideal scenario, rental income can even cover mortgage payments in the long term, effectively allowing the tenant to pay off the investor’s mortgage.
However, if the tenant cannot pay and decides not to move out, the landlord could be in trouble. On average, it takes six months to evict a non-paying tenant legally. The landlord must still pay the mortgage and monthly property ownership costs. If the tenant is unscrupulous, there might be damage to the property that must be repaired before a new tenant can be found.
Stability against market fluctuations
Unlike investments in shares, ETFs and unit trusts, physical property prices are less susceptible to short-term market fluctuations. The tangible nature of real estate often provides a sense of stability and security to investors, shielding them from short-term volatility. This can be a powerful psychological benefit to skittish investors who cannot sell their property quickly in a market downturn. The slow pace of transactions can help nervous investors to stop panicking and think more rationally. Sometimes, the best decision in personal finance is to do nothing.
Potential returns
While property investments can sometimes yield attractive returns, some property sectors have not been great historical performers. For instance, residential property growth rates have been modest compared to the stock market – even over very long periods. In South Africa, capital growth on residential property has delivered half the stock market’s growth over the long term.
Listed property used to be a star performer in South Africa, but the economic decline in the country combined with the move away from offices after the Covid pandemic has caused real damage to investors. More recently, some industrial properties that suit logistics operators have done well, and some pockets of residential property in the Western Cape have been great for investors. In summary, property returns will always be patchy and focusing on historical returns to predict future growth could be harmful.
Conclusion
While property’s passive income and long-term appreciation potential may seem enticing, financial planners must remind their clients to carefully weigh the pros and cons before diving into this asset class. Financial planners do not need to become property experts to offer a sounding board for their clients. Providing a perspective based on financial planning principles might be a real benefit. In addition, there is a real lifestyle value for some people who can afford to own multiple properties and it is the job of a financial planner to enable these clients to enjoy their lives if it is viable. The best financial planning decisions are not always driven by return on investment.
