Buying property for profit

There are essentially two ways to approach investing in property. You can either buy in the hope that the price will increase and you will be able to sell for a higher price in the near future (flipping) or buying a property for the rental income that it generates.

Flipping

The process of flipping is more speculation than investment.

Buying and then quickly selling a property at a higher price is only feasible if you can get the property at a price that is significantly below the market value, or if there is a very hot market and prices are rising continually. In both cases, the key is being able to resell – so you would have to be sure that there would be sufficient demand from buyers for your property when you resell.

The costs associated with buying and selling a property, together with a generous contribution to SARS, mean that the resale price has to be much higher than your purchase price to make the whole transaction worthwhile.

For example, if you buy a property for R1-million for cash, your costs would be about R30 000. Assuming that you sold the next day for R1.5-million, the estate agent commission could be as much as 6% plus VAT.

Doing the math, your before-tax profit would be around R370 000. However, this would probably be taxed as regular income rather than at the lower capital gains tax rate. At a maximum marginal tax rate of 40%, the profit remaining would be R222 000.

In other words, in this example, if you sold the property at a price that was 50% higher than the price you paid for it, your actual return after tax would be around 22%. Of course, if you had bought the property with some bond financing then your actual return on investment would be much higher.

Buying for rental income

Buying for rental income is a much lower-risk strategy than flipping. The goal is to earn an ever-increasing rental income as well as benefit from an increase in the capital value of the property over time.

You can often finance part of the purchase price with a bond. Whether your investment property is initially cash flow-positive (where the rental income is more than the bond repayments and additional costs such as rates) or cash flow-negative will largely depend on how much of the purchase price you paid in cash and how large the bond is. Clearly, if you made a large cash contribution then the bond would be small, your bond repayments will be low, and your property would more likely be cash flow-positive.

Although it is ideal to be in a cash flow-positive position from the start, this isn’t always possible and you may need to “top up” the rental income to match the bond repayments and other monthly expenses. Hopefully, in time, the top-ups will be exceeded by the increase in the capital value of the property.

The idea is that you should take a long-term view and try to keep the property until the bond is paid off (at which time most of the rent will be pure profit) or even never sell at all. This means that the property you choose to buy should be in an area where you expect people to still want to live (and rent) in future. This is also important because, if you ever do need to sell, you want to know that there will be potential buyers around.

Once your investment is cash flow-positive you can consider investing in another property, and in this way gradually build up your property portfolio and grow your wealth.