Written by Henri Raath B Acc (Hons), CA (SA), CFP®
Even with the massive growth in property values the last couple of years now a distant memory, some investors still favor property over RAs when they save for retirement. However, it is a very risky approach to be invested overweight in a single asset class over the long term.
With this newsletter we will evaluate some of the advantages and disadvantages of buying a property of R1.5million versus investing it as a lump sum in a new generation unit trust-based RA.
For both types of investments we will look at entry and maintenance costs, the taxation implications and the other risks and considerations involved.
Entry- and maintenance costs
Entry costs can be as much as NINE times more for property than for RAs, and this is illustrated with the following table:
Description Property RA
Gross investment value R1.5million R1.5million
Transfer fees R65,000 –
Attorney fees R5,000 –
Investment platform initial fee –
VRR initial fee (0.5%) – R7,500
Total initial costs R70,000 R7,500
% of gross investment value 4.7% 0.5%
With the property investment the maintenance costs can be unlimited due to various factors like the age, quality and finishing thereof, the quality of the tenants and regulations of the body corporate in a sectional title complex, including rates and taxes.
With a RA the ongoing maintenance costs consist of the annual management fees of the investment platform, the individual asset managers and the financial advisor fee for the administrative and advisory aspects pertaining to the investment. This can be between 2.0% and 3.0% per year, depending on the investment platform and the underlying investment funds.
Description Property RA
Estate duty Fully included in an estate for estate duty, except if it was purchased in a trust. Not subject to estate duty at all because it is regulated by the Pension Fund Act.
Income at retirement Fully taxable after qualifying expenses have been taken into account. Fully taxable as an annuity when the pension is implemented
Capital gains tax Capital gains are taxed when the property is sold, irrespective of which legal entity the property is registered in. No capital gains tax is applicable for any capital gains generated in the RA. Further to this an amount of R300,000 can be withdrawn tax free as a lump sum at retirement.
Deduction of payments or contributions Only the interest component of a mortgage payment is deductible for tax. This is beneficial at the beginning of the mortgage term, but not so beneficial as the term of the mortgage becomes shorter. Contributions is deductible for tax subject to certain limits. It is especially beneficial for people who do not contribute to an employer retirement fund.
Both these investments have different risks. RAs have market risks while property incorporates indirect market risks, namely that prices can increase or decrease when interest rates fall or rise. RAs are interest sensitive in a positive way because as interest rates rise the return can be increase because it is not taxed within the RA at all.
The risk of tenants defaulting on rent payments is another significant risk which is associated with direct investments in property which is becoming an increasing problem. The balance of power has unfortunately swung from the owner of the property to the tenants, and to evict tenants have become increasingly difficult.
When the owner of the property is declared bankrupt the creditors can stake claims against the property, except where it was purchased in a trust. An RA is fully protected against creditors in terms of the Pension Fund Act, and this makes it extremely attractive for business owners who work in high risk industries.
Long term returns
The returns of the two investments will differ over the long term, but what matters is the net growth in the investments after all the costs and expenses have been taken into account.
The income on residential property and listed property is fully taxable. The property index does not take into account the cost for main residential property (in other words rates and taxes, maintenance, et cetera). Rental income on residential property is also not reflected in the Residential Property Index, and have to be added to the growth mentioned above.
Is it highly unlikely that the returns mentioned above will be repeated in any of the three sectors mentioned. Consumers and investors have to lower their expectations when they plan, irrespective of what investment vehicles they decide.
RAs provide the opportunity to diversify an investment between the different asset classes, namely shares, bonds, cash and listed property. A direct investment in actual property only gives exposure to one asset class and is very restrictive.
Diversification is a fundamental rule of any successful long term investment strategy. It is therefore acceptable to invest in direct property, but a well-diversified RA is strongly recommended. Changes in regulation and the introduction of low cost unit trust based RAs makes these investments extremely attractive.
Please contact us if you would like to have more information about the above article, or if you have any questions about investments in general.