Is it a good idea to invest in investment properties as a retirement plan?


Dear reader,

Your question has been debated in the financial planning world for many years, and the reality is that there is no right or wrong answer.

Simply put, there are four traditional asset classes available to invest or store your wealth in, namely cash, bonds, property and stocks.

Investors can either physically own these assets (by holding cash, buying government or corporate bonds, buying property, or owning direct shares of listed companies) or invest “indirectly” in these asset classes. assets by owning units of a mutual fund that invests in any one or a combination of these asset classes (i.e. investing in a mutual fund).

When it comes to investing in real estate, you can either invest in a tangible, physical property where you can own one or more properties for investment purposes or invest in a real estate investment fund. The difference is that owning the property yourself means you control every decision and every aspect of the investment, such as size, geographic location, and type of property (eg, residential or commercial). Additionally, you are responsible for managing all risks associated with the physical property such as maintenance costs, vacancy risk, rental legislation and liquidity risks, to name a few. .

On the other hand, if you were to invest in a real estate mutual fund, you would typically own units of a fund with exposure to various listed real estate companies, whether local or global. The return profile is based on the same economic parameters, such as the capital value of the property plus the rental yield you receive from the property, but a unitary trust fund offers much more diversification and liquidity compared to the possession of a single property in your own name. .

An important factor that needs to be considered is how you would finance such an investment. In order to buy a physical property, you are likely to need to access funding through a bond facility, whereas banks will not lend money to investors to invest in a unit trust portfolio .

Many real estate investment successes are the result of leverage.

By qualifying for a bond, an investor is able to purchase a property and generate rental income (which they then use to repay the bond), while at the same time building equity in the property or l access requirement – ​​all of which serves to qualify the investor for higher levels of financing with which to purchase the next property, and so on. Eventually, the investor has a portfolio of investment properties that provides them with annuity rental income – but keep in mind that this investment strategy is not without risk.

Refunds of the deposit will be due at the end of each month, whether your tenant has paid their rent or not.

Your ability to cover maintenance costs, property vacancy, and monthly rates and taxes are just a few of the considerations you need to make before purchasing an investment property. Also keep in mind that you will need to have sufficient funds to cover all initial costs associated with purchasing an investment property.

One consideration when investing for retirement is diversification – not just within an asset class, but across asset classes – as well as diversification across types of investment vehicles used for retirement. There are times when asset classes, both local and global, perform well, and times when they perform poorly.

The table below shows the average returns of different asset classes over one-year periods going back to 2007.

The volatility of each asset class highlights the need for long-term investors not to react instinctively to market fluctuations, but to have a diversified investment portfolio.

Source: Asset Class Matrix, Old Mutual Wealth, June 2022

When deciding which type of investment vehicle to use, keep in mind that retirement annuities are designed specifically for retirement savings purposes, allowing you to claim contributions as a deduction tax. The legislation allows you to deduct up to 27.5% of gross annual taxable income capped at R350,000 per year.

For example, suppose you have an extra gross income of R10,000 per month to save. Your marginal tax rate is 41%. You are hesitating between investing in a retirement annuity or buying an investment property. If you buy a property, you will have an after-tax amount of R5,900 per month to invest for this purpose. On the other hand, you would be able to invest the full R10,000 per month in your retirement pension as it is a tax deductible contribution. There are, of course, rules and regulations regarding retirement annuities and how you access these funds in retirement.

As can be seen from the above, both approaches have advantages and disadvantages and it is not uncommon for investors to implement a blended approach to retirement savings by maximizing their retirement pension contributions, creating liquidity options by investing in a discretionary unit trust and a tax-free savings account, and owning investment property if they are interested.

To build a solid investment plan for retirement, it is advisable to engage with your financial advisor to help you make informed investment decisions so that together you build a plan that matches your needs and goals.

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