Weighing up owning a rental property against investing in a balanced fund

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A R700,000 Johannesburg apartment promises a 20% gross rental yield, but tax, levies and risks complicate its comparison with an investment ...

A R700,000 Johannesburg apartment promises a 20% gross rental yield, but tax, levies and risks complicate its comparison with an investment fund.

I am considering making an offer on a two-bedroom apartment in Johannesburg. The asking price is R700,000 and the monthly levies are R3,000. From the research I have done, I believe I could rent the apartment out for R12,000 per month.

Would you recommend buying the apartment as an investment, or would I be better off investing the money in shares?

The apartment you are considering certainly looks attractive on paper, but before you make an offer, I would suggest we compare the after-tax returns with those from a diversified balanced investment fund.

If you manage to rent the apartment out for R12,000 a month, you will receive R144,000 a year. On a purchase price of R700,000, this represents a gross rental yield of 20%. Unfortunately, this is not what you will actually earn – there are costs and when they are considered, the yield drops to 12%, as can be seen below.

Let’s compare what could happen if you invested R700,000 in either the apartment or a diversified balanced investment fund over 15 years. For this comparison, I will assume that the property increases in value by 5% a year and that the balanced fund earns an average annual return of 10%.

The apartment generates R144,000 in annual rental income. After deducting levies of R36,000 and other expenses of R24,000, you are left with R84,000. However, we must also account for income tax.

Your rental profit is added to your other taxable income and taxed at your marginal income tax rate. Assuming an illustrative tax rate of 40%, your R84,000 rental profit would be reduced to R50,400 after tax.

Let’s assume that you reinvest this R50,400 each year in a balanced fund earning 10%, rather than spending it. To see how the two investments could compare, look at the table below. At first glance, the property comes out slightly ahead. However, there are some important differences.

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