By Johann Rossouw
The internet is littered with articles highlighting the numerous advantages of buy-to-let properties. If I had a rand for everytime I heard an iteration of “Why pay off your landlord’s bond when you can BE the landlord?”, I would have been a property mogul by now.
But is this really a sure-fire way to achieve financial freedom? Buy-to-let, as a strategy, has many drawbacks which aren’t often discussed in a South African context.
Buy-to-let refers to purchasing a property with the intention of renting it out to someone else. This has long been considered a popular investment option for those seeking to generate passive income and accumulate wealth.
The allure of a steady rental income and potential capital growth often attracts new entrants to the real estate market. However, beneath the promising facade of buy-to-let investments lie several pitfalls that could damage your chances of becoming financially independent.
1. Your tenant is not always your friend
One of the most significant risks of buy-to-let property is tenant risk. A low-risk tenant refers to someone who pays the rent on time, follows the terms of the lease and refrains from damaging your property.
Finding a low-risk tenant is easier said than done – and even the most reliable tenant is not immune to economic downturns.
Landlords need to thoroughly screen potential tenants – which can be a time consuming and expensive exercise.
Properties require regular upkeep to attract and retain tenants – a cost most buy-to-let investors fail to take into consideration and make appropriate provision for.
Issues such as plumbing, electrical faults, and general wear and tear can quickly escalate, consuming a significant portion of the rental income. Failing to adequately budget for these expenses can result in financial strain for you, as the landlord, and hinder the profitability of the investment.
Taxation and legal regulations can also significantly impact the profitability of buy-to-let properties. Governments may introduce changes in property tax laws, capital gains tax, or other regulations that directly affect rental income.
Buy-to-let properties are illiquid, meaning that it can be challenging to convert them into cash quickly.
In a situation where you need immediate access to your capital, you may face difficulties selling the property within the desired time frame. This lack of liquidity can leave you, as the investor, vulnerable during emergencies or when other investment opportunities arise.
4. Interest rates
A substantial proportion of buy-to-let investments are funded through debt, exposing investors to interest rate risks. If interest rates rise significantly (as they have done over the last two years), bond repayments increase, eroding rental income and profit margins.
5. Concentration risk
When you invest in a buy-to-let property, you are effectively tying up a significant portion of your wealth in one specific asset class, in a suburb of a single city in a single country. This means you are placing all your eggs in a single basket – the polar opposite of diversification.
The popularity of cities and suburbs can change over time and crime patterns or traffic can quickly turn a popular neighbourhood into one avoided by good tenants.
Have a plan
While buy-to-let properties have enticed many with the promise of passive income and long-term wealth, they are not without their risks. Economic fluctuations, unforeseen maintenance costs, problematic tenants, changing legislation, liquidity challenges, and interest rate risks all pose substantial threats to the financial stability of investors.
Before venturing into the buy-to-let market, potential investors must thoroughly research, plan, and evaluate the potential risks.
Creating a well-thought-out strategy, budgeting for contingencies, and staying informed about the property market and relevant regulations can help investors mitigate some of these pitfalls and make more informed decisions. It is also advisable to seek out the services of a suitably qualified financial planner, like one who holds the Certified Financial Planner accreditation, who will be able to guide you through the various considerations associated with this big decision.
Johann Rossouw is an Associate Financial Planner at Fiscal Private Client Services.
This article was published first on SMART ABOUT MONEY, an initiative by the Association for Savings and Investment South Africa (ASISA).
** The views expressed do not necessarily reflect the views of Independent Media or IOL.