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Which is best: R3m home or investment fund?

Jan 31 2016 16:34

A Fin24 user wants to know which is best: buying a R3m house or rent and stay invested over the next two years in a fund where you can earn up to 12% return.

He writes: "Would you invest in property (around R3m) now or stay invested where you can earn a conservative 8% - 12% and rent for the next 2 years?

Property prices at the moment are so ridiculous and it’s not getting better with panic buying sustaining these prices. What do you think?"

Matthew Chapman, a CFP® Professional, of NFB Financial Services Group responds:

The answer to this question lies in the underlying assumptions of the question. Can you really earn a ‘conservative’ 8% – 12% for the next two years?

In South Africa we have become accustomed to double digit real returns over the past few years in multi asset portfolios, on the back of strong equity and listed property bull markets as well as bonds which have been earning returns in excess of inflation. What this has led to is an expectation of continuation from these asset classes. However, the dreaded asset management disclaimer can’t be pertinent now more than ever – past performance is not indicative of future returns.

The common view in the market place is that we have entered a period of global economic slowdown, with China failing to repeat the unprecedented catalytic global growth boom and a shift in US monetary rate policy leading to a lowered appetite for emerging market assets.

Historically, an expansionary monetary policy in the States, in the shape of near zero interest rates and a prolonged period of quantitative easing, has seen ‘cheap’ money freely flowing across the globe searching for yield. A fair amount of this money found its way into our debt and equity markets which led to a boom in local asset prices across the board.

However, as this strategy has now shifted to that of a contractionary nature (raising interest rates) investors are now not willing to accept the added risk of developing markets in the place of dollar security. Couple this with lacklustre local economic growth; our own structural and political issues and you have an equity market which may well be in line for muted returns in the short to medium term.

Furthermore, with inflation creeping up to the top of the SA Reserve Bank's target range of 6%, as well as a rapidly depreciating currency, we too have begun on a path of rising interest rates. This is typically negative for the bond market, especially in the longer dated fixed rate sector. In addition, our recent credit downgrade and flirtation with a further downgrade (this time to junk) has led to government debt becoming more risky and thus more expensive.

Therefore, as we expect more muted returns in the ‘high risk’ assets like equity and listed property, coupled with an inverse short term relationship for bonds, we would not expect a repetition of the extraordinary performance we have become comfortable with in your allotted investment time horizon.

Timing risk

On the other hand, in terms of fixed property, the expectation in the market is that again of somewhat muted returns.

Property prices and interest rates also tend to have an inverse relationship due to the increase in the cost of borrowing on floating rate debt (on which most home loans are based.)  You mention your time period is two years - I’m assuming you are going to be buying a property after this stage regardless and are looking for intermediate solution for your capital.

In this case, what you need to ultimately decide is whether you plan to stay in this property for the foreseeable future or are looking to sell in the short to medium term. If the latter is the case, I would wait for a stabilisation in the interest rate hiking policy and subsequent normalization of property prices.

If you are in fact looking to live in this house for a while, then purchasing a property is ordinarily more efficient than renting. Remember, depending on where you are buying and what yields are available, people with investment properties will try as much as possible to get the rental income to cover the bond repayments.

If you can afford the debt (or better in this case the full capital amount) then owning your own property makes a lot of sense. You could then use the excess monthly cash you would have spent on rent to build up an investment portfolio and in the time make use of rand cost averaging and thus reducing the risk of entering the market too early or too late.

Hope that helps!

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