Property rewarding for astute investors, but note the warning label
Owen Holland, Business Partners property investment general manager, understands why business owners who find themselves in the harvesting stage of their careers often look to the property industry to invest their surplus income.
It is one of the few industries which allows for a certain degree of passive return on investment. Any other business, from a coffee shop to a consultancy, requires a huge amount of blood, sweat and tears before it starts bearing fruit.
Not so in the property game, where it is theoretically possible for even an amateur investor to get a decent return in the very first year of investment, and it can require as little as one day’s work a month to meet with the property management company appointed to take care of the asset. For any business owner who has surplus cash to invest without wanting to start an all-consuming new venture, building a property portfolio is a valid and reasonable strategy.
But Holland slaps a huge warning sticker over the whole idea: “The property game is simple, but one mistake can wipe out millions,” he says.
Ordinary business folk who drive through any South African city and see the numerous unfinished development projects that have ground to a halt may think to themselves: “Shame, the financial crisis treated them badly.” But Holland, who manages a property portfolio of R1bn and has been in the property business for decades, responds differently, and thinks for example: “That one must have got the zoning wrong” or “That one possibly had something wrong with the title deed”. There can be any number of potentially expensive pitfalls when conducting pre-acquisition due diligence processes.
The danger to inexperienced investors is how to avoid buying a bad property, or paying a price that doesn’t take into account hidden defects or expenditure required on future upgrades. There are a myriad of pitfalls that the amateur property investor may not even consider. Zoning and demarcation issues are just two possible traps. A building may have structural defects, the area may be deteriorating, access or parking could be difficult, or the power supply problematic, the very soil of the property may be contaminated.
Then the investor has to tackle the issue of leases, making sure that they are strong enough to protect the investment and confirming that the tenants that come along with existing buildings are all that the seller makes them out to be.
As long as first-time investors are aware of the dangers, acknowledge their lack of experience, and appreciate the critical importance of a thorough due diligence before buying, the property industry can be fertile soil for those who want to build up a portfolio of investments, says Holland. An investment in property may be easy to manage once you own it, especially if you outsource the routine management to professionals.
Start by giving some careful thought to your game plan. How big are you prepared to grow your portfolio, and how soon do you want to get there? If your targets are too ambitious, you may make mistakes by rushing into deals. If you are too careful, however, you will never get a portfolio off the ground because you are too picky. An astute property investor must find a balance between the two.
You will need to contemplate the kind of property you want in your portfolio: retail, industrial or offices. Business Partners, for example, prefers not to invest in office complexes as they have had excellent results by focussing on industrial and retail properties. Depending on your risk appetite, you may choose to invest in what Holland calls “pure return” properties – those with stable national tenants and ten-year leases. The price will be high but the risk is low.
The market also impacts on other aspects of your strategy. If existing buildings are in short supply because property is in demand, as it currently is, you may aim to invest in new developments. On the other hand, you could go the riskier route of buying a poorly managed property at a lower price and turning it around, which initially will entail a higher degree of management involvement.
Do not count on a good deal “falling into your lap”, says Holland. The harder you work at it, the better the property you are going to find. It entails “tramping the streets”, networking, building relationships with reputable agents and researching the market.
Financing and gearing also form an important part of any property investment strategy. High gearing – bonding your existing properties to the maximum in order to buy more – allows for faster, but more risky growth as cashflows then come under pressure.
As you begin growing your portfolio, you need to make sure that your management structure grows with it. Even if you outsource the day-to-day management of the properties to professional agencies, you have to ensure that they manage your properties optimally. “You need a strong team who ensure that the property is managed to its maximum potential otherwise you are not going to get your returns,” says Holland.
Because of the large amounts of capital required, property investment often takes place in joint ventures with other property investors or business owners, but co-investing opens a whole new set of risks. Choose co-investors with high levels of integrity and make sure there is a clear, wide-ranging shareholders’ agreement in place that covers everything from decision-making processes to buy-out arrangements. To avoid debilitating disagreements, Holland advises that any group of co-investors must agree upfront to appoint one decision-maker – preferably the one with the most property experience – to manage the investment.
The property game can be very rewarding to those who go into it carefully and prepare for the risks. Holland says reading up on the industry and asset management will help, but experience is most important. Beginners should seek out experienced property investors in their networks and ask them regularly for advice and guidance.