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BOITUMELO NTSOKO: Today we’re tackling a common dilemma, choosing between two popular investment options: unit trusts or real estate. Both have their merits and drawbacks, but which one is the better choice for you? Joining us to discuss this further is Devon Card, who is a certified financial planner at Crue Invest. Welcome to the show, Devon.
DEVON CARD: Hi, Tumi. Thanks for having me.
BOITUMELO NTSOKO: To start, could you provide a brief overview of what unit trust and real estate investments entail?
DEVON CARD: Of course. I think it’s quite easy to explain what a real estate investment is. Very simply it’s the purchase of a property, whether industrial, residential, or commercial, where someone invests in a hard brick-and-mortar asset to benefit from capital growth and rental income, whereas a unit trust is probably the most common way people go about investing nowadays, where you invest through what is commonly known as a lisp [linked investment service provider] platform.
Read: Is it necessary to invest in property to build wealth?
These lisp platforms will have a whole array of different unit trusts that investors can invest in, where you buy units in a fund. They normally have fairly low barriers to entry and minimums are required to open these accounts. Investors can choose from investments – either local or offshore income funds, or bonds, property or equities – or a combination of these kind of assets, depending on what type of fund choice they select.
BOITUMELO NTSOKO: Let’s discuss some key points to consider when comparing the two options. First, liquidity. Why should investors have this top of mind?
DEVON CARD: Probably the most important point to consider is the whole liquidity conversation when it comes to these types of investment choices.
So with a unit trust you have what we call complete discretion where investors can invest either by a monthly debit order or do ad hoc contributions. Just as easy as it is to get money into the investment, it’s as easy to get money out. You can either set a regular withdrawal, where it pays you out on a monthly basis, or you can just do an ad hoc withdrawal where it’s obviously not instantaneous but has a couple of days’ turnaround time. You can have either the entire fund or a portion of the fund released into your designated bank account.
But with a property, obviously it’s a little more complicated than that. Once you’ve invested in the property, the liquidity that you have is fairly limited.
You obviously have a monthly cash flow, however you’ve structured your rental agreement with your tenant. The concern and sometimes risk that comes in there is whether your tenant pays on time, and the monthly costs associated with that property as well. So that’s got to be taken into consideration. And if as the investor you need access to funds, there’s no way to sell off a portion of your property; the entire property would have to be sold off for you to get your cash out. You can’t chip away a few bricks if you need to cash in a little bit and pay some bills.
BOITUMELO NTSOKO: Devon, another aspect is diversification. How does this compare between the two investments?
DEVON CARD: As I mentioned earlier, when it comes to unit trusts investors have a whole range of options. You can go quite specialised. You can invest in a 100% property fund, for example, where it’s all listed retail property or commercial property. But even in those funds focused on one specific asset you’re going to have diversification because that fund’s not going to invest in one property, for example. It is going to be invested in multiple properties around various countries across the globe.
Read: How much must I allocate to property in my investment portfolio?
And you can go diverse in what we would call a balanced fund – where you have some cash, some bonds, some property, some equity – again diversified across both local and global in various property shares and income-generating assets.
Whereas with a property investment, a real estate investment, obviously you are now hyper-focused and not diversified at all because you’re going to be investing in one single asset, one single property, in one very specific geographical location.
It’s not to say that that’s going to [diminish] your return, but obviously the risks are just that much higher where you are so super-focused and you don’t have much diversification.
BOITUMELO NTSOKO: We’ll get to some of the risks later on. But what are some of the key considerations for investing – the key tax considerations?
DEVON CARD: Like with anything, these are the taxes to be paid in various situations regarding what investment you make.
Property
So if we use the real estate investment option first, tax is applicable there. Your rental income, your rental yield, is obviously seen as taxable income. So that’s income that you’re going to have to report to Sars and pay income tax on.
Read:
What’s the most tax-efficient way to build wealth through property?
For tax purposes, can I set up a shelf company to buy property?
The other tax that you need to consider is what is known as capital gains tax.
The capital value of your property, one would hope, would increase over the years while you hold the property. And one day, when you decide to sell that property, the difference between what you purchased the property for and what it’s worth now – if you’ve had a capital gain – is going to have to be reported. There’s a certain calculation that goes on behind the scenes, and a portion of that gain is going to be included in your taxable income, and you’ll have to pay tax on that.
Read: Don’t make investment decisions based on potential capital gains tax
Unit trusts
When it comes to unit trusts, it depends on what type of asset class you decide to invest in. If you invest in cash and bonds, those assets are interest-bearing. So if you are earning interest in those funds, if you cross the threshold of your annual interest-free amount – R23 800 for anyone younger than 65 years – you’re going to have to add that amount to your taxable income, and again you’re liable for income tax.
Read/listen: Tax season: Do you know how your investments will be taxed?
And then when it comes to equities it’s much the same as the capital value on the property. There is capital gains tax that you need to take into consideration. So if you sell any units or there are any switches that happen inside the fund, that’s seen as a capital gains tax event where – if there’s any gain being realised, depending on the calculation if it’s above the annual abatement of R40 000 per year – there will be certain taxes applicable to that.
And if you invest in property as an asset class in your unit trust – they call it a Reit, a real estate investment trust – that also gets included in your tax return much like a property investment. If it’s generating certain rentals and income, there are taxes applicable to that as well.
Read:
How will I be taxed on unit trust withdrawals?
Can I switch unit trusts without incurring CGT?
Should I transfer funds from a unit trust to a tax-free investment account?
And then within the unit trust, especially on the shares side, there is dividend-withholding tax. So if there are dividends that are being generated by the shares that you hold, the service provider that you invest through withholds 20% withholding tax for those dividends, and they are paid directly over to Sars.
BOITUMELO NTSOKO: Let’s talk about costs and fees. Unit trusts typically charge management fees while real estate investments involve expenses such as property-acquisition fees and maintenance costs. How should investors factor these costs in when evaluating their options?
DEVON CARD: The great thing about unit trusts through lisp platforms is that these are quite transparent. So with any unit trust investment there are typically three fees involved. One is your admin or platform fee – that’s the service provider you decide to invest through, which is going to charge you an admin fee and will disclose the percentage upfront.
Normally that fee scales down the more funds you have invested on that platform.
Then, depending on what fund you choose to invest in, that fund’s going to have what’s known as an investment charge. These fees are all disclosed on all the various ‘fund fact sheets’ which you can go through when making these choices.
And then the final fee. If you have a financial advisor, the most common practice is that financial advisors will have an advice fee that they disclose with you upfront, which you agree with, and that will be [levied] on the investment as well.
Read:
Investment and performance fees 101
Navigating the investment fee landscape
Investment management fees and ‘double dipping’
All of these fees are percentage-based, so very simply, a percentage of your fund value will be used to pay fees, while obviously you hope as the investor that your fund that you invested in is growing by more than what you’re paying in in fees. But it’s quite clear and transparent.
On the real estate side there are a few things to consider. Obviously, you have your ongoing costs and fees such as maintenance and insurances. If you have a managing agent looking after the property as well, they normally take a fee as well. There are obviously the monthly taxes that you have to pay on the rental that you yield.
But the fees that are often forgotten are what we call the ‘sunk costs’ when it comes to a property. Those are the fees that you pay to the conveyancer when you are purchasing the property and doing the transfer.
You [may also] need to change the carpeting or put new windows in, or give it a new coat of paint. That’s not necessarily going to add value to the property, but that’s going to be an expense that you’re going to have to outlay that is often not taken into consideration when looking at the value of the investment and what that yield’s going to be from that investment.
BOITUMELO NTSOKO: Devon, for those leaning towards going the property route, how can they calculate the net return on their investment property?
DEVON CARD: Much like what we just discussed now on the fees. Basically when you’re looking to make an investment, what you are looking for is a return, otherwise known as your yield. So it’s your return on investment, often disclosed as a percentage.
There’s this – I don’t want to call it a myth – but a general feeling that because you invest in property, you have the capital value and you have a rental income, [so] it’s the best way to invest and get a return. And so there’s often a general feeling that it’s better than, say, a unit trust, for example.
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But to really work out what your net return on your investment is going to be is quite simple to do. Most financial advisors will have built some sort of spreadsheet to help their clients really analyse this information. Very simply, what you’re looking at doing is saying, okay, well there’s obviously an outlay, a capital outlay for the property and that’s your investment value.
Read:
Am I calculating the ROI on my rental property correctly?
What is the real return of your investment property?
Buy to let: How to lose 60% of your investment
Your return on your investment is going to be made up of two parts. One, it’s the rental income that you get, but you have to minus the tax that you pay, the insurances, the security of the tenant, the monthly agent fees that you have to pay and the maintenance that you have to do.
Something that’s also important when you’re forecasting those long-term yields is you need to take tenant risk into consideration. It’s very difficult to assume that someone [will get] 12 months’ rental income on a property in perpetuity.
Common practice is to assume you get 11 or 11.5 months of rental income on your property investment.
And when you take all of that into consideration you get a percentage yield on your property, and then you’ve got to add in what your capital appreciation’s going to be on that property. Of course where you invest will affect what that capital yield’s going to be, the property value.
But common practice around the globe – and history shows us this – is that on average property globally as a capital value will keep pace with inflation.
So basically you’re going to get your return on investment being inflation, which is your capital value in your property, plus the percentage yield, which is your rental income net all those fees.
BOITUMELO NTSOKO: Devon, both unit trusts and rental property come with their own set of risks. I know you touched on liquidity risk and tenant risk for property, so how should investors evaluate these?
DEVON CARD: As with building any financial plan or portfolio you can’t look at it in isolation. We’ve touched on all the risks.
So to maybe pull in the last point I made about that, that net return – normally what happens is once you get to that number where you see what your net return on the investment is going to be, you need to ask yourself, okay, ‘Well, am I willing to take the risk of owning a property, having tenants in, and running the risks of having a single asset in a single area for that return?’ You need to take your whole portfolio into consideration.
Read: Investing in property: The good, bad and the ugly
It could be a situation where you have other investments or other property elsewhere. And if you are already exposed to a lot of property – whether via your primary residence or a holiday home – and now you start investing in real estate as well, and you start looking at that overall distribution of your assets, you see that you are quite overexposed to property.
If property goes through a slump, like we’ve seen it do in the past, you run the risk of having a lot of your portfolio exposed to that downfall. Much the same as investing in a unit trust, it’s not to be done in isolation.
Look at your overall asset distribution map and see where you can find more diversification.
That, combined with the associated risks of each one, should ultimately lead you to make a well-informed decision around whether you [have an] appetite [for] the risks of either a unit trust or a property portfolio.
BOITUMELO NTSOKO: Devon, can you maybe give us an example that perhaps illustrates the possible returns each asset class can offer investors?
DEVON CARD: Sure. It’s always difficult as a financial advisor when clients say ‘What is the return going to be on this unit trust, or what’s the return going to be on this property?’ While the expression ‘You can’t look at historical returns to forecast future returns’ is very true, all we can do is look at what those asset classes have done historically to help us have an idea of what to expect moving forward.
Read/listen: Rental property vs listed equities: Which could make you rich?
And when we look at what history shows us, if we look at the four main asset classes – cash, bonds, property and equity – there’s a trend around each asset class in terms of long-term expected returns.
Very simply, cash is going to give you inflation-like returns, and bonds are going to give you inflation plus maybe 1% to 2%.
Then, when you move into your growth assets like property and equity, historically property around the world yields somewhere in the region of inflation plus 4-5% on an annual basis, whereas equity yields somewhere in the region of inflation plus 6-7%.
So, having run multiple calculations for clients looking at a property as an investment, it’s quite nice to see that when we take in all of those considerations and try to work out what those returns on investments are, we tend to see that theme pull through – that if you’ve got fair value for your property and you’ve got fair value for your rental, the return on investment tends to be somewhere around inflation plus 4-5%. Of course it varies depending on what your income tax bracket is.
Read: Express wealth creation: listed equities or financed physical property?
And then obviously, in unit trusts it all depends on what asset class you’re investing in. If it’s pure equities, you should expect inflation plus 6-7%. If it’s a combination and more like a balanced fund, you’d probably sit around that inflation plus 4-5% as well.
BOITUMELO NTSOKO: Would property unit trusts be like a happy middle ground between the two?
DEVON CARD: Yes. It’s always the reference we make. So if you want to invest in property and that’s something that you want to do but it’s not necessarily that you are trying to build a property portfolio, but you believe that property is where you want to have your wealth, it is extremely risky to invest in a single property and a single geographical location.
So investors can take up the option of investing in what’s known as a ‘property unit trust’, where you have the combination of exposure to that asset class, but also the benefits of the unit-trust flexibility where you can access your funds easily.
It’s transparent and you’re not exposed to just one property, but a whole arrangement of residential and commercial properties – so across both local and global geographical locations as well.
Read: Direct real estate vs property unit trusts
So yes, I would say that’s probably a happy middle ground for someone looking for property exposure, but alleviating the risk of having a single real estate property investment.
BOITUMELO NTSOKO: Devon, just lastly, what advice would you have for investors grappling with deciding which path to take?
DEVON CARD: The advice I would give is to try and make the most informed decision possible. The only way to do that is to have all the information that you can at your fingertips and to not only do the analysis once; it needs to be ongoing analysis.
Property values change, rental agreements change, market conditions change for equities. So when making these types of decisions it’s important to engage with your financial advisor, bringing forward all the information.
Your financial advisor’s not going to tell you that there’s a right or a wrong answer, but is going to go through exactly what we went through today in all the questioning that we’ve done, [to] help you understand the risks associated with each decision, what you should be able to expect as a long-term return from each option, factor in what your overall financial plan looks like – and then ultimately get you to a point where you can make an informed decision, one that you don’t regret later on.
Read:
The A-Z of buying investment property
A beginner’s guide to property gearing
How much must I allocate to property in my investment portfolio?
It’s often the case where you might make a decision that’s informed and right, but things could be different in two or three years’ time. The property market might change or the investment market might change or your financial situation might change, and you’ll need to make an adjustment to your retirement plan and your financial plan.
BOITUMELO NTSOKO: Alright. Thank you so much for joining us on this episode, Devon.
DEVON CARD: Absolute pleasure. Always good to be here.
BOITUMELO NTSOKO: That was Devon Card, who is a certified financial planner at Crue Invest.
Listen to previous Money Rules podcasts here.
