First appeared in Daily Maverick 168

Question: I am thinking of buying some investment properties and using these to provide me with a pension when I get older. It looks good on paper, but there’s a spreadsheet and then there’s the real world. What are the pros and cons of going this route?

Answer: Investment properties can be a great way of building up personal wealth and funding your retirement. I have seen people make a lot of money this way, but have also seen people suffer financial hardship when property investments go wrong.

One of the big advantages of investing in property is gearing. Here you put down an initial deposit and take out a loan to pay off the property. Any capital growth that you get will be on the full value of the property rather than the relatively small initial deposit. You are therefore gearing up the returns on your initial deposit.

You then let the property and use the rental income to pay off the bond. By the time you retire you will have a paid-off property that will provide you with a pension.

On the surface this looks like a brilliant concept. An initial deposit has effectively secured you an asset that will pay you an income when you retire. However, as you mention, there is the spreadsheet and then there is the real world. Here are a couple of the downsides that you need to consider.

Property requires active management. You will have the hassle factor of dealing with broken geysers and automatic gates at inconvenient times. You also have the issue of dealing with tenants who may damage your property. If you want to invest in rental property, you need to be prepared to get actively involved or to hire someone, at a fee, to do this for you.

Your income streams are not guaranteed. There can be problems when it comes to collecting your rent. Many who are reliant on rental income were reminded of this during the lockdown, when tenants were unable to pay all or part of their rent. 

It is not that easy to evict a delinquent tenant, so you need to have a war chest that will cover lawyer’s fees and a couple of month’s rent should you have a non-payment problem. You do not want to be in a situation where you default on your bond and rates.

Property can be cyclical. I have lived through two “buy to let” booms during which the demand for rental property was strong and the capital value of houses increased rapidly. Unfortunately, these booms were followed by crashes in which the supply of property exceeded demand and people were stuck with empty townhouses for more than a year. Be careful about overexposing yourself. Run a couple of cashflow models under different scenarios. You must be able to survive if you have no rental income for a period.

Pensioners, especially when they get older, can do without the stress of managing property. They also need the certainty of a guaranteed income. Since the lockdown, several pensioners have sold their investment properties and bought life annuities. Annuity rates are attractive at the moment, so this is a good time for those pensioners who want to decrease their reliance on property income to make a change.

I recently had a case of a 70-year-old who sold a property worth R3-million. He bought an annuity that pays him R24,000 a month with an annual increase of 5% each year. The money is guaranteed and will be paid for the rest of his life. He no longer has to deal with delinquent tenants and home-maintenance issues.

If you choose to go the route of traditional retirement funding, you will get very generous tax breaks on your contributions. The investment growth will be tax-free, which is attractive. You won’t have the concentration risk of having your investment exposed to just one asset type — property. Your investment will be in a portfolio consisting of equities, property and cash.

So, to summarise, if you want to use property to provide you with a pension, you must be prepared to actively manage the investment. Do not over-extend yourself and make sure you have adequate cash reserves to handle the non-payment of rental, the eviction of tenants and household maintenance. 

The advantages of gearing and capital growth are certainly attractive. When you get older and managing the property becomes more difficult, consider switching out of property and take out a life annuity. Alternatively, you can fund your retirement the traditional way. DM/BM