Q: What are the legal implications of setting up a trust?
There are various types of trusts ranging from a general trust to trusts with specific purposes, such as a Trading or Property Investment Trust, the latter is set up purely for the purpose of holding property. Regardless of the type of trust, all are created by setting up a Trust Deed, which is done by the founder of the trust and must include why the trust exists, how it should be run, and who the beneficiaries are. A trust is its own persona, with its own taxation regime.
Trusts are managed by Trustees, and it is recommended that there should be at least three Trustees to ensure the trust is considered to be an independent entity. It is also advised that one of the Trustees should be a professional independent trustee, such as an attorney or an accountant.
Q: Who ideally should be part of the trust?
Often a Property Investment Trust is created by a family to house investment properties, and is to be managed for the benefit of the beneficiaries.
Commonly, the three Trustees include a mother, a father, and a non-related party such as a trust company or other professional person – even a trusted friend of the family - and the beneficiaries will likely then be the children to whom the expected benefits would flow.
Q: How do Trusts play a role in property investment?
Trusts allow investors to place their investment portfolio outside their own estate. This is done for a number of reasons, including:
- Estate Planning: to ensure the investment property is not included in their estate at death and the related associated taxes and expenses, and benefits continue to flow to beneficiaries.
- Risk Management: when a person is concerned that their normal business has an element of credit risk that could lead to creditors attaching their assets, and they want to keep these assets outside of their personal balance sheet.
- Tax efficiency: done correctly, with the right advice, trusts can offer improved tax efficiency on their earnings.
These three strategies allow investors to benefit from trust structures, without actually owning the property.
Q: What does a good cash flow indicate relative to property and why is it important to ensure continued and efficient cash flow?
Property investment provides benefits in both building an asset portfolio, as well as deriving cash flow from these assets. However, a balance needs to be met between building a healthy asset portfolio comprising good quality properties in areas where values will be sustained and ideally see growth, as well as such properties providing good cash flow that exceeds the monthly running costs of the properties.
A great property, with negative cash flow, will be a drain on an investor’s other income, and in many cases is then considered a liability. An investor’s primary aim should, therefore, be to target positive and sustainable cash flow income, whether this is a net rental after expenses, or the profit from selling a property after a FLIP (ie. a buy, renovate and sell strategy).
Q: How best can an investor manage cash flow to ensure property investment goals can be achieved?
It’s all in the numbers! An investor should understand the expected income and expenses associated with the property they are considering purchasing. Expected rentals can be obtained from local letting agents as well as examining property rental portals, such as Private Property, for a specific area.
TPN is another site that provides an invaluable Investor Report. This report lists details pertinent to a suburb, the expected rentals across several property types, the type of tenants living in the area, the levels of rental payment, etc.
Before purchasing a property, an investor is advised to request from the agent or seller, the Rates and Taxes, Utilities, and Levies bills that the property has been incurring to date. Thereafter add in the expected Homeowners Insurance, monthly and annual maintenance costs, and other running costs.
Based on this formula, an investor will then have a good idea of the expected cash flow that can be derived from the investment property, to inform their decision-making prior to making the offer to purchase.
Q: Should a property investor be consulting with financial advisors?
By their very nature, property investors generally have a long-term outlook and appreciate the benefit of medium- to long-term financial planning. Obtaining financial advice is key to achieving financial goals and aspirations, and in being able to check that the investments are on track, and ensure that the investment, whether it is a property or funds, works hardest to achieve the goals.
A financial advisor also allows investors to appreciate the implications of long-term decisions being made today, whether it is tax, estate planning, or even just an understanding of the opportunity cost of investment funds in a current project, as opposed to leaving it as an investment to reap the multiplier benefits of compound interest.
Q: Can you provide an example of a property investor's goals and cash flow implications?
Many property investors have the goal of financial freedom with property investing as the main contributor. This can, in effect, mean a property investment covers car payments, an annual holiday, or even match a salary so that there is no need to commit to a working job.
Goals by their nature need to be specific and should be time-based. Having a clear idea of the cash flow you want to achieve, and what it will be used for, therefore gives clarity and provides motivation. For example, if you want a property investment to fund the annual family holiday, which has a cost of R20,000, the rental property will need to achieve a little more than R1,600 pm in net rental.
It is important to remember that tax needs to be paid on the rental profits.
Q: What is your overall take on property investing as a concept?
Property investing tends to be a long-term endeavor, with the benefits only realised after several years. R1,000 extra pm won’t make a significant difference in many people’s lives, but when the portfolio is increased, and this grows to R5,000 pm over a couple of years, it will contribute to your monthly utilities, a car payment, schooling or help you pay off your primary residence home loan sooner. There are many property investment books and online portals providing information. I recommend subscribing to those and accessing quality podcasts and video channels to obtain the best knowledge. Or you can consult with an Absa financial advisor who will set you on the right path to help you reach your financial goals sooner and in a sustainable manner.