Which is better: direct or indirect investment in property?

Private Property South Africa
Michael Bauer

If a person is considering investing in property, should he choose between direct investment (owning one or two properties that he physically rents out and manages) or indirect investment (shares in a property loan stock or unit trust company)? Either can be rewarding, but a person must choose the investment vehicle carefully and plan properly.

When buying property, and owning it 100%, there are pros and cons, as with everything. The advantage of owning a property outright and not in partnership with anyone is that it is yours and you can gear up to 100% of the investment (which means you own property without equity). You earn the future rewards of that property and have 100% decision making ability on that property. The disadvantage is that the risk is 100% yours - in terms of financial market risk (interest rates), business risks, and the risk of default when you have tenants.

There are also limits with this type of investment in terms of scale. The average person could perhaps buy to the limit of R2-million and then they have reached their borrowing capacity. The properties bought might not be A-grade property and because of the limitation in investment ability he might find it difficult to diversify and find avenues to invest in higher grade properties.

The other ways of investing without carrying such high risk, are investing in property loan stock companies and property unit trusts, which are generally good investment propositions.

There is also unlisted property syndication as an option but one must be very careful with these as they are not as easy to exit. If things go wrong with a property syndicate, it is difficult to get your share sold and if things turn nasty, it is possible that partners could try to force you out.

The advantages of investing in the indirect types of property investments is the larger scale the investor has access to. He can invest in a much larger portfolio, with better properties in the portfolio, and the risks here are shared. In addition, it is a passive form of investment, which means the investors does not have to get involved in the day to day hassles like rental collection, maintenance, etc.

A property fund will be managed professionally, which is a benefit and the investor will have an income from this in the form of dividends. Investing in this way also gives you steady capital growth as the underlying asset of the shares is property.

The disadvantages here are that the investment is equity based, you have to pay upfront for what you have and you usually cannot borrow much against shares.

With direct investment in property, the investor has the advantage of being able to gear it against other property investments.

Owning property and renting it out is not for the fainthearted. It can, and often does, become hard work and may involve a lot of time. If you’re investing in shares you have the benefit of not having to deal with tenants’ problems.

The two things to look at carefully are the funding being used for the investment and the strategy for investing.

Surprisingly, many people buy without a strategy; there is no business plan. If you’re building a property portfolio, you need to list the objectives behind investing, what income is needed from your portfolio and the time frame you will be taking to pay off the bonds. Plan ahead carefully and understand fully the commodity you’re investing in.

The benefit of investing in shares is that you can rely on a broker to assist you in finding the right investment and managing it properly. If you don’t have the knowledge initially it is still possible to invest in this way without the huge risk that direct investment holds. Ultimately it is better to put your money in something you understand fully and are able to manage properly. Remember Warren Buffett’s advice that you “Never invest in a business you can’t understand”, and get proper professional advice before investing into anything.

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