ILU – A much better way to buy-to-let

Many affluent South Africans are firm believers in owning additional properties, which they rent out to tenants, the buy-to-let strategy. This is a solid strategy, which offers good long term returns at low risk, an understandable business model and has made a few people very wealthy.

I myself own a two-bedroom property in Centurion, which I purchased for R 640,000 two years ago. The monthly rent is R6200, but after I have deducted rates, taxes, agent’s fees and levies, I am left with R3700, an annual return of 6.9%. That is if the tenant pays, no repairs are required or any other unforeseen events occur.

Indluplace Properties (ILU) is a listed REIT (real estate investment trust) that owns 5,500 apartments and manages them on the shareholder’s behalf. Their properties are worth R2.3bn and they have 97% occupancy. At this scale their risk is diversified and maintenance is centralised. ILU paid a dividend of 93c in the last year, putting them on a yield of 8.9%, a full two percentage points higher than my buy-to-let property.

“But, Mr Business Musings”, you may argue, “you do not understand the purpose of buy-to-let! Have you considered: “

  • “My property is in a fantastic location and is sure to go up in value.”

ILU own bachelor, one and two bedroom apartments, which are 90% in Gauteng, particularly in the revitalising inner cities. I have previously explained how demographics are almost certain to positively affect property prices in this province. If the value of ILU’s properties goes up, so will the share price and the yield. If my view of the fundamentals of the property market changes, then I can sell my shares within a day. If I wanted to sell my property in Centurion, that would be a far more difficult and expensive undertaking.

  • “My rent goes up every year, my bond costs stay the same”

As rents go up, so will the funds that ILU has available for distribution. The costs of debt change for both you and ILU in line with interest rates. Although, it is likely the ILU – as a billion rand company – will get better interest rates than you.

  • “You are ignoring taxes in your assessment!”

Taxes are the same for rental income and dividends paid by REIT’s. Both are taxed at your marginal tax rate. You can offset your interest rate on your bond and your property expenses, but ILU is doing the same, before they pay out their remaining cash flow in dividends.

  • “You are forgetting the benefits of gearing!”

Indeed, this is the only good argument I have heard for buying your own rental property. A deposit of R100k means that if the property increases in value from R600k to R700k, you have doubled your investment. ILU is mostly ungeared, their debt is only 10% of assets. However, I do not regard this as a negative. I believe this offers them room for massive growth in shareholder returns. As their debt-to-equity ratio is increased, they will more closely approach this last benefit offered by buying your own property.

In fact, I am convinced that management is keeping their debt low in preparation for a juicy acquisition at current low property prices. In the forecast of the previous annual report:

“The board is confident that ample opportunities for acquisitions exists and that Indluplace will grow the portfolio substantially over the next few years notwithstanding the current financial climate”

It is therefore not surprising that they are currently trading under a cautionary announcement, pending the announcement of a transaction.

I never tire of taking joy from directors holding shares in the company, in this case 7.3%. Cornerstone and founding investor Arrowhead Properties hold 60% and are likely to provide strategic guidance and direction for the moment.

 

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