Buying My First House
My First Purchase
Starting out is one of the hardest ventures to embark on. I have watched my colleague toil with this phase for the better part of two years to no avail. The trick here is your ability to filter the mass of information out in the market on deduce what is useful for you.
Like any filtering process there are a few key points here which key to finding the right property for you.
What will you use the property for?
Investor (Passive): You can be a speculative investor who is looking for the market price to increase over a period of time. This is called capital appreciation and it is the most common return received by property investors as it requires a more passive management of the asset.
Investor (Active): You could also invest in the properties ability to generate an income. This requires more active management of the asset, the reason for this is in order to generate a monthly income from the property you will need to find a tenant for the space. This function of property management can be outsourced but that will have an impact on the returns received from the investment.
Residential (Passive): While this is not seen as an investment generally. There are many advantages of living in the property once you have purchased it. By living in the property you effectively earn yourself rent by not having to pay the rent to another landlord for the space. You will also experience the capital appreciation explained earlier. The major advantage of this route is that you are the tenant and the landlord. This means that you never have any complaints from the tenant and you Vacancy levels will be close to zero. It is also tax efficient because as there is no income being earned from the property you won’t have to pay taxes on it.
The "Flip" (Active): This involves buying a property that requires a level of tender loving care (TLC). The property is generally run down but in a location that has very good underlying property fundamental. The buyer here is looking to do a quick revamp and a small renovation and the end product is that of a similar standard to the new stock available on the market at present. Here a good understanding of the location, the market price of a certain type of space and a working knowledge of how to fix the property or the cost involved in the process are very important. This is by far the most difficult type of property to invest in, however if done correctly it can prove to be the most rewarding.
I am a naturally ambitious person so my idea was that I would combine both a Residential Strategy with a “Flip” Strategy to maximise my long term returns. I had very little clue about the mountain I was attempting to climb.
What type of property are you looking for?
House: This is a classic, these are free standing properties. These are generally the largest form of residential property and are the easiest in terms of renovating. A house might have a garden or a swimming pool.
Townhouses: This type of property is generally joined by one wall. The townhouse will also consist of two or three levels.
Apartment: These are generally smaller in size than houses, however they can be more desirable as their location is generally better and the lock up and go lifestyle is very desirable.
In Cape Town there has been an aggressive move towards densification of the cities around certain nodes. The choice to look for a slightly older apartment was an easy one as the potential wealth I could create for myself was a very attractive notion.
How much can you afford?
If you have recently won the lottery this is a rather easy calculation, go to your bank account and your balance should be indicative of the amount you can spend. For the rest of the "less" lucky souls out there you will need to raise a substantial portion of the purchase price from a financial institution, such as a bank. There are a number of criteria that the bank requires the lender (You) to provide.
Deposit: Different banks have different lending criteria; on average the bank will probably lend you around 80% loan to value (LTV). Please note that it is Loan to value and not loan to purchase price, banks general views on value and yours are often different and this is because they have to take a more conservative view to protect themselves. This means that your deposit will need to make up around 20% of the purchase price.
This can be calculated using your basic calculator: Deposit = 0.2 x Purchase price
If your available fund are equal to or more than the deposit you are well on your way to understanding what price range you are in.
Another what to find out your price range is to: Price = Deposit/ 0.2
I was able to string together around R 200 000. Using the equation above:
R200 000 / 0.2 = R1000 000
This meant that my total spending power should be around a million rand.
This is an indicative measure. For a more accurate gauge of affordability please consult your banker.
Mortgage Bond: To work out the amount that the bank will lend you on your own is an important part of understanding what you can afford. The banks value cash flow, for example how much cash goes into your account each month. The general rule for the bank is that one third of the borrowers (you) cash can go towards the payment the banks will need every month from your loan. The reason for this is that the theory is that by limiting the expense to one third the risk of the borrower defaulting is reduced. In reality i feel that this is a fantastic introduction when my first property I was initially quite annoyed by this limitation, however after a few months of my bond payment depleting my account I can say that I am grateful that it was limited to a third. I would suggest that even if your financial institution does not impose this one third of income rule that you as a buyer consider it.
An easy way of calculating your maximum payment (PMT) is: PMT = (Monthly income - tax on income)/ 3
My monthly income after tax income at the time was R 15 600 per month. This meant that the bank would consider around R 5 200 as my PMT.
The next thing you will need to know to is the interest rate that the bank will lend to you. Here you will need to consult the wise google on your countries prime lending rate. The prime lending rate is indicative of the lending rate given to the person who has the average lending risk. Therefore, if you have a good strong lending history then a prime minus one or two percent. If you have a lot of debt and have previously struggled to pay debt on time a prime plus one or two percent would be appropriate. A higher interest rate means that the expense of the loan every month is higher. This means the amount that you will be able to borrow will decrease.
The interest rate I was given from the bank was prime + 0.1%, which is a reasonable first time borrower rate. Prime in South Africa was around 9.5% at the time. This meant that my interest rate for the bond calculation was 9.6%.
Lastly you need to understand the term of your mortgage bond. If you are under the age of 50 the bank should give you a 20 year bond. If you are below the age of 30 the bank should consider a 30 year loan. The length of the loan is important as the longer the loan term the more you will be able to borrow from the bank.
As I was 24 years old the bank was more than happy to consider a 30 year mortgage for me.
The calculation for Mortgage loan amount is a bit too complex for a simple calculator. Here is suggest using a program like Microsoft Excel.
So far you should have:
- The PMT
- The interest rate applicable to you (i)
- The term of the loan (T)
Open Microsoft Excel and type the following into one of the cells:
Sub in your values for i, T and PMT and you should end up with the value of your bond.
Using the calculation for myself I was able to get R 613 092 as shown below:
Purchase Price: As the bank is conservative you have to realize that the bank will always try to lend you as little as they can so your limit will be:
Purchase price = Deposit + Mortgage bond
Provided that the deposit is at least 20% of the loan value.
My maximum purchase price was:
R 613 092 + R 200 000 = R 813 092
Where should you buy?
Location, location, location... a phrase used by many in the industry and one that still holds today. The underlying value in any property is due to the scarcity of land with similar amenities in a similar location. When looking for property one needs to understand that the underlying fundamentals of the location. There is also a reason that you as the buyer finds the location attractive but in order to ensure that the market value of the property holds you need to test that assumption and ensure that the market values the property in the same way that you do.
An easy question to ask yourself is, what is the reason I would live here?
- what is close to the property? An easy way to see this is to go onto google maps and to drop a pin in the property and get an idea of how close or far things are from your property. Where are the gyms, the grocer, the hospital, the schools, and the entertainment.
- Make a list of reasons other people would stay at the property. What people would like; what people would dislike.
- Visit the property at unusual times. Brokers learned many years ago that a property is not great at all times of the day, it could be noisy, get the wrong sun, have a funny smell.
- Find out more about the demand. Visit websites that show what properties in the area are renting out at, what they are selling for. Talk to different people about the area.
This is an important step as you need to understand who will buy the property from you. This also helps when renting out the space. Ensuring that you understand location helps reduce the risk of resale and marketability of your investment.
The areas I was particularly interested in was Claremont, Newlands and Rondebosch. The predominant reason for my interest in the area was the proximity to the University of Cape Town.
How do you buy?
Broker: The simple way of getting a selection of properties to buy is to approach a broker. They will "guide" you through the process of buying. Please remember that the broker receives a commission when the sale is made. The broker does not care about your happiness after the sale of the property so make sure you do the essential ground work yourself.
Website: Property websites are fast becoming the exchange point for property. They are fast, information is available, and selection is wide along with the commission for these website is becoming more and more competitive.
I used the popular website property24 for my analysis of the property options in the area. Through this I eventually was able to find the apartment I ended up buying.
The visit: Generally, you will have one chance to visit the property so it’s important not to be shy. Take your time, don't rush, and ask whatever comes to mind. Open cupboards, check that windows open, run the taps, tap on the walls, make sure that you as the buyer really understands what you are buying. Bring anyone who knows anything about property with you. It helps to have someone who is objective and can give you a perspective that has no interest in the property.
When visiting the property for the first time, I did not take my own advice I went by myself, I was very shy and I did not try out any of the fixtures. Luckily for me these all panned out to be fine, however I still have sleepless nights considering what could have gone wrong.
Information gathering: Here you need to understand that there are numerous documents that come with a property and you need to have line of sight of them before making an offer.
- Title Deed: The title deed for the property is one of the most important documents to get a hold of. This document contains all the rights and obligation of the property. Here you will be able to find out if there are any limitation to the property.
- Lease: If there is a currently tenant in the property, the obligation of the lease will transfer with the property, as a buyer you need to know what you are in for.
- Plans: The approved plans will show what the extent of the building is and will give you a better idea of the property you are buying.
- Body Corporate Rules: When buying an apartment, you will form part of body corporate. This is the effective entity for the entire apartment block. At the formation of the body corporate rules and regulation for running the apartment block are put into place. As an apartment owner it is important to understand the do's and don'ts of the apartment block and whether you can submit yourself to these rules.
- Body Corporate Financials: Every month the tenants pay a levy to the body corporate for the day to day running of the building. This will cover expenses such as cleaning, gardening, maintenance, water and rates and taxes. It is important here to make sure that the body corporate is spending the money that they receive in and that they are not over spending.
Here I was more on the ball and was able to gather all the appropriate information. The important piece of information here for me was to determine the rules around how the body corporate manages a renovation. If it is too onerous then it would make purchasing the “fix me upper” a no-go. The requirements of my body corporate are that I needed to get plans drawn by an architect and those plans needed to be approved by both the trustees of the body corporate and the City of Cape Town local authority. At the time I did not fully understand how long and tedious this process would be.
Making an offer: This is one of the key parts of purchasing a property. Once you have found a property that you are interested in it is time to engage with the seller over the price of the property. There are many different philosophies on making an offer.
- The Low ball offer: This is when you offer an amount that is far below the market value of the property. The idea here is to startle the seller into thinking he/she is asking too much for the property or in the hope that the seller is desperate and takes the first offer that they receive.
- The Fair Value offer: This is where you decide from the outset that the value of the property is X and you make an offer based on this amount. Here you need to be able to walk away from the property if the seller wants more but you know that what is being offered is fair.
- The Negotiable stance: This is when you offer a slight discount to the asking price in order to induce a compromise between the two parties.
You offer approach is important as it can lead to a successful purchase at a good price or a lost opportunity.
Please be careful when you prepare the offer to purchase (OTP). Make sure that the offer has an expiry period and that it is subject to obtaining a bond from a reputable financial institution.
The property that I put an offer in for was asking R850 000, my approach was based on the fair value offer strategy. My estimation was that the property was worth R20 000 per m². This mean that the extent of my property (40 m²) should be worth R800 000. The seller came back with counter offers twice which I turned down before he accepted the offer.
Congratulation! Your offer has been accepted: This is where you put all your hard work into practice. The most important part of this is finding a financial institution that will lend you the money you require. You can approach a bank directly or work through on of the many home loan originators. The documents you will need for this are your ID, your proof of address and your proof of earnings. This is a roller coaster ride... for the lucky few you will get accepted immediately no stress no fuss, for the rest you will be declined as banks won’t come to your values and will struggle to understand where your income comes from. This is why you need to make sure that your OTP is subject to bond approval.
Once you have a bond approval the transfer will be prepared by the seller’s conveyancers (This cost along with transfer duty will be for your account, so be careful).
The last leg is a waiting game. The local deeds office needs to register the transfer and this can be a very long process.
My reality was that three of the large banks turned me down based on the fact that the building was old and they could not find appropriate sales in the area. After my fourth attempt I lucked out and the bond was approved.
The total transaction costs were around R 35 000 which is considerable when looking at the total purchase price of the property.
After moving my way through this entire process I am happy to say that it is not the easiest thing to purchase ones first property but done correctly one can build an asset that is really worth owning.
The next step was to start my renovation.