{UAH} Is it worthwhile anymore to invest in rentals ?

Is it worthwhile anymore to invest in rentals ?
Original article by Mr Nantagya. Edited heading!
I often find myself amused and disappointed by the amount of retail investor liquidity that is held up in residential and to some extent commercial real estate. I would love to believe the issue is not the overpriced gratification that comes with being called a landlord, but rather a flawed investment appraisal model.
So, I bury myself in spreadsheets working to find that missing logic in my investment appraisal model that seems to churn out a somewhat guaranteed return, principal protected, divisible, tax efficient and risk-free investment asset option over the illiquid, indivisible, laden with occupancy assumption, heavily taxable and risky investment option called real estate.

Perhaps, let us do some back-of-the-envelope number crunching together. According to Knight Frank Kampala-Market Update 2018 report, for a Kampala suburb dwelling demanding a rental income of Shs1.5m, one would need to part with Shs300m to take ownership of the same.

Among the deductions against income – 90 per cent assumed occupancy, annual KCCA rental income tax of Shs2.3m (20 per cent tax charge having made KCCA deduction assumptions for costs and occupancy) and 10 per cent costs (repairs, administration and security) – combined to give a mind-blowing 4.03 per cent return per annum or Shs12.2m.
Compare this net return with that of a 15 year treasury bond – currently returning 14 per cent and attracting a final withholding tax of 10 per cent. This would give a final return of 12.6 per cent. So clearly the numbers have the landlord up against the wall but why does this asset class continue to tie up so much capital for retail investors despite the obvious inefficiencies.

For starters, most landlords are not doing a thorough appraisal of their investment options before deploying capital into this asset class. Speaking to a few house brokers the rule of thumb for property valuation is that cost should amount to the total monthly income over 120 months (10 years) – in our example above the value of the property would be Shs180m so either the rents are too low or the property is simply overvalued, the jury is still out on this one.

If landlords did these thorough appraisals or engaged an investment advisor prior to making such large investments, we would see more capital directed towards options yielding better return (in this case government securities) and with time the yields on government bills and bonds would dwindle as a derivative of the increased demand and in turn lending rates – another discussion we can have all day.

Circling back to the Covid-19 and the real estate sector; I did note that one of the attractive attributes of the bond and money markets was the divisible nature of the asset class. If I needed a portion of this investment, I can simply sell a portion of it without affecting the entire investment. This is not the case for real estate – one would need to liquidate the entire property only to access a portion of their capital. Granted, there are products to allow for divisibility but these come at a cost.

Many landlords today find themselves on the end of honest excuses for tenants not to pay rents for the last four to five months coupled with a presidential plea not to evict.

This has been the true test for this asset class, a tough lesson on why we need to keep exposure to this asset class at 10-15 per cent of our total investment portfolio with a bias toward undeveloped real estate. We need to get past the pride society bestows on landlord.

Mr Nantagya is a financial markets and investment professional

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"When a man is stung by a bee, he doesn't set off to destroy all beehives"

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