Property investments are growing as a staple in many pedestrian investors’ portfolios.
This often takes the form of informal structures which do not adequately consider the attendant legal, governance, and tax factors.
Some of the main problems that can arise with informal property investment structures are:
- Loss of income to taxes, fines, and fees.
- Inefficient management of costs.
- Uncertainty of income distribution.
- Drop in property value due to poor management.
- Inconsistent collection of rentals.
- Losses due to premature lease terminations.
- Exponential legal costs due to incorrectly executed evictions.
A potentially optimal structure is one in which the individual or partners sets up a Trust, which in turn owns a Company that ultimately owns the Properties.
The benefits of such a layered structure include:
- Relative tax efficiency in respect of not only income tax rate but also capital gains tax and inheritance tax.
- Certainty in succession planning as the ultimate holder is a Trust which is an effective entity to manage.
- Centralised ownership of properties which reduces the possibility of an individual’s personal credit record scuppering financing alternatives.
- Easier accounting of the costs of property management, and upfront clarity on the distribution of income.
Whilst such a structure is more costly to set up and maintain than an informal arrangement, the efficiencies that it generates justify the administrative cost.
Enhanced by the appropriate agreements and governance practices, such a structure mitigates – if not eliminates – the problems of an informal structure.
Structuring property investments informally, in your personal capacity (or that of one or more partners) is a cheap solution that has some disadvantages.
- Adverse tax consequences if income is deemed to be personal income, which is generally taxed at higher rates.
- Personal financial profile may compromise the opportunity to leverage the existing equity in the properties to raise funds for growth.
- Complications in respect of succession planning in the event of any ‘key-man risks’ materialising.
- In partnerships, a disproportionate allocation of liability to the individual that ‘owns’ the property.
Informal investment structures tend to favour self-management of the property portfolio to minimise upfront costs.
Whilst this is cost-effective upfront, it can lead to complications on how to place a value on the activities of the investor or partner tasked with property‑management.
Furthermore, as the portfolio grows, a self-management structure may become ineffective as the workload becomes inordinate.
The alternative to self-management is to engage a professional/agent to manage the property at a commission that is usually a percentage of the rental amount.
The advantage to the investor/s is that they have a full-time professional managing the properties, but there are some key issues that may lead to disputes –
- Tenant acquisition
- Commission and any other fees payable
- Appropriate service-levels
- End-of-contract procedures
- Post-contractual obligations
Whether the investor/s opt for a self-managed or agent-managed structure, the terms of property management must be carefully negotiated and agreed.
Property leases are deceptively simple documents considering the multi-faceted nature of the relationship that they seek to govern.
The issues to be particularly wary of for a property investor primarily relate to the –
- regular payment of rentals and other fees;
- devaluation of the property by wilful or negligent conduct of the tenant;
- conduct that may negatively affect an insurance claim in the event of the destruction of the property;
- early termination of the lease; and
- liability for make-good repairs upon termination of the lease.
Whilst there are many passable templates that are available online, it is aways prudent to have a lease drawn up by legal advisors.
Investors must take note of all the provisions of the Lease/s and actively manage ongoing compliance therewith.
Property investors must be cognisant of the provisions of the Prevention of Illegal Eviction from and Unlawful Occupation of Land Act (“PIE Act”).
The main aim of the PIE Act is to protect both owners and tenants by detailing the procedure by which the lawful eviction of unlawful occupants.
A tenant can be unlawful occupier as defined in the PIE Act if the tenant’s continued occupancy is without the express or tacit permission of the owner of such property.
For an eviction to happen lawfully, an owner must –
- give the tenant notice of the owner’s intention to apply to court for an eviction order;
- apply to the court to have a written notice served on the tenant stating the owner’s intention to evict the tenant; and
- procure service of the notice by the court on the tenant and on the municipality in which the property is situated, at least 14 days before the date of the hearing.
Whilst property investments are universally acknowledged to be safe havens for growth, prudent investors must ensure that they structure their investment vehicles appropriately to mitigate and/or avoid disputes with partners, agents, and tenants.
