Investing in Rental Property vs Unit Trusts: Which is Better?

Investing in rental property and unit trusts are two common ways to build wealth. While property offers rental income and potential appreciation, unit trusts often provide better long-term returns with fewer risks and costs. Below, we compare both investment types, including scenarios where an investor buys property with and without a home loan versus investing in unit trusts.

Scenario 1: Buying a Rental Property with a Home Loan

Let’s assume an investor wants to buy a R1 million rental property using a home loan.

• Purchase price: R1 000 000

• Deposit: R100 000 (10%)

• Loan amount: R900 000

• Interest rate: 11.75% (typical South African bond rate)

• Repayment term: 20 years

• Monthly bond repayment: R9 700

• Rental income: R7 000 per month

• Expenses (rates, maintenance, insurance, etc.): R1 000 per month

• Net cash flow: -R3 700 per month (shortfall covered by investor)

Even with rental income, the investor must cover a R3 700 monthly shortfall from personal funds. Over 20 years, this amounts to R888 000 in additional payments.

Assuming 5% annual property appreciation, the property will be worth R2.65 million after 20 years. However, deducting bond interest, maintenance, and selling costs significantly reduces the net return. The total net return will be R1.762 million.

Scenario 2: Buying a Rental Property Without a Home Loan

Now, let’s assume the investor pays the full R1 million in cash instead of taking out a loan.

• Initial investment: R1 000 000

• Rental income: R7 000 per month

• Annual rental increase: 5%

• Expenses: R1 000 per month

• Net monthly income: R6 000 (R7 000 - R1 000)

After 20 years, factoring in rental increases and reinvestment, the investor earns approximately R3.5 million in rental income. Combined with the R2.65 million property value, the total value is R6.15 million.

Scenario 3: Investing in a Unit Trust Instead

Instead of buying property, the investor invests the R100 000 deposit and R3 700 per month (the bond shortfall) into a unit trust earning 8% per year.

• Initial investment: R100 000

• Monthly investment: R3 700

• Investment period: 20 years

• Average return: 8% per year

After 20 years, the unit trust investment is worth R4.1 million—a competitive alternative to property.

If the investor had R1 million in cash (instead of financing the property), investing it in a unit trust at 8% per year would result in R4.9 million after 20 years.

Pros and Cons of Rental Property vs. Unit Trusts

Rental Property (Financed with a Home Loan)

Pros:

✔ Rental income provides a cash flow stream

✔ Property value may appreciate over time

✔ Ability to leverage borrowed money

Cons:

✖ High initial costs (deposit, transfer fees, bond registration)

✖ Ongoing expenses (maintenance, vacancies, tenant issues)

✖ Negative cash flow in early years

✖ Liquidity issues—selling takes time

✖ Total returns may be lower than other investments

Rental Property (Paid in Full)

Pros:

✔ No interest payments or debt risk

✔ Rental income generates positive cash flow

✔ Property value appreciation over time

Cons:

✖ Large upfront capital requirement

✖ Ongoing expenses and maintenance costs

✖ Liquidity challenges—property takes time to sell

Unit Trust Investments

Pros:

✔ Higher long-term returns with no debt risk

✔ Fully liquid—can withdraw funds anytime

✔ No maintenance or management required

✔ Lower transaction costs compared to property

Cons:

✖ No monthly rental income unless invested in income funds

✖ Market fluctuations can impact short-term value

Final Thoughts

If financed with a home loan, rental property can lead to negative cash flow for several years. Even if bought in cash, the return is similar to unit trusts but with additional risks and management responsibilities.

For long-term wealth creation, unit trusts provide higher returns, more flexibility, and fewer risks. Property can still be a good investment for those willing to manage tenants and expenses, but unit trusts offer a more passive and efficient way to grow wealth.

Disclaimer: This article is for informational purposes only and should not be considered financial advice. For personalised advice tailored to your specific financial situation, please contact us or one of our qualified financial advisers at Corona Financial Services.