Question:
My mom just passed away and left her assets, which includes a house, to us four kids. A family member suggested we rent the house out and put the rental money in a trust.

I would like to know if this would be a good move and what the pros and cons would be.

Answer:
There is little doubt that letting a property can be financially rewarding. As is the case with any business asset you do, however, need to accept that this will also mean that you will be exposed to certain risks and liabilities. You therefore need to determine whether the financial reward will justify the work and risk associated with the property.

So, what are the rewards of investing in property? There are two aspects we need to consider here: The income (rent) and the capital growth (rise in value over time) of the property itself.

You could use a bank index — not a real estate agent — to get an objective idea of the long-term growth you can expect for properties in the area. You then need to take the rental income into account, which will be taxable in your own hands. After a fairly conservative marginal tax rate of 30 percent, a rental income of, say, R7500 will come down to R5250 per month. From this you will mainly need to deduct your letting agent's fee, maintenance cost of the property, insurance costs and occupation risk (those possible few months when you might not find someone to rent the property). This will leave you with a basic net income expectation. By adding this to the capital growth, you will get a good idea of the yield or return you can expect over time.

If this does not compare favourably to other investments such as shares or a diversified portfolio, it could make sense to rather sell the house and invest the proceeds.

As far as the risks are concerned, you must remember that your property investment will be in a very specific sector (residential property) in a very specific economy (South Africa) with very specific risks associated to the asset itself (i.e. damage, occupation risk, specific costs, prospects of the residential area, etc.). There is nothing that you will be able to do to diversify away from these if you choose to keep the home, so ensure that your potential return justifies the risk.

In my experience, the more human aspects of the arrangement you are proposing are also challenging. The assumption that all your siblings will continue to want the same thing from the same asset over time could be seen by some as optimistic.

In terms of whether a trust is an appropriate vehicle for the proceeds, there are a few questions to consider. The purpose of a trust is mainly to minimise estate duty, offer protection from creditors (and predators!) and manage wealth for the benefit of others.

From a financial perspective, the registration and annual maintenance of the trust will have to be deducted from its assets. This will also impact on the returns you can expect from your trust assets, especially in the first few years or so. You also need to consider that the main asset, the property, will continue to grow outside the trust and consequently you will each be liable for estate duty in your own capacities. You will also need to think about the practical consequences if something should happen to one of your siblings.

To summarise, I suggest that you ask yourselves the following questions:

1. Will the growth we get from the home justify the risks? If not, sell the home and split the proceeds. This will allow each of you to use the money in your own best interests (e.g. settling debt or investing in line with your personal financial objectives).

2. Will our personal family dynamics and relationships sustain a joint strategy over time?

3. Will the benefits of a trust justify the cost and inconvenience of registering and managing it?

4. Do all four of us need a trust?

5. If we want to use the money to the benefit of our families, would it not be cheaper and easier to rather insure our lives with the income the home generates?

6. What will the consequences be if one of us passes away?

By starting with the above questions, you should hopefully get a clear idea if this is really the best long-term solution for all concerned.

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