Buying an investment property before purchasing your own home may actually be more feasible and accommodating to your lifestyle than the traditional approach.
Blogger: Andrew Cull, founder, Sound Property Group
‘Save to buy your home, move to where you can afford and then work hard to pay it off’ – this idea has been instilled in Generation Y and the Millennials from their parents’ generations. However, in cities such as Sydney where average house prices are now hovering around the $1 million mark, is this still achievable and desirable? Is there another way to get on the property ladder that may actually be more feasible and accommodating to your lifestyle? The strategy of investing before purchasing your own home may seem like a backwards approach, but it can be the smartest way to gain property ownership in the current economic climate.
A recent study by REST Industry Super of 1,000 young Australians showed that an alarming 80 per cent of first home seekers are unable to get into the market. Worse still, those who don’t own their own home when they retire are at a higher risk of poverty and welfare dependency. Strong price growth in many capitals including Sydney and Melbourne, fuelled by a low-interest-rate environment, has squeezed affordability to a record low. Many of those lucky enough to have a sizeable deposit are being forced to make sacrifices on size and features, or to buy where they can afford rather than where they want to live. Pushed further away from their employment, desired lifestyle and social network, they are left dislocated, with the arduous task of paying off their far-from-dream home over the next 30 years.
From a financial perspective, rental yields in Sydney and Melbourne have been compressed due to the recent price growth to an average of 3.4 per cent and 3 per cent respectively. It may now be cheaper to pay this rent than to buy and pay a 4 per cent-plus mortgage, as well as other non-tax deductible expenses such as body corporate and insurance. However, the question that then arises is how to reclaim this ‘dead’ rent money.
‘Rentvesting’ is a relatively new term that is being used to describe the action of buying property in an affordable area and renting it out to pay the mortgage, while renting in an area that you would like to actually live in or that makes more financial sense. Identified as the “most common new buying habit” in LJ Hooker’s The (new) Australian Dream white paper last year, Google Trends has also shown that the term has tripled in search requests.
A recent Mortgage Choice survey found that a third of investors in 2016 were first-time buyers who had not yet bought their own home – people renting where they want to live and buying where it’s smart to invest.
Tommy Lim, director of SF Capital, an awarded Sydney mortgage firm, has assisted many clients in executing rentvesting strategies, particularly young professionals who are excelling in their careers.
“In our experience, renting sensibly and purchasing a well-considered investment property has resulted in several financial and lifestyle benefits for our client,” Mr Lim said.
Types of rentvestors
There are a couple of types of rentvestors: young people utilising the strategy and saving for a first home, as well as an increasing number of professionally employed people of all ages taking advantage of tax breaks and creating wealth through property investment rather than ownership. Mr Lim also commented that rentvesting allows many clients to remain “globally mobile” – pursuing either valuable work experience or further studies in overseas markets such Hong Kong, London and the US.
Advantages of rentvesting
- Flexibility – Renting gives you the flexibility of not being locked into an owner-occupier mortgage. You are free to travel and move around, or upsize should your family grow at any time.
- Lifestyle – Rentvesting may be less financially strenuous, by investing in a cheaper market and gaining access to the various tax concessions currently available.
- No compromise on location or size – Many first homes are not ‘dream’ homes. They are often located where buyers can afford, and are further from work, amenities, family and friends. Also, to fit a budget, various other features such as the number of bedrooms, car spaces or bathrooms may be sacrificed.
- Enter the market sooner – Instead of saving and saving to buy where you want to live, you may be able to continue renting and enter a market elsewhere straight away. History shows that a well-selected investment property can quickly outperform average saving abilities.
- Potentially better capital growth than local area – The performance of a property in your desired area may not produce the equity gain needed if you are looking to upsize in the future.
- Tax deductions may lead to extra income to assist with rent – In today’s interest and tax environment, there are many investment properties that will produce a positively geared cash flow that may be used to supplement personal rental expenses.
- Reclaim ‘dead’ rent money – If you are renting and not investing, then your rent money is not working for you in any way. Investing in a property and receiving rent from a tenant will offset this ‘dead’ rent money and also provide some capital appreciation.
Disadvantages of rentvesting:
- At the mercy of your landlord – If the landlord decides to sell then you may be forced to move.
- Can’t make alterations or renovations to your home – As you don’t own the property it may be harder to alter the dwelling to your taste or requirements.
- Capital gains tax if you sell – Currently, if you sell an investment property there will be capital gains tax to pay on any profit (a 50 per cent discount may apply on property held longer than 12 months). Owner-occupied homes are exempt from any capital gains tax.
The rentvestor mindset
Before you can begin to rentvest, you have to have an honest think about your relationship with debt, and make the distinction between ‘good’ debt and ‘bad’ debt. In life it is very easy to spend more than you make, through taking on debts such as car loans, credit cards and other ‘necessities’ sold by crafty marketing firms. Buying property requires you to take on what will probably be the biggest debt of your life to date. It would be easy to add this debt into the same basket as the bad debts mentioned above, but the big difference with property, or any well-selected investment, is that the asset you have purchased should be appreciating in value, not depreciating like the latest iPad or BMW.
Tip: The required mindset for rentvestors has to include an understanding of both ‘good debt’ and the power of leveraging ‘other people’s money’ (such as the bank’s). It is also important to understand your risk profile, and select an investment property that is reflective of this in terms of the size of debt and location of the property.
After all, rentvesting is meant to enhance your lifestyle, not make it harder to sleep at night. The rentvesting concept is counter-intuitive according to past social norms, requiring a thick skin to ward off the naysayers conditioned to a life more ordinary.
Quite often we see rentvestors firstly drawn towards what we call ‘comfort investing’. If they can’t afford the average property in their local suburb, then they start to compromise. Often these compromises include buying a cheaper one-bed or studio apartment, or looking to the closest suburb that they can afford. It is important that once you have made the decision to invest, you draw a line in the sand and avoid looking at places you might be able to move into. Assessing property in this light will only put buyers somewhere in the middle – not in the best investment, nor the best home to occupy. Make your decision to either invest or buy as an owner-occupier, and stick to it.
If you have made the decision that rentvesting is the smarter strategy for your situation, then it is important to do your research on the investment in order to reap the best results and reduce risk. Not all properties are created equal, but there are fundamentals you can look for to ensure consistent, stable growth and less risk.
Skyrocketing house prices and the desire to still enjoy one’s lifestyle is creating the emergence of ‘generation rent’. Those who want their money to work harder will be considering the new practice of rentvesting. There are the obvious downsides of the rentvesting strategy, such as not being able to paint the walls your favourite colour and having to move if the property is sold; however, these items seem a small price to pay for taking control of your financial future by creating wealth, freedom and flexibility. This is especially important as the benefits created by rentvesting could also include growing your deposit to buy that dream home down the track, not to mention extended holidays or even early retirement.
Are you ready to get off the fence and capitalise on the lowest interest rates in history to rent your way to the top of the property ladder?
About the Blogger
Andrew Cull is the director and founder of Sound Property Group, a property investment and education company that sources strategic real estate investments tailored to client’s individual needs. He has had a decade of experience in the real estate industry and has a wealth of knowledge to share. His Professional Services Program was created to help diversify and add value to the mortgage advisor’s client offering by having an end-to-end property investment solution. He has been involved in hundreds of successful property transactions with clients, and has developed innovative systems to ensure clients take action and secure property that provides for their tomorrow.