The traditional sentiment of owning your own castle has long been the Great Australian Dream however, savvy investors have been using the idea of ‘rent-vesting’ to create wealth for the past few decades.
As property prices and the cost of living continue to rise faster than the average income, this nontraditional method is becoming more and more popular particularly with the younger generations who are eager to get into the property market sooner rather than later.
What is ‘rent-vesting’?
Essentially, the rent and invest strategy is to buy an investment property within your budget first, while renting where you want and/or need to live.
Why is this strategy gaining popularity?
Getting into the property market can seem like a moving target.
It can take years to save for your first deposit and by the time you’ve reached your goal savings, property prices have increased and you find yourself still priced out of the market and having to either continue saving (while prices continue growing) or compromise on location and quality of home. The easy answer being spouted by out of touch media and politicians is to buy in ‘regional’ areas. This over-simplified solution fails to take into account important factors such as employment opportunity and amenities. If you’re unable to find suitable employment in these regional areas you’ll no longer be able to afford the repayments and will likely end up spending a small fortune in fuel or public transport costs travelling to and from the city each day, defeating the purpose of moving to a more affordable area in the first place.
This conundrum is forcing younger generations to think outside of the box.
You don’t need to sacrifice career opportunities or waste valuable time and money travelling to and from work each day.
How does rent-vesting work?
The idea is to buy a property within your budget, in a location that is set to increase in value (see our preferred locations here) and will achieve solid rental returns that essentially cover your mortgage repayments plus expenses, while renting in a location close to your employment and allowing you to enjoy the lifestyle you want.
It’s a tactic that overcomes financial obstacles and exorbitant property prices while making your money work best for you and avoiding the ghastly commute to and from work. If you’ve chosen a smart location to invest in, your investment property will increase in value affording you the opportunity to pull equity from it and re-invest in your second and third investment properties.
Yes, the old adage of rent-money is dead-money still applies, unless you’ve strategically rent-vested.
Who is rent-vesting suited to?
If you live and work in regional or outer fringe suburbs, affordability may not be a problem therefore buying your own home could absolutely be achievable.
However, if you’re one of the many Australians who live and work in Sydney or Melbourne for example, buying in either of those cities is going to be very costly and will not give much, if any, capital growth which significantly reduces the chances of you ever building a profitable property portfolio.
Rent-vesting is the one time that low yields work in the investor’s favour.
City rental markets haven’t yet caught up with accelerated prices.
For example, the median price for a unit in Sydney is in the high $700,000s, but the yield is only around 3.8%. With a rent-vesting strategy, you would buy in a high capital growth area outside of Sydney, where prices and yields are more in sync.
For example, a yield of 5% will give you more rental return to cover your mortgage repayments. Then, you would be able to take advantage of the lower asking rents in the city or a preferred lifestyle location you wouldn’t normally be able to afford to buy in.
In the same time it might take you to save enough deposit for your one dream home, you could be adding multiple investment properties to your portfolio which will eventually give you enough equity to buy your dream home plus enjoy returns from your other investments.
For a quick rent versus purchase example, let’s say you wanted to buy a house in a middle-ring Melbourne suburb, where the average home is $800,000.
Assuming a 20% deposit (which in this case would be $160,000) and a 5% interest rate, the mortgage repayments would be around $880 per week (principal and interest).
On the other hand, the average rent for a house in the same market is only $500.
And of course, that scenario assumes you can save a deposit of that size.
A smaller deposit will attract Lenders Mortgage Insurance, which will bump up the repayments further.
Now we can see how first homebuyers are chose to purchase an affordable, risk-averse, high growth property and still live in their preferred location at a rent that would be lower than owning a property in that location.
Who else can benefit from this strategy?
Money isn’t always the motive behind buying an investment property first, rent-vesting also helps those who:
– Need to move around a lot for work
– Like to travel for lengthy periods
– Prefer the flexibility of renting (which eliminates buying and selling fees)
– Want to live in upmarket suburbs or near entertainment hubs that are out of their buying budget
– Can take advantage of rent assistance programs (i.e. military personnel)
RENT-VESTING PROS & CONS
The cons list for rent-vesting is admittedly shorter than the pros list and consists more of emotionally-fueled preconceptions.
If done correctly, it’s a simple and effective strategy for starting out in property.
Advantages of rent-vesting:
1. Getting into the property market sooner.
As we’ve discussed in previous blogs, your main goal when purchasing property is to achieve capital growth which is largely dictated by location.
Capital growth requires time to really reach it’s potential which means that buying sooner rather than 5 or 10 years from now while you save for a deposit and/or grow your income is an essential step to successfully growing your future wealth.
2. You can choose a financial structure that allows for a smaller deposit (less than 20%).
If properly structured, a smaller deposit for an investment loan is still a feasible tactic as long as the mortgage is offset by the rental income. You don’t want an asset that is a crippling financial burden. A knowledgeable mortgage broker can help you calculate your minimum deposit requirements in line with your financial situation.
3. You can choose an investment property in your budget, without being constrained by location.
Your investment property doesn’t have to be in the same neighbourhood as you. Before you buy, you should create a plan based on long-term goals, and then find a property that fits in with your strategy. For example, you might decide that you’re going to build a new duplex to bolster tax deductions and generate duplicate rent. Or, you might buy purely for capital growth, but choose a location near a different city where prices are within your means.
4. You can live in a location you can’t afford to buy plus have the freedom to move should your circumstance change.
The advantage of renting is the flexibility to move without significant expense, which can be beneficial to those who move around for work, or when personal circumstances change.
5. Tax deductions from the investment property help to offset the mortgage repayments.
Numerous expenses related to your investment property will be tax deductible, including improvements and repairs you make along the way. Even your property manager’s fees are tax deductible. At the end of the financial year, these deductions will help to cover the costs of managing your asset.
6. Without a huge mortgage to pay, you can save for your own home or next investment.
Earlier, we showed an example of the difference between buying a middle-ring Melbourne home vs renting. In the example, it cost $350 less per week to rent than to buy. If circumstances allow, rent-vesting can create more margin in your finances so you can put money aside – and all the while, your investment property is growing in value and being paid down by your tenant.
7. You can take advantage of any rent assistance programs you may be eligible for.
If you’re in the military for example, you may be eligible for rent assistance if your property investment is 35km from your base meaning your tenant is paying down your mortgage while you’re saving for a deposit for your next property.
1. You’re still renting.
This is a sticking point for some people, who can’t shake the feeling that rent-money is dead-money, or who would like the freedom to personalise their own home.
2. You don’t have the security of owning your own home.
It can be unsettling to some people to be at the mercy of your landlord.
3. You may miss out on the first home-buyers grant.
Eligibility for the grant when you’ve bought an investment property first depends on the state or territory you live in but generally speaking, you’ll likely miss out on this grant. If you’ve done your research and chosen wisely, this grant can often be less than advantages and savings you’ll get by rent-vesting.
4. You may have to pay capital gains tax when you sell.
Capital gains tax can be a hefty levy if your property has done its job and grown significantly in value.
Is rent-vesting suitable to you?
Like any investing strategy, you’ll need to run the numbers and truly take into consideration the factors affecting your own personal situation.
A knowledgeable and experienced mortgage broker can help you determine your safe borrowing power while an independent and unbiased property professional can help you compare purchase prices and rents that your preferred location command.
Every investing strategy has it’s advantages and disadvantages and it’s up to you to decide what’s right for you.
If you do choose to invest first, you’ll be joining the growing league of rent-vestors who are delaying the ‘Great Australian Dream’ in their quest to secure a wealthy, financially free future.