Rentvesting – Paving the way to prosperity

More new homeowners are rejecting yesterday’s sentiment of owning their own castle and buying investment properties before their own home instead.

Driven by affordability and smart financial forecasting, Australians are investing as they’re starting to see the benefit of owning rental properties as a strategic move up the property ladder.

Our investors are getting younger, too

The average investor age is lower than ever at 34, according to the surveys.

These statistics tell us two things:

1. Young people are more switched on when it comes to real estate than any previous generation.
2. Our Millennials are not averse to putting smart property strategies ahead of the ‘great Australian dream’.

If you’re amongst the growing cohort considering an investment property as your first property, you might feel – like so many others – that property prices are the factor forcing your hand. 

Dwelling values in several markets are rapidly outpacing wage growth, which means every year you spend saving for a deposit, the market is moving further out of reach.

It can feel a little like running on a hamster wheel.

Rentvesting is a smart property acquisition strategy that gives first-time property buyers the opportunity to buy sooner rather than later.

It’s a lifeline for those who are trying to gain a foothold in a property market that’s essentially a moving target.

Rentvesting is a paradigm shift away from the traditional idea of the ‘white picket fence’ house.

We’ve been brought up with the idea that we should buy our own home first.

But in today’s property climate – where house prices are rising at record-breaking rates – what used to work is no longer an easy option.

Rentvesting, therefore, is a strategy that saves people from being renters their entire life.

It gives struggling first homebuyers an opportunity to enter the market – even if they’re not buying the home for themselves.

How rentvesting works

Essentially, the rent and investment strategy is to buy an investment property first (where you can afford to buy) and rent where you want to live (but probably can't afford to.)

It’s a tactic that overcomes financial obstacles and exorbitant property prices because you can buy in a location that fits your budget and then rent in a location that suits your lifestyle.

It works because even though you’re renting, the property you buy is an asset that’s growing in value (assuming you choose a smart location) and being (in part) paid off by your tenant.

Not only that, but you’re gaining equity that can launch you into other property purchases down the track, including (when the time is right) a home to call your own.

Who needs rentvesting?

If you live in regional or outlying suburbs, affordability may not be a problem. 

However, rentvesting is a particularly helpful strategy for those who are required to or want to live near our more expensive cities.

Our capital cities are now booming economic hubs that command high prices due to land-locked supply and increasing demand from the many people who like the lifestyle and amenities afforded by these locations.

As such, many white-collar workers – particularly Millennials who make up a high proportion of middle-income employees – face few choices if the inner suburbs are too costly.

They can buy in a less expensive outer fringe suburb and live with a ghastly commute, or they can rent closer in.

City rental markets haven’t yet caught up with accelerated prices.

For example, while the median price for a unit in Sydney is in the high $700,000s,  the yield is only around 3.5%.

With a rentvesting strategy, you would buy your investment property in a high capital growth area further from the city, and you'd be able to take advantage of the lower asking rents in the city, or, if you prefer, an enviable lifestyle location you wouldn’t normally be able to afford to buy.

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.

• Also read:Pre-settlement inspection guide: what to inspect, why and when
• Also read:The offer and acceptance process when buying a property
• Also read:Caveats – The Red Flags of Real Estate
• Also read:How much you need for a house deposit in each Aussie city
• Also read:Guide to Downsizing a House in Australia

And of course, that scenario assumes you can amass 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 choose 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.

It’s not just for the financially challenged.

Lifestyle seekers can benefit from rentvesting too.

You see…money isn’t always the motive behind buying an investment property first, rentvesting 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

Rentvesting pros & cons

Admittedly, there aren’t many items on the ‘cons’ list for rentvesting.

If done correctly, it’s a simple and effective strategy for starting out in property.

Advantages of rentvesting

1. Rentvesting gets you into property sooner. When you buy property for wealth creation, you should ideally chase capital growth. Capital growth needs time towork effectively, which means that buying today – rather than 5 or 10 years from now while you wait to accumulate a deposit 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 location constraints. 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, and have the flexibility to move or upsize/downsize. 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, I gave an example of the difference between buying a middle-ring Melbourne home and renting. In the example, it cost $350 less per week to rent than to buy. If circumstances allow, rentvesting 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.

The disadvantages

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’s not easy being at the mercy of a landlord, and some people grate at the idea that the place they lay their head is not their own.
3. You may miss out on the first homebuyers grant. Eligibility for the grant, when you’ve bought an investment property first, depends on the state or territory you live in. I’ve addressed this in detail further down.
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.

Affording the investment

In terms of finances, there’s a world of difference between an investment property and a principal place of residence.

Investments offer additional benefits that can give you a significant leg-up with lenders, and affording the mortgage.

1. It adds to your cash flow.
   Your investment property offers a lot of tax breaks, year after year. There’s depreciation, deductible expenses like interest, rates, repairs, management fees, and the negatively geared portion of your mortgage repayments. These extra financial perks can help lenders look more favourably on your application, and offset the mortgage repayments.
2. When you’re buying an investment property, location is only based on capital growth prospects.
   An investment property gives you the freedom to find a location that fits your budget and your strategy. Get some professional advice, research different areas and find one with strong growth drivers.
3. You can generate financial breathing space through renovation.
   Finding a property that needs a little TLC gives you the opportunity to do a ‘spit and polish’ that improves its value. This manufactures equity, improves asking rents and strengthens capital growth. As an added bonus, many aspects of renovations are tax deductible and attract depreciation benefits.

How rentvesting can grow your wealth

Wealth creation through property is about growing a substantial asset base by owning properties that grow in value over time and spit out rental returns.

Rentvesting is no different to any other property strategy - it’s just another tool in the tool belt.

While any examples I give can’t factor in all the variables in interest rates, growth values and personal circumstances, it does help to get an idea of how buying a property – whether you live in it or not – trumps sitting idly and paying dead rent money.

For a simplified example, let’s say a renter has a $30,000 deposit and decides to purchase a $500,000 investment property that grows by 6% each year.

After five years, he has gained $170,000 in capital on the home.

Comparatively, a renter who starts with $30,000 and saves $1500 a month for five years (assuming a 2% compounding interest rate) will have $127,000 – but he won’t have had the advantage of tax deductions, a diminishing mortgage, and a brick-and-mortar asset that he can sell or use as seed capital.

In addition, a rentvestor with the right financial structure may have the wiggle room to continue saving while renting, giving them more opportunity to add to their portfolio down the track.

What about the first home buyers grant?

Every state and territory has different policies regarding grant eligibility.

Some states, such as Queensland, won’t hand money out to buyers who own any kind of property anywhere in Australia.

However, Victoria considers you eligible as long as you bought the property after 1st July 2000 and didn’t live in it for six consecutive months.

If the idea of missing out on the grant is worrisome, then you’ll need to weigh up whether you absolutely need it to buy, and whether you’ll still be eligible for it down the track. Crunch the numbers and decide if the grant money outweighs the other benefits of rentvesting.

Alternatively, you could consider buying the property as an owner-occupied home, live in it for the required period to fulfil the criteria of the first homebuyer's grant, and then rent it out.

You may even be able to rent out a room during that time to help pay for the mortgage.

Deciding if it's right for you

If you’re not sure rentvesting is for you, you’ll need to weigh up all your options.

First, a savvy mortgage broker can help you determine your safe borrowing power.

Then, you’ll need to compare the purchase prices and rents that your preferred location commands.

Rentvesting has advantages and disadvantages, but it’s up to you to decide whether it’s a suitable fit for your circumstances.

If you do choose to invest first, you’ll be joining the growing army of rentvestors who are delaying the ‘great Australian dream’ in their quest to secure a wealthy, financially free future.