Owning a home is considered a big part of the great Australian dream. However, with the ever-increasing prices of real estate, it has become extremely difficult for many Australians to gain a foothold in the property market, let alone being able to buy in an area where they want to live. As a way of both owning property and living in a desired location, Aussies are increasingly adopting a practice known as ‘rentvesting’.
What is rentvesting?
Rentvesting is the practice of living in a rental property while simultaneously renting out an investment property that you own. Rentvesters typically rent property they want to live in (but can’t afford to buy) and buy property they can afford (but don’t want to live in) and rent it out as an investment property.
For example, if your dream home is a three-bedroom home situated close to or within the the city fringe, the prices are usually quite high and you may not be able to afford it.
Essentially, you are splitting out the two factors of ‘property affordability’ and ‘quality of living’ and trying to optimise each one without having to deal with the baggage of the other!
But is rentvesting a good idea? Here are some key points to think about:
Your purchasing power doesn’t affect the lifestyle that you want
Rentvesting makes it possible for you to live your preferred lifestyle or quality of life and at the same time, get onto the property ladder and create an extra income stream.
The rapid growth in property values across the broader market in Australia over the past decade has not been matched by rental growth. Due to this, gross rental yields (eg. annual income as a percentage of the property value) have declined to a level that is around 3% p.a for housing (averaged across Australia). This has been a key driver of the rentvesting trend simply because the effective cost to rent a property has fallen below the cost to own the same property.
A partly renovated house located in a sought-after area within a 6km radius of an Australian capital city is valued at $750,000. With annual interests costs of $27,000 (4.5% on a $600,000 loan) and annual ownership costs (for insurances, maintenance and council rates, etc…) of $6,000, total annual holding costs equate to around $635 per week. Using the average gross rental yield of 3% p.a as a guide, the same house would cost you around $430 per week to rent.
Rentvesting can help you buy a property sooner
Since rentvesting allows you to buy a property purely from an investment perspective (eg. a focus on capital growth and rental yield – as opposed to ‘how much you love the property’ from a quality of life perspective), it’s likely you’ll be able to get onto the property ladder quicker.
This is because you can target properties which are substantially cheaper than your dream home, so you’re not required to save up as much for a deposit. Also, since the properties are cheaper, the 20% deposit required to avoid Lenders Mortgage Insurance (LMI) is more within reach, so you’re a better chance of both avoiding LMI altogether as well as negotiating a better interest rate from having an LVR (loan value ratio) of 80% or less.
Buying an investment property offers tax advantages
One of the biggest advantages of rentvesting is that all of the expenses associated with your investment property are tax deductible (eg. home loan interest payments, property maintenance, insurance, council rates, depreciation, etc). So if for some reason your property investment makes a loss (i.e. the expenses are more than the gross income from rent), you can leverage those losses to reduce your taxable income from your own salary. Take note that Savings.com.au always recommends to people that for any matter relating to taxation, they should talk to a professional for qualified advice.
Some property investors actually set up their property investments to make losses so that they can leverage these against other incomes which are taxed at top marginal rates (eg. 47-48%+). This is known as negative gearing. While it sounds like a clever way to minimise tax, this strategy assumes investors are able to service the home loan debt and other expense commitments and that the value of the property will increase over time (why else would you make a loss on an investment?).
You are more likely to make a smart decision when purchasing a property
Buying a home usually comes with a lot of emotions since it’s your dream and you already have a picture in your mind of the kind of life that you and your family will have when you live in the house. On the other hand, buying an investment property doesn’t come with the same level of emotional engagement – you’re likely to be more focused on a property’s potential return on investment (ROI).
So, is rentvesting a good idea? It really depends on your goals and the level of sacrifice you are willing to make to get ahead in life. If living within 5km of the city is a must for you so that your commute to work is less than 15mins and you’re surrounded by your favourite restaurants and coffee shops, then rentvesting can be a valid route to get you onto the property ladder without greatly sacrificing your aspirational quality of life.
However, if you are hell-bent on building your future position as quickly as possible and are willing to make material sacrifices in your quality of life to do so, you are just as likely to build your future position through buying a property in an area where you can afford it, and living in it. If this property grows in value over time, you will not pay any capital gains tax from its sale, whereas the sale of an investment property (as part of your rentvesting strategy) will attract capital gains tax which will, in turn, eat into any profits that you make from its sale.
The Savings Lesson
Rentvesting can be a good strategy to help you build your future position through property ownership while maintaining a certain quality of life. The one big health warning to be heeded here is that the success of this strategy is almost always reliant upon solid growth in property values over the period of your investment.
Bear in mind that this method of entering the property market is not for everyone. Be sure to understand how investing in real estate works and determine if rentvesting could work well for you based on your own time frames and financial objectives. As is always the case, don’t be hesitant to seek professional advice.