Rentvesting property ladder

Rentvesting your way to the top of the property ladder


Save to buy your home, move to where you can afford and then work hard to pay it off… This is what has been instilled in so many Gen Y and Millennials from their parents’ generation. However, in cities such as Sydney where average house prices are now hovering around the $1m 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 1000 young Australians has alarmingly shown that 80% 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, fueled by a low interest rate environment, has squeezed affordability to an all-time low. For those lucky enough to have a sizeable deposit and enter the market, many are being forced to make sacrifices on the size and features, or buying where they can afford, not 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.

Also from a financial perspective, in cities such as Sydney and Melbourne, rental yields have been compressed due to the recent price growth to an average of 3.4% and 3% respectively. It is now cheaper to pay this rent than to buy and pay a 4%+ mortgage and other non-tax deductible expenses such as body corporate or insurance. However, the question then arises how to reclaim this ‘dead’ rent money.

Rentvesting

‘Rentvesting’ is a relatively new term that is being used to describe the action of buying property in an affordable area, renting it out to pay the mortgage, while then 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 have also shown that the term has tripled in search requests.

A recent Mortgage Choice survey has found a third of investors in 2016 were first-time buyers who had not yet bought their own home, people rentvesting, or 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 execute a rentvesting strategy, in particular 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”, Tommy states.

Types of Rentvestors:

There are a couple of types of rentvestors. Young people utilising the strategy and saving for a first home and an increasing number of professionally employed people of any age taking advantage of tax breaks and creating wealth through property investment rather than ownership. Tommy Lim also comments rentvesting allows numerous clients to remain ‘globally mobile’ – either pursuing valuable work experience or further studies in overseas markets such Hong Kong, London or in the United States.

Bondi BORDER1Rent where you want to live….

Advantages of Rentvesting

  • Flexibility – Renting gives the flexibility not to be locked into an owner occupied mortgage. You are free to travel and move around or upsize should the family grow at any time.
  • Lifestyle – Rentvesting may be less financially straining 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 and are often located where one can afford and further from work, amenities, family and friends. Also to fit a budget, various other features such as number of bedrooms, car spaces, bathrooms may be sacrificed.
  • Enter the market sooner – Instead of saving and saving to afford where one wants to live, they may be able to continue renting and enter a market elsewhere straight away.  History shows that well selected property can quickly outperform average saving abilities.
  • Potentially better capital growth than local area – The desired suburb to live may not contain the 15 Key Investment Drivers (explained later) and therefore the performance of the property may not produce the equity gain needed if the owner is 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 a 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 sell – Currently if you sell an investment property there will be capital gains tax to pay on any profit (a 50% discount may apply on property held longer than 12 months). Owner occupied homes are exempt from any capital gains tax.

The Rentvestor Mindset

Before anyone can begin to rentvest they have to have an honest conversation with themselves about their relationship with debt and make the distinction between ‘good’ debt and ‘bad’ debt. In life it is very easy to spend more than we make through taking on debt such as car loans, credit cards and other ‘necessities’ sold to us by crafty marketing firms. Buying property requires people to take on what will probably be the biggest debt of their lives to date. It would be easy to add this debt into the same basket as the bad debt mentioned above, however, 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). 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 may be counter intuitive according to past societal norms requiring a thick skin to ward off the naysayers conditioned to a life more ordinary.

The Investment

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. Many times these compromises include buying a cheaper 1 bed or studio apartment, or looking to the closest suburb which they can afford. It is important that once you have made the decision to invest, 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 invest, or buy to live in, 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. As we all know not all property is created equally, but there are basic fundamentals you can look for to ensure consistent, stable growth and less risk.

>>TIP: At Sound Property we use 15 Key Investment Drivers as a preliminary guide, Fig 3

15 key drivers to successful property investmentIn a nutshell, stick to capital cities or economically diverse areas, away from large developments and oversupplied areas. Don’t chase fads such as mining towns and ‘cheap’ areas. Cheap areas of cities are an easy target for the rentvestor due to their lower entry prices, but these areas can have higher unemployment and lower incomes, making them more sensitive to rate rises and higher crime. All of these elements add risk to an investment, and may prevent future growth.

‘Top-down’ approach – The 3 levels of Key Investment Drivers

Macro: The Marco level assesses Australia as a whole and its various capital cities. The big driver here for people looking to grow their wealth quickly is market cycle. You need to invest counter-cyclically or buy at the bottom rather than the top of the boom. Often this will go against what the media and other people are telling you to do and takes courage to invest in this subdued period. However, if the market exhibits the other macro drivers it is sure to improve and benefit those investors who got in early.

Micro: Micro level drivers relate to suburb specific factors. Two favourites are vacancy rates and affordability. If there are low vacancy rates, excess demand and affordability through strong incomes and low interest rates then it creates an advantageous market for price growth.

Property: The final, Property level is where it is important to to assess the specific dwelling and its match for the local demographic. For example, it would not be advised to buy a one-bedroom unit in a suburb removed from accessible amenities and known for families that desire houses. It will lack demand and therefore growth. Instead, look for features that will attract owner occupiers as this is the group of future purchasers buying with emotion and pushing values up. Conversely, avoid high-rise and investor only developments, as these can be more volatile and restricted in growth.

>>TIP: Employ a ‘top-down’ approach by starting with the Macro level first rather than the Property level. This will ensure that your investment has the best chance of performance and will not be negatively impacted by these higher level drivers.

Conclusion

Skyrocketing house prices and the desire to still enjoy our lifestyle is creating the emergence of ‘generation rent’. Those who want their money to work harder will be considering the new age of rentvesting. Within the rentvesting strategy there are the obvious downsides such as not being able to paint the walls your favourite colour and having to move if the property is sold, however those 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 these benefits created by rentvesting could also include growing your deposit to buy that dream home later on 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?

capitalise on lowest interest rates

Written by Andrew Cull

For a FREE eBook on the Rentvesting strategy please go to our resources page here or contact us on 1300 655 899


This article is provided for general information only and does not constitute personal advice, as it does not take into consideration your personal circumstances. Please consult a licensed tax or financial advisor before making any decision to invest.