Are you looking to climb the property ladder, but can’t afford to buy in the area you want to live? Rentvesting could be your key to entering the property market.
The ever-increasing property prices have had many new investors weighing up the issue of lifestyle versus property ownership.
However, the rentvesting strategy has allowed many Australians to expand their property portfolio without having to sacrifice their lifestyle. It’s the best of both worlds.
But how does it work? What are the pros and cons? Is it the right option for you? Does it make sense to pay off a mortgage and rent at the same time?
We aim to answer all your questions and more through this step for step guide to property rentvesting.
The rentvesting strategy involves purchasing an investment property in an area that suits your budget, generally outside of the city. At the same time, you rent a property in an area that suits your lifestyle.
So, essentially, you are finding the perfect balance between owning an affordable property and living in your dream home - that you can’t currently afford to buy.
Lisa is currently renting a house in Melbourne that’s close to her office and in close proximity to all her friends.
Although she would love to own the home she lives in, she can’t afford to purchase a property in Melbourne city.
Lisa set out to do some research to compare buying or renting her dream home in Melbourne. The average cost of a 2-bedroom home in Melbourne will cost her about $880,000.
If Lisa paid a 20% deposit, she would have take out a home loan of $704,000:
$880,000 x 20% = $176,000: deposit
$880,000 - $176,000 = $704,000: home loan
Borrowing at an interest rate of 4.5% p.a. On a 25-year loan, Lisa’s monthly mortgage payment would be $3,913 per month.
Lisa is currently renting her home at $540 per week, which totals to $2,160 per month.
$3,913 - $2,160 = $1,753: difference in mortgage cost and rental cost
So, to rentvest, she should be able to afford around $1,753 per month mortgage.
After doing some research on the property market, Lisa has seen that Hobart would be a great investment option for her because she’s happy with the rental yield as well as the potential growth prospects.
She found a beautiful home in Hobart for $350,000. If Lisa paid a 20% deposit, she would have take out a home loan of $280,000:
$350,000 x 20% = $70,000: deposit
$350,000 - $70,000 = $280,000: home loan
Borrowing at an interest rate of 4.5% p.a. On a 25-year loan, Lisa’s monthly mortgage payment would be $1,556 per month.
|Buying the Melbourne Home||Rentvesting in Melbourne and Hobart|
|Monthly Spend||$3,913 (mortgage repayments)||$3,716 ($2,160 rent in Melbourne + $1,556 mortgage payment on Hobart investment home)|
|Property Purchase Price||$880,000||$350,000|
|Property Value After 10 Years||Average of 6.2% per year = $1,425,600||Average of 9% per year = $665,000|
|Capital Gain||$545,600 (62%)||$315,000 (90%)|
She has opted to purchase the home in Hobart as her first property investment while still renting in the city, where she can be close to her work and her friends.
It’s important to note that this was just a simple calculation, and a great range of variables could affect your own equations. Nonetheless, the calculations intended to give you an idea of the potential benefits of rentvesting.
So, is rentvesting the right option for you? You may want to consider the various pros and cons.
The main advantage of using the rentvesting strategy is the ability to live your dream life, while still climbing up the property ladder.
Instead of waiting until you can afford to purchase your dream home, the rentvesting strategy allows you to start building your property portfolio sooner.
Owning an investment property allows you to claim several tax deductions that you aren’t able to claim if the property was your home.
When you’re renting, the absence of permanency allows you a degree of flexibility when it comes to choosing a home based on your circumstance. For example, you may get a promotion at a company in another city. Renting gives you the flexibility to move that city without the hassle of selling a home.
As much as you may love the lifestyle that comes with renting your dream home, it’s, unfortunately, not your home. This means you may have difficulty settling into the property as if it was your own, and you will have to seek permission and assistance from property managers and landlords if something needs to be fixed or if you simply want to hang a picture on the wall.
One factor that may dissuade you from going the rentvesting route is the idea of purchasing a property just to rent it out, while you pay someone else’s mortgage at the rental property you live in.
If you own the house that you live in, you are generally exempt from paying capital gains tax on the eventual sale of your home. However, if you sell an investment property, you’re usually liable to pay capital gains tax on the profit you make from the sale.
As you will not be occupying your new home, and rather investing it, you won’t be able to access the First Home Owners Grant.
It’s not always guaranteed that your investment will increase in value. Suppose it decreases in value. If that is the case, you might have to sell it at a loss.
Besides the benefits and disadvantages of rentvesting, there are a few other factors that you should consider before making your final decision.
Rentvesting obviously needs to make financial sense in your specific circumstances.
On one hand, if you’re considering rentvesting as a strategy for your first property purchase, you’ll be missing out on considerable first-time buyer benefits such as the First Home Owner Grant or a reduction on stamp duty.
With the grant potentially saving you $10,000 and a reduction in stamp duty fees, it all adds up.
On the other hand, if your property is negatively geared (i.e. it’s running at a loss), you could claim deductions to save on your personal income tax. So, it could potentially compensate for the lost benefits.
Either way, you need to check your numbers. It pays to crunch your numbers first to make sure the rentvesting strategy makes sense for you.
While you may have access to certain tax savings from a negative gearing property, it’s not an ideal situation to be in as a first-time property investor.
The high transaction costs paired with the costs of maintaining the property is likely to stretch your cash flow quite thinly.
The key to the rentvesting strategy is to consider your property as a long-term asset. You’ll need to hold on to the property for at least five years for it to realise potential growth. Even if you buy in an area with a strong rental return, it’s not likely that the rental income will cover all the costs.
Along with seeing your purchase as a long-term investment, you should make sure you can cover the gap between the costs of the property and the rental income.
If, after weighing up the pros, cons and all the other variables of rentvesting, you’ve decided that this is the best property investment strategy for you, you can start taking the next steps on your investment journey.
The first step involves securing a deposit for a property. If you can secure a 20% deposit, then you won’t be required to pay Lenders Mortgage Insurance (LMI).
While 20% sounds like a daunting figure, remember, 20% of $450,000 is much better than 20% of $1,000,000!
Rentvesting is a fantastic strategy for investors looking to get into the property market sooner, but only if you make the right investments.
Essentially, choosing the right location to buy your property starts with evaluating your long-term goals. You’ll need to consider factors such as:
You may want to consider getting the opinion of an expert during the research step. For example, a buyer’s agent will have all the information you’ll need to buy your investment property at an attractive price and with good potential for growth.
The aim of using the rentvesting strategy is to fast track your wealth-building by getting into the property market sooner rather than later. So the next step would be to start considering your next property goal.
If you’re able to secure that 20% deposit and buy in an area with the potential for future capital growth, it’s entirely likely that you’ll be able to start seeing a positive cash flow from your investment property early. Especially if you’re claiming all the tax deductions available to you, such as depreciation.
The savings and equity held in your first investment property can help you secure the deposit for your next investment property or even your future dream home.
There is no “one-size-fits-all” strategy when it comes to building your property portfolio.
The key to choosing a property investment strategy is making sure it lines up with your current financial circumstances, your lifestyle preferences as well as your future financial goals.
One property strategy you might want to consider is rentvesting. Rentvesting allows you to balance your lifestyle goals as well as your property goals by getting your foot in the property market faster while still fulfilling your social desires.
As with all property investment strategies, however, rentvesting comes with many advantages, as well as a few disadvantages.
Making the right decision requires having a good understanding of the property market, the costs involved and how you can make every dollar count.
As a team of property investors ourselves, we, at Duo Tax, understand that every dollar counts, especially if you’re just starting in the investment property sphere.
Whether you’ve decided to rentvest or not, we’ve got the expertise to help you take your property investment to the next level through depreciation schedules and property valuations.
Depreciation on your investment property is a significant tax-deductible expense. In fact, it’s the second-largest tax deduction for your investment property after interest on your loan. That is why it helps to purchase a tax depreciation schedule.
To see how we can help you with your future property, get in touch with us today.