Rentvesting: How it works and the pros and cons

Rentvesting can be one option for people wanting to get their foot on the property ladder but how does it compare to buying your own home? We crunch the numbers.

Many Australians see property as a safe and desirable asset to hold. It’s part of the great Australian dream to one day be a property owner. This is because property values have continued to enjoy steady growth over the long term.

The growing challenge for aspiring homebuyers is saving for a deposit and also being able to afford the type of property they want in the location they want to live in.

There are three main ways this can go:

1. They can afford to buy a property that suits them for now.
2. They can’t buy something in their preferred area at their price point, so they compromise and buy in a location that’s more aligned to their budget.
3. They can choose to rent where they want to live in a property that suits their needs, because it’s cheaper to rent than pay the mortgage repayments, but they buy an investment property.

This third option is essentially the concept of ‘rentvesting’ – a strategy where a person or family chooses to rent where they want to live while putting their surplus money to work by buying an investment property to build wealth and to compensate for not buying an owner-occupied property.

Who does rentvesting suit?

Rentvesting works well across many income ranges and financially it works best in locations where the monthly differential in rent payments versus mortgage repayments are highest. Conversely, it’s not generally a suitable strategy when the mortgage repayments are roughly the same as the cost of rent for a property within a desired location.

Rentvesting might suit younger people who have been ‘priced out’ of inner-city locations, single-parent households where the location of raising a family is important and family households also looking for superior locations and a suitable property to accommodate them comfortably.

The pros of rentvesting

• Lifestyle: You rent where you want to live. There are lots of compelling reasons here – budget considerations, where you are at in your life cycle, local amenity interests, safety and security, to name just a few.
• Wealth building: Because your borrowing power is greater and/or you are saving on higher mortgage repayments, your money could potentially work harder for you and your future by building up your retirement nest egg.
• Cost savings: As a renter, your landlord is responsible for the maintenance, upkeep and safety of the property, as well as covering costs such as council and some utility services (outside of usage), and any potential body corporate fees, etc. They will also cover the upfront costs such as stamp duty and potentially Lenders Mortgage Insurance. It’s worth noting that as a potential rentvesting landlord, you too will have to cover these items but, in many cases, they are tax deductible.
• All care no cost responsibility: Again, as a residential tenant, it’s the landlord’s responsibility to maintain the property. They are responsible for ongoing upkeep and working order of the property. Any issues with electrical, hot water, leaks, air-conditioning, building deterioration, inbuilt fixtures and fittings and worn items are at the landlord’s cost.
• Ease your property cost burden: Your tenants help you out via the monthly rent they pay.
• Tax benefits: You can potentially claim tax deductions. You may also be able to claim depreciation on the building, plus in some instances any new fixtures and fittings added to the property.
• Go with the flow: Although the rental market can be tight during periods of time, being a renter can potentially offer the flexibility to ‘mix it up’ and try a variety of accommodation types and locations whereas, due to the very high stamp duty costs and other buying and selling costs, once you buy it’s not smart financially to do this as an owner, too often.

The cons of rentvesting

• Loss of full capital gains tax (CGT) exemption: This is the one that many will tell you, “You’re mad to ignore”, as your ‘principal place of residence’ carries a full exemption of any capital gains tax liability if you sell the property for a profit. (Rental properties are generally subject to capital gains tax if sold for a profit).
• Emotional cost: You’re missing out on the ‘Great Australian Dream’. Many of us grow up dreaming of one day buying a property, making it our own and creating great memories.
• Loss of control: One of the biggest frustrations and risks of renting is being told by the landlord that for some reason you must vacate the property. Ultimately, it’s their property and by rights they do have control over it.
• Mercy of your landlord: Some landlords are better than others, and whilst tenancy laws have given more rights to renters, the owner of the property is still the landlord and may not be as flexible or understanding as you’d like them to be.
• Peer pressure: Don’t underestimate the potential judgement by some family and friends if you chose the rentvesting path, even if it is more financially rewarding.
• “Rent money is dead money” and therefore you need to invest to benefit from this strategy. If you decide to rentvest, but don’t actually buy an investment property, then you aren’t rentvesting at all – you are going backwards financially. The key is that you must invest that surplus money, otherwise it is ‘dead money’.
• Changing your mind:  If you decided you want to rentvest, and then you change your mind a few years later, chances are the costs in holding and changing your strategy will outweigh more than you’d make from becoming a rentvestor in the first place. You need to stay the course or decide beforehand that it’s not for you.

Buying a home to live in vs rentvesting

To get a picture of how rentvesting works let’s take a look at a hypothetical scenario. Meet Kylie – she’s 29 and works as an intensive care nurse in one of Melbourne’s inner-city hospitals. Because she works shift work and loves living near all the ‘action’ with her friends, Kylie wants to continue living close to her work, but she also understands she needs to have one eye on her financial future. She isn’t completely ready to settle down and for the type of property in the inner-city location she wants, she is priced out of the market. So, she wants to run the numbers on a rentvesting strategy that might be a better option for her.

Kylie earns $96,000 a year and currently spends $300 a week in rent, and while she still enjoys the luxury of inner-city living, she has been a good saver, having put away $75,000 over the years. Her parents are happy to kick in $20,000 to get her moving forward with her property plans so she has $95,000 to put towards a deposit. Let’s consider her two options…

Buying a home to live in or rentvesting

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The first thing you will notice is the difference in what she can buy (purchasing power). This is the result of being able to include a percentage of the rental income, which helps increase her borrowing power. All things being equal in terms of capital growth performance, owning a higher value property will mean the capital gain will likely be larger over time in dollar terms.

Purchase costs are higher on the investor side because Kylie doesn’t enjoy first home buyer grants or incentives. This also results in a slightly higher borrowing amount. If she goes down the rentvesting route she will have $7,000 in cash leftover that can be added to her mortgage offset account as opposed to having a healthier $42,200 if she bought a home to live in.

After Kylie purchases the property, thanks to the rental income and the tax benefits, the overall surplus cashflow on the investment property is going to be superior to that of owning, even with the anticipated holding costs. She would have $12,766 left over each year when rentvesting versus $10,019 if she had bought a house to live in.

Buying a home to live in vs rentvesting: 10 years on

Let’s now fast forward 10 years to see what her potential position could look like.

Future forecast: 10 years on (2033)

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Assumptions: Residential loan interest rate: 6.0% P&I, Investment loan Interest rate: 6.5% P&I,  Capital growth: 6.0%pa, Rental growth = 6.0%pa, No depreciation claims,  Occupancy rate: 92%pa, Ongoing holding cost: 1.5% of property value per year,  property management fees: 8.5% of rental income, Inflation/indexation = 2.5%pa.

At the 10-year mark, we can see that the loan interest costs for the rentvesting scenario are higher than they are for the owner-occupier strategy – partly due to the fact that rates on investment loans are higher – and the same goes for the debt level.

However, in terms of Kylie’s overall net property wealth position, she is $35,800 better off with the rentvesting strategy, when you combine both the cash on hand and the appreciated value forecast. Interestingly, this is even though she borrowed more initially to invest.

This gain might not be suitable for some given the higher debt levels. It’s also worth noting that any capital gains tax impact would reduce this gain if Kylie decided to sell up at this point.

Buying a home to live in vs rentvesting: 20 years on

If we then take a look at Kylie’s overall position in 20 years, the numbers look even more interesting.

Future forecast: 20 years on (2043)

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Assumptions: Residential loan interest rate: 6.0% P&I, Investment loan Interest rate: 6.5% P&I,  Capital growth: 6.0%pa, Rental growth = 6.0%pa, No depreciation claims,  Occupancy rate: 92%pa, Ongoing holding cost: 1.5% of property value per year,  property management fees: 8.5% of rental income, Inflation/indexation = 2.5%pa.

It is important to acknowledge that 20 years is a long forecast period so it isn’t without the risk of margins of error. And of course, a lot can change in this time, which could alter this result. That said, it’s still always important to attempt to get a greater understanding of the future financial outcome you are trying to achieve before ever making any investment decision.

Let’s look at how things stack up at the 20-year point for Kylie. The net debt position in both scenarios is zero as the money in offset at the time, plus the principal reductions have done their jobs. The positive cashflow is a very healthy $67,100 per year (and growing) for the rentvesting strategy and it’s still a healthy $65,450 if she bought a house to live in. Kylie’s net worth position is potentially $163,750 higher when rentvesting based on this modelled scenario.

Now the message here isn’t to just drop everything and start rentvesting. Whilst financially there may be a gain, there are several variables that could alter this outcome over such a period of time. Through doing these types of case studies over the past 10 years I have observed that the financial advantages of rentvesting over buying have diminished. This is largely due to the fact that lenders are now charging a premium on investor loans over owner-occupier loans, which has stripped out some of the cashflow advantages as the cost of holding an investment property has increased significantly.

What this article should convey, though, is that some serious considerations and planning should go into any property-buying decision, including the lifestyle impacts just as much as the financial impacts. If rentvesting is appealing to you, from a lifestyle impact perspective as much as a financial perspective, then continue to do further research on this matter or seek some professional advice. As with any decision you make, your future self is depending on you.

Cover image source: Burdun Iliya/Shutterstock.com

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