Rentvesting: How it works and the pros and cons

BEN KINGSLEY
12 April 2021
Rentvesting can be a great option for people wanting to get their foot on the property ladder. We take a look at how it works.

As the world slowly moves closer to a post-pandemic new norm, many Australians find themselves in a very enviable economic position. Record low interest rates, coupled with strong government support for the housing sector, mean our love affair with property is once again ignited.

Many Aussies see property as a very desirable asset to hold because property values continue to grow over the long term and, importantly for investors, the rent can form part of their passive income in retirement.

The challenge for many is being able to afford the type of property you want to live in, in the area where you want to live.

There are three main options:

  1. Yes, you can afford a property that suits you for now.
  2. No, at that price point it doesn’t suit so you compromise and maybe buy in a location that’s more aligned to your budget.
  3. You can choose to rent where you want to live in a property that suits, because it’s cheaper to rent than pay the mortgage repayments, but you’ll 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 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, family households also looking for superior locations and a suitable property to accommodate them comfortably.

 

Couple on beach
Image source: FS Stock (Shutterstock.com)

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 the building, plus in some instances any new fixtures and fittings added to the property.
  • Go with the flow: Because you don’t have the high-cost burden of buying (or selling for that matter – up to 2.5% of the sale price), and due to housing flexibility and variety, the world is your oyster. You can ‘mix it up’ as renting can give you that flexibility and potentially a variety of accommodation types, whereas due to the very high stamp duty costs and other buying and selling costs, it’s not financially sensible 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.
  • 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’.

 

Young nurse
In our hypothetical case study a young nurse weighs up buying her own home vs investing. Image source: Kues (Shutterstock.com)

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 $78,000 a year and currently spends $240 in rent per week in her share house, 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

Buy to live in Rentvest
Wages (gross) $78,000 Wages (gross) $78,000
Living expenditure (pa) -$36,580 Living expenditure (pa) -$36,580
Purchasing power

(wage only)

$480,000 Purchasing power

(wage & rental income)

$550,000
Est. Purchase Costs

(inc. FHB concessions)

$10,698 Est. Purchase Costs

(stamp duty, legal, LMI)

$46,568
Loan amount

(88% Loan-to-Value ratio)

$428,298 Loan amount

(90% Loan-to-Value ratio)

$508,568
Remaining savings $32,600 Remaining savings $7,000

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 at 90% loan-to-value ratio (LVR) and will see her cash position post purchase of $7,000 to be added to her mortgage offset account, as opposed to having a healthier $32,600 added if she bought 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 $7,480 left over each year when rentvesting versus $1,830 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 (2031)

Buy to live in Rentvest
Wages (gross) $100,700 Wages (gross) $100,700
Living expenditure (pa)

(Inc. prop fees etc)

-$40,850 Living expenditure (pa) -$31,450
Annual outgoing rent $0 Annual outgoing rent

(share 2-Bed apt.)

-$20,650
Gross rental income (pa) $0 Gross rental income (pa) $36,250
Loan interest (pa)

(with offset benefit)

-$5,200 Loan Interest (pa)

(with offset benefit)

-$7,800
Rental property expenses $0 Rental property expenses -$13,350
Est. tax payable (pa) -$22,450 Est. tax payable (pa)

(with invest prop)

-$27,300
Surplus cashflow (pa) $32,150 Surplus cashflow (pa) $36,350
Savings/cash on hand

(offset interest)

$265,350 Savings/cash on hand

(offset interest)

$268,950
Net outstanding debt $162,950 Net outstanding debt $239,600
Capital growth forecast (pa) 6% Capital growth forecast (pa) 6%
Property’s forecast value $859,600 Property’s forecast value $984,950
Net worth (excluding super) $696,650 Net worth (excluding super) $745,350

Assumptions: Interest rate = 3.5% Interest Only, capital growth = 6.0%pa, rental growth = 6.0%pa, zero depreciation, occupancy rate = 92%pa, ongoing holding cost 1.5% of property value per year, property management fees = 7.7% of rental income, Inflation / indexation = 2.5%pa.

From the table above we can start to see the financial differences appearing. The combination of the rent Kylie earns being much greater than the rent she pays; the tax benefits; and the interest she is saving from the $4,200 ($32,150 vs. $36,350) surplus cash being generated per year and placed into her offset account, at the 10-year mark shows a difference of $3,600 ($265,350 vs. $268,950).

Furthermore, 100% of all the holding costs ($7,800 + $13,350) are now being covered by the rent ($36,250) so the remaining $15,100 is now passive income being added to the savings/offset account.

In terms of Kylie’s overall net property wealth position, she is $48,700 better off, when you combine both the cash on hand and the appreciated value forecast. Interestingly, this is even though she borrowed more initially to invest.

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 (2041)

Buy to live in Rentvest
Gross rental income (pa) $0 Gross rental income (pa) $64,900
Est. tax payable (pa) -$29,900 Est. tax payable (pa)

(with invest prop)

-$44,650
Surplus cashflow (pa) $46,700 Surplus cashflow (pa) $56,650
Savings/cash on hand $556,150 Savings/cash on hand $626,700
Net outstanding debt $0 Net outstanding debt $0
Capital growth forecast (pa) 6% Capital growth forecast (pa) 6%
Property’s forecast value $1,539,450 Property’s forecast value $1,763,900
Net worth (excluding super) $2,095,600 Net worth (excluding super) $2,390,600

Assumptions: Interest rate = 3.5% Interest Only, capital growth = 6.0%pa, rental growth = 6.0%pa, zero depreciation, occupancy rate = 92%pa, ongoing holding cost 1.5% of property value per year, property management fees = 7.7% of rental income, Inflation / indexation = 2.5%pa.

It’s true that 20 years is a long forecast period and a lot can change in this time, which could alter this result. Furthermore, in both scenarios she would have been in a position to buy additional properties, which could have improved the outcome even more.

Alternatively, she may have decided to increase her rental commitments to have her own place rather than live with a flatmate.

Other scenarios could also include Kylie meeting a life partner and starting a family, which could have resulted in the sale of whichever property she decided to buy.

All that said, when weighing up a buying home to live in versus rentvesting decision it’s important to consider the financial impact. At the 20-year point, the net debt position in each scenario is zero as the offset balances cover the initial loan amounts drawn, the positive cashflow is a very healthy $56,650 per year (and growing) and Kylie’s net worth position is potentially $295,000 higher when rentvesting based on this modelled scenario.

Now, the message here isn’t to just drop everything and start rentvesting – that would be silly as everyone’s circumstances are different and forecasting isn’t an exact science. What this article should convey is that some serious considerations and planning should go into any property buying decision as your future self will thank you for it.

Lowest interest rates for 1-year fixed home loans

The comparison table below displays some of the 1 year fixed rate investment home loan products on Canstar’s database with links to lenders’ websites available for a loan amount of $350,000 at 80% LVR in NSW, and available for Principal and Interest repayments. The results are sorted by ‘current rate’ (lowest to highest), then by provider name (alphabetically).

*Comparison rate based on loan amount of $150,000. Read the Comparison Rate Warning.

Lowest interest rates for 3-year fixed home loans

The comparison table below displays some of the 3 year fixed rate investment home loan products on Canstar’s database with links to lenders’ websites available for a loan amount of $350,000 at 80% LVR in NSW, and available for Principal and Interest repayments. The results are sorted by ‘current rate’ (lowest to highest), then by provider name (alphabetically).