What is rentvesting?

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

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

But if a buyer can’t yet afford a property in their preferred area to live, there are a couple of other strategies they could consider:

1. They can compromise and buy in a location that’s more aligned to their budget.
2. 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 second 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. This investment can help to build wealth, which could help to enhance the investor’s lifestyle and support them to one day buy an owner-occupied property where they want to live.

Who does rentvesting suit?

Rentvesting can work well across many income ranges. Financially, it typically works best in locations where the monthly differential in rent payments versus mortgage repayments are highest. Conversely, it’s generally a less suitable strategy when the mortgage repayments are roughly the same as the cost of rent for a property within a desired location.

Some of the household types that rentvesting may suit include:

• 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 looking for superior locations and a suitable property to accommodate them comfortably

The pros of rentvesting

Lifestyle

You rent where you want to live. This may better suit your budget and lifestyle, as you may have better access to your preferred amenities that you might as an owner-occupier living further away.

Wealth building

In some cases, rentvesting may be able to enhance your borrowing power, as the lender may factor part of your predicted future rental income into its serviceability calculations. This may help you more easily afford a property, which could in turn rise in value over time, building the potential wealth you could access in the future.

Similarly, buying a more affordable property in another location, rather than a more expensive place in the area you want to live, means it’s much easier to add mortgage repayments to your budget. This could let you put more of your money to work elsewhere, such as investing in shares or other assets.

Cost savings

As a renter, your landlord is responsible for the maintenance, upkeep and safety of the property, as well as costs such as council rates, some utility services (outside of usage), and any potential body corporate fees. They will also cover the upfront home ownership costs for the property where you’re living, such as stamp duty and potentially Lenders Mortgage Insurance (LMI).

It’s worth noting that as a rentvesting landlord, you too will have to cover these items for your investment property. That said, in many cases, part of these expenses are tax deductible.

All care no cost responsibility

As a residential tenant, it’s the landlord’s responsibility to maintain the property’s ongoing upkeep, and keeping its utilities in working order. Any issues with electrical, hot water, leaks, air-conditioning, building deterioration, inbuilt fixtures and fittings and worn items are at the landlord’s cost.

Keep in mind that while you shouldn’t need to worry about these expenses for the property where you’re living, you’ll be responsible for handling these issues for the tenants of your investment property.

Ease your property cost burden

As an investor, your tenants can help you out with your mortgage payments via the monthly rent they pay, which can help ease some of the stress on your budget. Keep in mind though that your lender will likely prefer that you can still afford the repayments even without the rental income, for those periods between leases where the property is vacant.

Tax benefits

Property investors can potentially claim tax deductions on their investments. You may also be able to claim depreciation on the building, plus in some instances any new fixtures and fittings added to the property. The interest charged on your investment mortgage may also be tax deductible.

In some cases, if the cost of maintaining an investment property is more than the rental income you receive, this negative gearing could affect the income tax you pay.

Go with the flow

Although the rental market can be tight, being a renter can potentially offer the flexibility to ‘mix it up’ and try living in a variety of accommodation types and locations. This may not be as easy as an owner-occupier, due to the high stamp duty costs and other buying and selling expenses.

The cons of rentvesting

Loss of full capital gains tax (CGT) exemption

Your ‘principal place of residence’ carries a full exemption of any capital gains tax liability if you sell the property for a profit, while rental properties are generally subject to capital gains tax if sold for a profit. This could cost you money in the future if you later plan to upsize or downsize your investment.

Emotional cost and peer pressure

You may feel that by rentvesting, 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 home, and creating great memories there.

Also, sometimes your family and friends may be critical of your decision to choose rentvesting over home ownership, even if it offers its own financial and lifestyle benefits.

Mercy of your landlord

One of the biggest frustrations and risks of renting is not being in control of the property you live in. While tenancy laws have given more rights to renters, the owner of the property you’re living in may not be as flexible or understanding as you’d like them to be. You may not always be able to get the lease terms you prefer, and in some cases, you may be required to vacate the property with limited notice, which can be an enormous disruption to your lifestyle.

Risk of going financially backwards

As the old saying goes, ‘rent money is dead money.’ If you decide to rentvest, but aren’t able to actually buy an investment property for any reason, then you won’t be building your wealth over time. And if you do buy an investment property, but aren’t able to get rental income from tenants for any reason (such as if the property goes untenanted for a length of time), you could find yourself at financial risk.

Changing your mind

If you decide you want to rentvest, then change your mind a few years later, the costs involved in changing your strategy may outweigh what you made from becoming a rentvestor in the first place. It may be worth making some careful calculations to estimate if it would be better to stay the course, or if rentvesting is not for you.

Buying a home to live in vs rentvesting

Would you be better off rentvesting, or buying a home to live in? Because property is a long-term financial commitment, it may not always be easy to predict the best choice, especially as everybody’s financial situation is different. The answer may depend on your current situation, plans for the future, and financial goals.

Buying a home to live in means you may not be able to afford to live in the area you want, at least at first, which could affect your lifestyle. You also may not be able to borrow as much to purchase your home, as you won’t be able to access extra potential rental income. However, you may be able to benefit from first home owner grants and similar incentives such as discounted or waived stamp duty, lowering some of your upfront costs.

This could potentially leave you with extra cash available to put into your offset account, reducing some of your interest charges. Plus, interest rates on owner-occupier home loans are generally already lower than for investment mortgages. You may be able to pay less in mortgage repayments each month, leaving more money in your household budget, or put extra money towards further lowering your mortgage principal, getting you out of debt sooner and lowering the total interest you’ll ultimately pay on the property.

While rentvesting could potentially let you benefit from rental income, improving your household cashflow, there are also expenses involved, requiring you to commit money, time and energy towards the property. And while your property could grow in value, you’ll need to account for capital gains tax if you choose to sell your investment, unlike your principal place of residence (PPOR).

That said, it’s not easy to forecast what your lifestyle or finances may look like 10 or 20 years into the future. It’s possible that over time, the two scenarios could financially even out. A lot can change in this time, which could affect the accuracy of any calculations or predictions you make.

Is rentvesting right for me?

Before you drop everything and start rentvesting, there are a few more potential complications to keep in mind. For example, while you could benefit financially from rentvesting, this is in no way guaranteed.

It’s important to remember that some lenders put higher interest rates and/or tighter restrictions on investor mortgages compared to owner occupier home loans. This could reduce some of rentvesting’s cashflow advantages as the cost of holding an investment property may be higher. And if lenders choose to tighten conditions further in the future, this could also affect your rentvesting strategy. There’s also a real risk that your investment property’s value could plateau or even decline over time, which could put you into a difficult financial position.

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 it’s important to carefully research the potential pros and cons, and to consider seeking professional advice from a mortgage broker or financial adviser.

Cover image source: Perawit Boonchu/iStockphoto.com