Rentvesting: what is it and why would you do it?

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Rentvesting: what is it and why would you do it?

Rentvesting

‘Rent money is dead money’ or so the saying goes. The idea of surrendering a portion of your wage to the landlord may appear to go against the cornerstone of the Great Australian Dream.

With skyrocketing property prices, home ownership may be under threat for many Gen Y and Gen Xs not to mention the millennials, especially if they live in Sydney and Melbourne. Take Sydney for example; in 2009, 36% of the average gross salary went towards paying off the average new mortgage. This is assuming a 20% deposit and an interest only payment arrangement. These days, that figure is closer to 54%. Melbourne hasn’t performed well on the affordability index test either. Melbournians are now forking out 42% of their gross salary to service the average new mortgage, up from 30% in 2009.

Property is a cyclical business and all markets undergo periods of expansion, stagnation and contraction. These phases determine housing affordability and ultimately whether one should buy their first home or run with a rentvesting strategy. This leads us to the question, what is rentvesting?

 

Rentvesting involves renting where you want to live and buying an investment property in a more affordable market with strong growth fundamentals.

Take this scenario for example. You’re from Melbourne and want to live close to the CBD, in suburbs such as Carlton, Richmond and Fitzroy. To get into a single fronted terrace house, you are looking around the $1.25M mark. Let’s say you have a 10% deposit, an amount that would have taken you approximately 7 years if you are on the average wage factoring in a 20% saving of your income. Interest only repayment on a $1.1M loan is approx. $1,000 per week. Rent for the same property is $600. Instead of purchasing your principle place of residence, you can instead rent the property you want to live in and divert the extra funds that would have been required to service the mortgage to an investment property in a more affordable suburb. So, you could still live in your desired property as a renter while simultaneously building up a property portfolio.

 

Rentvesting is a legitimate option and will produce the best financial outcome when someone wishes to buy their first home in an area where property prices are at the top of the cycle. The top of the cycle is characterised by roughly 7 years of consistent capital growth where income and rents have failed to rise at the same pace during the same period. The net result is the suburb will experience very low yields and a very high affordability index. During this phase, one should avoid purchasing in this market and instead apply the rentvesting strategy.

On the other hand, if your target market is at the bottom of the property cycle, purchasing your principle place of residence will be the best option. During this phase of the property cycle, prices are most affordable and therefore home ownership can be achieved more easily. In this instance you get the benefit of ownership, the benefit of living where you want to live, the benefit of growth and lastly the eventual sale of this property will be Capital Gains Tax free.

 

Some will argue that you can’t put a price on the benefits of ownership. We would argue that for first home owners there is no ownership. It is extremely rare that one’s first home will be their last – it’s a transitional property to get them to the next stage of the property ladder.

So, make no mistake, your first property is an investment and you are only renting from the bank. This is especially the case if your mortgage is interest only. Buying your first home at the top of the property cycle which are where most suburbs in Melbourne and Sydney are at the moment can be a bad financial decision for many first home buyers.

 

If you are a first home buyer, what should you do? That depends where in the property cycle your target suburb is. One thing for certain is that we should not be afraid of rentvesting. As we move into an era where Australian housing is consistently being ranked among the world’s least affordable, the traditional route to home ownership needs to be challenged. Rentvesting may not be the solution to the housing affordability crisis but it does offer an alternative approach to help first home buyers get onto the property ladder sooner.