Housing unaffordability continues to be the biggest barrier preventing many aspiring homeowners from securing a property in many of the country’s most desirable suburbs. In capital cities, where many people work and aspire to live because of easy access to modern conveniences, for example, the price difference between buying and renting a home remains significantly high.
This price gap has prompted many first-time home buyers to turn to a savvy investment strategy as a stepping-stone to achieving their dream homes. The strategy is called rentvesting, which has been growing in popularity these past few years.
How does rentvesting work?
According to experts, rentvesting is a homeownership strategy where you buy an investment property in a place you can afford while renting a home in a place you want to live but cannot necessarily afford.
This tactic allows you to still live in an area where buying a home might not be possible due to financial constraints while at the same time holding a property in a location that suits your financial situation.
“Essentially, the rent and invest strategy is to buy an investment property first where you can afford to and rent where you want to live but probably can’t afford to,” wrote Michael Yardney, chief executive officer of Metropole Property Strategists, in his property update blog. “It’s a tactic that overcomes financial obstacles and exorbitant property prices because you can buy in a location that fits your budget and then rent in a location that suits your lifestyle.”
Yardney added that rentvesting is an effective homeownership strategy because even though you continue to rent, the house you bought could potentially rise in value, particularly if it is in a “smart location,” and part of the cost is being paid off by the tenant.
What are the pros of rentvesting?
Some experts say that one of the biggest advantages of rentvesting is that it gives you “the best of both worlds.” The strategy allows you to buy a home and rent it out to cover some of your homeownership costs, while continuing to live in an area that suits your lifestyle. If your investment property is generating profit, you can even use that income to cover your rental expenses. Here is a breakdown of some of the other benefits of rentvesting:
1. It helps you get on the property ladder sooner
Rentvesting allows you to enter the housing market sooner as the property you purchase often require a smaller deposit. This is as opposed to delaying your home-buying plans for several years because you have yet to save enough for a deposit.
2. It allows you to building wealth to save for your dream home
Property investments typically provide a great opportunity to generate wealth, allowing you to save enough to purchase your dream home.
“The number-one advantage for me is that it’s like a forced saving, in that having an investment property whilst you rent focusses your attention on wealth creation rather than buying expensive things for your own home,” said Luke Harris, property expert and co-author of property investing book Let’s Get Real. “At the same time, you are already building equity with the investment property you have purchased.”
3. You get to live where the action is
Rentvesting also gives you an opportunity to live in places where buying is not ideal due to skyrocketing purchase prices. And assuming the area that you want to live in has a relatively affordable rental price, then you will be able to take advantage of the location without having to commit long-term on a huge mortgage.
4. There’s more room for flexibility
Because you are renting, you can easily upgrade or downsize to a different home if ever your financial situation changes without having to worry about stamp duty or other legal expenses.
5. You can access a host of tax benefits
For property investors, the Australian Tax Office provides a range of tax deductions that can help minimise your annual tax bills. This can sometimes spell the difference between positive cash flow and negative gearing.
“Of course, your own home is not tax-deductible, and so rentvesting may give you tax benefits that you wouldn’t otherwise get which gives you the chance to build your portfolio faster," Harris said.
What are the cons of rentvesting?
Rentvesting, however, has its share of disadvantages. Here are some of them:
1. You will miss out on FHOG
Entering the property market as an investor rather than an owner-occupier will mean you will be missing out on the First Home Owners Grant (FHOG), which has strict eligibility criteria.
2. There is less security
One of the downsides of being a tenant is that there is less security in your primary residence. If your landlord decides to sell, you may need to make the property you are renting available for open inspections or even vacate it.
3. You also need to take care of homeownership costs
As an owner, you are responsible for the costs of management and maintenance of your investment property. This may cost you more in the long run, especially if your rental income is less than homeownership costs.
4. You incur capital gains tax liability
If you decide to sell your investment property, you are required to pay tax on capital gains. In contrast, selling an owner-occupied property does not require CGT payment.
What are the things you need to consider before rentvesting?
As with other property investment strategies, rentvesting requires you to be financially prepared. You will still need to spend for the usual costs associated with purchasing a property, including deposit, stamp duty, lenders mortgage insurance, and other legal and bank fees.
Rentvestors should also be able to afford their rent while ensuring their monthly mortgage is covered. Additionally, there are several costs involved in the management and maintenance of your rental property, so it is best set aside a budget to cover for these.
Investing in the right location can also pay dividends. Areas with good capital growth potential is best if you are rentvesting with the goal of securing your dream homes. If you are planning on becoming a long-term renter, choosing an investment property located in an area with a potential for strong rental return is more suitable.