What is Rentvesting?
Rentvesting is the act of living in a home you rent while simultaneously owning a property which you rent out to someone else. So you are both a tenant and a landlord at the same time.
Rentvesting is often touted as a way to live a comfortable lifestyle, renting in your ideal location and at the same time, get into the property market by buying property in a more affordable location.
Rising property prices over the past twenty five years has meant that saving the deposit to buy a home has become increasingly more difficult.
Inflation, not matched by rising wages, and rising interest rates is now making servicing the larger home loan required more difficult.
As a result, the Australian dream of home ownership, seems further and further away for many.
That’s why an increasing number of millennials are getting into rentvesting seeking to get a foot in the door of the real estate market, without sacrificing their lifestyle.
With the rentvesting strategy, you rent where you want to live and invest in an area where you can afford to buy a property.
But can you really have the best of both worlds? Or is this just another cruel hoax, playing on the fears of young Australians?
Let’s have a look at what rentvesting is and if it could be right for you.
It's more a marketing tagline than an investment strategy
Rentvestor is a registered trade mark of LJ Hooker, one of Australia's largest real estate agencies.
This alone should give you pause for thought as to whether Rentvesting is just a cynical marketing ploy to sell more property or is a genuine financially responsible alternative way for young Australians to achieve their home ownership dreams.
Often, rentvesting is used as a technique to sell property to Melburnians and Sydneysiders who are used to high prices. When purchasing at lower-prices, especially in Queensland, they feel they are getting a bargain.
Reality is, over the past 18 years, the real estate market in Brisbane has consistently underperformed the Sydney and (to a lesser extent) the Melbourne ones.
Of course, there are exceptions in every market, and good investments can be made.
It might shock you to hear this, but there are very limited circumstances when rentvesting makes true financial sense.
It conflates three decisions
- Should you rent or buy your home? I have analysed the numbers on whether it is better to rent or to buy your home in detail in my article Rent or Buy: How to pay for your home
- If you decide to rent, you need to decide how to invest the money that you would have used for the deposit, and the difference between the rent and the cost of buying the same property?
- If you do decide to invest in property, where and what should you buy?
Whenever, we conflate multiple decisions, we usually end up reaching the wrong conclusion.
Photo by Wendy Wei
So how do the numbers stack up?
I'll use the example of a home that rents for $556 a week and costs $850,353 which equates to a rental yield of 3.4%. In other words, you need to spend just over 29 times the current year’s rent to buy the property.
This is the same example I used in my
Rent or Buy article.
Two individuals, Harriet and Roger, each have savings of $203,411 which they use to buy the property.
The initial cost of purchasing the property consists of a deposit. Traditionally this has been 20% ($170,071) plus stamp duty of $33,340 (in NSW). The balance is funded by a mortgage of $680,282 (over thirty years at 5.64%).
A deposit need not be a full 20% as I discuss in my article
How to buy your first home but it avoids the cost of Lender's Mortgage Insurance. I have used 20% because it simplifies the modelling and doesn't change the overall conclusion.
Harriet Homeowner
Harriet Homeowner chooses to buy the property using all her savings.
Each month she pays principal and interest repayments on her loan of $3,923. She must also pay for maintenance (I assume a typical 1% of the property value per annum), or an initial $708 a month. This cost rises annually with inflation). And of course, there are council rates of $125 which also rise with inflation each year.
Her total monthly cost is, therefore, $4,756. ($3,923 + $708 + $125)
Roger Rentvestor
Roger Rentvestor chooses to rent where he lives and invest his savings in an identical investment property.
Roger pays an initial $556 a week (or $2,416 a month) in rent. Each year the rent rises in line with historic wages growth of general consumer inflation (CPI) + 1%. He receives the same amount on the property he owns and rents out.
Roger also has the same costs of ownership that Harriet does, but in his case, they are tax deductible, as is the interest on his mortgage. On the downside, he will pay capital gains tax on any profit on sale of his property. The rent he pays on his home is not tax deductible.
Making the comparison
I have assumed that both Harriet Home Owner and Roger Rentvestor earn between $45,000 and $120,000 so that their marginal tax rate is 34.5%.
There are two ways to compare Roger's and Harriet's financial position.
- How much they spend each month
- What the net value of their assets is at any time.
Cash Flow of Buying vs Rentvesting
As Roger’s rental income is the same as his rental payment, the only real difference (apart from the minor agent’s fee to manage his rental property and the slightly higher interest rate he pays as an investor) is tax.
Initially, Roger’s tax deductions for interest, ownership expenses, depreciation, and agent’s fees exceed his rental income. As a result, he will receive a tax refund for the difference. This is a situation known as negative gearing. This refund means that Roger’s net out of pocket costs are lower than Harriet’s for the first few years (until the rental income starts to exceed the other expenses).
Over time the rental income rises while most of the remaining costs remain stable. Eventually, Roger becomes a net taxpayer and his monthly outgoings exceed Harriet’s. In this example the cross over happens in year 7.
Net Asset Position of Buying vs Rentvesting
This comparison is a little more complex.
In order to equalise the cashflows, I assume that whoever has the lower monthly cashflows of the pair adds it to their savings.
Initially, Harriet is worse off because Roger receives a tax refund, so he invests the difference in a high growth fund. After the cross over point identified above is reached, Harriet spends less each month, so she invests in the same fund.
On the other hand, Roger will need to pay Capital Gains Tax on his profit on sale, Harriet will not.
In both cases, I have allowed for property selling costs of 5% of the sale value to pay for agent’s fees, marketing and legal fees and an allowance for minor repairs and staging costs when assessing the value of the property.
Again, under most long enough scenarios, there will be a crossover point where Roger’s capital gains tax liability will exceed the investment he’s built up from his lower monthly net outgoings, leaving Harriet better off.
In this example, the crossover for Harriet takes just over 3 years. Any time after this, Harriet's net assets will exceed Roger’s.
If Harriet and Roger were higher rate taxpayers the break-even periods would increase.
The lie behind the Rentvesting pitch is the claim that you can “live where you want and buy where you can afford”.
This is based on the fact that you can rent somewhere for less than the first-year cost of buying it.
In this case Roger could rent a property worth $965,000 for the same cash cost as Harriet can buy the $850,000 property in this case study.
This ignores the fact that rent rises, typically slightly faster than CPI, and so in the second year, inflation will have pushed Roger’s rent up, increasing his total monthly cash flow above Harriet’s.
This gap will widen each year, leaving him $61,000 worse off over 10 years as a result of choosing to rent the better home.
Other negatives of Rentvesting
You will forgo many of the first home buyer incentives, which are limited to first time owner occupier buyers only. This can be thousands of dollars.
You will not be able to borrow as much (all other things being equal) which either means a larger deposit or a higher Lender’s Mortgage Insurance bill. The difference between Harriets’s borrowing capacity as a homeowner, and Roger’s as a Rentvestor would be $30,000 - $50,000 with most banks.
Is Rentvesting for You?
If you have concluded that now is not the time for you to buy your home, and you do not intend to do so for a number of years, then investing in real estate may well be the right investment choice.
If you need a Sherpa to get a clear view of your financial situation and review rentvesting options with you, just whistle over the mountain path (or better, call us).
