Okay, there are so many articles out there on Google about rentvesting. What is rentvesting? This is where you buy an investment property (somewhere far away) while continuing to rent (in a desireable location). Some folks call it the reinvention of the home ownership culture, or the trend of the millennials.
Of course, everybody’s circumstances are unique and you should be seeing a financial planner if you would like to get a tailored advice. But in this article I thought I discuss rentvesting versus buying your own home, in a general manner.
Why do people rentvest? It can be any one of the following reasons:
- Their income is not big enough to purchase any sort of property in the suburb they want to live in (near their work, near a bunch of restaurants and cafes, near their friends)
- They believe that land appreciates and building depreciates, so they rather purchase a house somewhere far far away, than purchase a unit in the city
- They can potentially afford a bigger property (if they still live with parents rent-free) and believe that property value will grow quickly so want to maximise their capital gain by purchasing the most expensive property they can afford
- They need to move around a lot, perhaps due to work, so renting is more practical
- Maybe they think the suburbs which are good to “invest” are not the same as the suburbs which are good to “live in”
- Maybe they have a long term plan, to sell the investment property a few years later and then use the profits to put on a deposit on a dream home they want to buy
Why would people choose not to rentvest?
- They are forgoing stamp duty waivers for first home buyers buying their first property to live in (roughly speaking in NSW this is around 4% of the property value, or $22,490 for a $600,000 property)
- They are forgoing the $10,000 “grant” (in NSW) for buying or building a brand new home to live in
- They are forgoing the capital gain tax exemption for principal place of residence (this can be quite large over time)
- They do not like renting, they cannot renovate their home, cannot have pets, cannot host big parties, and so on
- They want to boast to their friends that they have a home
So, which method of home ownership is better from a financial perspective?
One issue with rentvesting is that you are forgoing $20,000 – $30,000 of “deposit” from the waived stamp duty and/or the grant for a first home buyer. Therefore, it works better for people who have small income, but somehow has a lot of cash savings or perhaps parents who can help with the cash deposit. Some parents may have plenty of equity in their own property, and may offer this equity for you to use in lieu of cash deposit, using what’s called a “guarantor loan”.
Your maximum property purchase price is generally dictated by 2 factors: your income, and your savings/deposit. Rentvesting may work if income is the limiting factor.
How much deposit do you need to buy a home?
If you are buying for investment, the ideal scenario is to have 25% cash savings (20% for the property deposit, 4% for the stamp duty, 1% for the incidental costs). This gives an LVR of 80% and avoids you having to pay for lender’s mortgage insurance (LMI). LMI varies greatly based on a range of factors, but roughly speaking it is between 1% – 4% of the property price. Perhaps you can think of paying LMI as similar to paying for one year’s worth of interest, or one year’s worth of rent.
If you are buying to live in, you may be able to get the stamp duty waived, so you only need 21% cash savings (20% for the property deposit, 1% for the incidental costs).
Therefore if you have $100,000 cash in the bank, from a deposit perspective alone you can buy (cheaply) a $400,000 property as an investment, or a $476,000 property to live in. No LMI. Cheap interest rate (in fact banks nowadays also offer cheaper rates to owner occupiers, on top of the cheaper rates offered to those borrowing at 80% LVR rather than 90% or 95%).
How much income do you need to buy a $476,000 property to live in, if you borrow at 80% LVR? Between $60,000 – $65,000 gross annual salary before tax if you are single with no existing debts; less if you do a joint loan with your partner and there are two income earners.
What about if you rentvest, what property price can you afford with the same set of circumstances above? Well, your cash savings is only $100,000, so you can only buy a $400,000 property unless you’re willing to pay lender’s mortgage insurance (LMI) and the interest rate may be a bit higher too. But what if you don’t care about LMI and rate? Surprisingly it works out to be slightly less than $476,000 if your rental expense is approximately the same as the rental income you receive from your investment property, i.e. you are buying a similar property as what you’re renting in. You really can only buy a bigger property if you live with parents rent-free instead of doing a full-fledged rentvesting and paying actual rent.
So does rentvesting really work? I personally do not think it works for most people, but I am happy to be proven wrong.
Please leave a comment below with your thoughts.