Rentvesting is an accelerating trend in Australia that I have employed in my own investment strategy.
If you want to have a prosecco-swilling, latte-sipping lifestyle while securing your future by building a property portfolio, rentvesting is key to help ensure you still have free cashflow to enjoy those activities.
Below, an article I wrote a few years back on a private blog before the trend had even got a name and some helpful example numbers that explain what I mean…
Much has been made of late of affordability of real estate in Australia and in particular capital city markets, and how it is affecting first home buyers (FHBs), who have fallen to just 14.7% of the total number of market purchasers in July 2013, while the non-first home buyers (upgraders) and investors are performing strongly in a rising market. The below graph shows the difference in finance approvals per month between upgraders, investors, and FHBs.
I can’t tell from experience as I’m just too young, but we are frequently told by the media that housing affordability levels are at historically low levels, while at the same time this is contrasted with commentary about many people being unable to afford their first home. I am certain that the recent market recovery in Sydney which is behind a 12% growth spurt in the recent year would be disheartening for many FHBs. The initial savings required to purchase one’s first property are substantial and right now it might feel that the bar just keeps being raised beyond reach. I can tell from experience it took me 5+ years to save for my first property which I settled on in January 2013. I think the reality is, saving for this investment will never be easy, even if something (policy) changes to improve housing affordability, which could be the subject of another article.
However, I wonder what percentage of the investor purchases in recent times are in fact first time property buyers, who have elected to buy into the market as an investor, without having bought a home? In other words, these first time buyers rent out their own place of residence or continue to live with their parents. I don’t believe the ABS (or other body) releases this kind of data. My suspicion is it would be a reasonable component of the investor buying market!
The reason for my hypothesis is because this is exactly what I have done! I rent in an inner city apartment but have purchased an investment property in the inner west of Sydney, which is a less expensive entry point into the real estate market than the inner city. I choose to live in the city for lifestyle reasons but I actually believe I am saving money by doing this. Let me explain.
Conditions are currently such that rental yields are high (5+% in many cases) while interest rates are trending down to 5% p.a. across the board. Coupled with the tax deductibility of expenses in a rental property as well as the ability to negatively gear a property investment against personal income, it becomes a very attractive proposition. Now I realise this gets a bit technical, but below is a comparison of the net cashflows of a purchase of $450,000 with a 10% deposit, between a homeowner and an investor who must rent his/her place of residence.
|Home owner (and occupying)||Investment|
|Interest rate (interest only)||5%||5%|
|Interest per annum||$20,250||$20,250|
|Gross rental yield||0%||4.5%|
|Rent income per annum||$0||$20,250|
|Rent income per week||$0||$388|
|Other costs (assume 25%)||$5,063||$5,063|
|Gross cash flow||-$25,313||-$5,063|
|Marginal tax rate||38.5%|
|Negative gearing benefit||$1,949|
|Net cash on property flow after tax||-$25,313||-$3,113|
|Rent (place of residence) $pw||$0||$420|
|Rent (place of residence) $pa||$0||$21,900|
|Net cash flow per annum||-$25,313||-$25,013|
|Net cash flow per week||-$485||-$480|
What I have tried to show is that the investor can actually afford to fund a higher rent for his/her place of residence than exists on the investment property itself. In the above example, $420 per week rent costs on the place of residence with a $388 per week rental income on the investment, is equivalent to the home owner living in that same property, from an ongoing cashflow perspective.
My assumptions are quite conservative as I have only used a rental yield of 4.5% (Sydney is typically 5%+), and I have assumed no depreciation benefits which would improve the investor’s position further, as would an upswing in mortgage interest rates. I did assume the income used for negative gearing would attract a marginal tax rate of 38.5% but this does not change the conclusions of the analysis significantly if it is varied.
Why would I want to live in my first property? I can enjoy my active lifestyle as a 20 something while I am young and still build my property portfolio (sometimes I think moving out of home from my parents was a mistake because I would have so much more property already!)
Of course you may say that this analysis ignores stamp duty exemptions available to FHBs on off-the-plan property and that the investor will have to deal with capital gains tax upon sale of the property. I also should comment that the investor will only be better off overall if they have bought a quality property with good prospects for capital growth! Otherwise funding negative gearing is still a loss, regardless of the tax benefits.
What do you think? Have young people got it tough or am I onto something here?