The pros and cons of rentvesting

So-called ‘rentvesting’ has grown in popularity as a way to break into the property market. Some proponents say it gives homebuyers the best of both worlds, but there’s more to it than meets the eye.

What is rentvesting?

Rentvesting is considered an emerging trend, but it most likely existed in some form before there was a name for it. It’s become increasingly popular with first home buyers who want to get into the property market but don’t necessarily want to live in the areas in which they can afford to buy.

Rentvesters typically purchase a home in outlying suburbs, more affordable cities, or regional towns. Meanwhile, they rent in a location that’s more desirable to them, whether due to amenities, a better ‘vibe’, or career or family commitments, but where they can’t necessarily afford to buy.

How does rentvesting work?

The theory behind rentvesting is that the rent paid by the tenants living in the purchased property will help the owner meet their home loan repayments while they continue to pay rent themselves.

At the same time, rentvestors hope the property they buy rises in value over time, potentially providing the capital needed to eventually purchase a home that better suits their lifestyle.

According to property investment experts, rentvesting is a tactic that can help some people overcome financial obstacles and own a property. But there are many things to consider before you become a rentvester.

Financial benefits of rentvesting: A case study

Josh, a carpenter in his late 20s, lives with his girlfriend in a leafy suburb less than 10 minutes from the city centre. They've rented in the area for several years and love their lifestyle. Josh’s share of the rent is $2,000 a month, plus bills, and he thinks it’s time he gets into the property market.

Image by Wesley Tingey on Unsplash

Although he’s got what he considers to be a good deposit – $120,000 – it’s not enough to purchase property in the area they live in. He likely wouldn’t be approved for a loan for the amount he’d need to borrow anyway.

He decides to purchase a home in a master planned outer suburb where he’s been working lately. It has new amenities like roads, a couple of schools, parks, a medical centre, and a train station is due to open there at the end of the year. He can buy a basic, newly built home there for $480,000 – around half the price of the lowest-priced apartment in his area.

His girlfriend refuses to live so far from the city centre where she works and Josh isn’t too keen to move out there either, so he does some calculations.

The mortgage repayments to purchase the home with a $360,000 investment loan are around $2,275 a month.

The area is popular with young families who are attracted to the new schools and parklands and the median rent in the area is around $650 a week for a three-bedroom home with a modest backyard. That would bring in around $2,800 a month – enough to service the loan and leave Josh with a bit extra to put towards maintenance and other investment property expenses.

To Josh, this is a no-brainer and he becomes a rentvester, purchasing what he can comfortably afford and continuing to rent in the area he wants to live in.

Benefits of rentvesting

1. Best of both worlds

Rentvesting proponents say that one of its biggest advantages of rentvesting is getting the best of both worlds – property ownership and lifestyle. Better still, if your investment property is generating a profit, you can use that income to help cover your rental expenses.

2. Gets you onto the property ladder sooner

Rentvesting may allow you to enter the housing market sooner, as the property you buy will likely require a smaller deposit than what you’d need if you were to purchase in your desired location. Rentvesting can be a better option than delaying your home-buying while you save for a larger deposit.

3. Allows you to build equity to purchase your dream home

Judicious property investments generally provide a good opportunity to generate wealth, which could help you purchase your dream home down the track.

Property investment proponent and co-author of investment book Let’s Get Real Luke Harris (pictured) says buying an investment property can be a method of ‘forced saving’.

“Having an investment property while you rent focusses your attention on wealth creation rather than buying expensive things for your own home,” he said.

“At the same time, you are already building equity with the investment property you have purchased.”

4. Lets you live where you want or need to

Rentvesting gives you an opportunity to live in areas where buying isn’t feasible due to high property prices. Renting in such locations allows to you take advantage of the lifestyle and amenities without being burdened by the large mortgages that generally goes with purchasing there.

5. More room for flexibility

Because you're still renting, you can upgrade or downsize to a different home if your financial or personal circumstances change without paying stamp duty and other expenses related to transacting in real estate.

6. Access to tax benefits

Property investors have access to a range of tax deductions that can help minimise their annual tax bills. These can sometimes spell the difference between positive and negative cash flows on rentals properties. They can also pave the way for you to purchase further investment properties. (A specialist tax accountant is best qualified to tell you what would be best for your circumstances.)

Drawbacks to rentvesting

As with most things that might sound too good to be true, rentvesting also has its share of downsides. Here are some of them:

1. You'll miss out on first home owner grants and concessions

Entering the property market as an investor rather than an owner-occupier will mean you miss out on the First Home Owners Grant (FHOG), stamp duty concessions, and other first home buyer benefits. These grants and concessions are generally not available to investors, even if they are to first home buyers.

2. Less security

A lack of security is one of the common downsides to being a tenant. If your landlord decides to sell their property or move in themselves, you’ll generally need to look for somewhere else to live. Of course, moving can demand many different costs and a whole lot of stress.

3. You'll also have homeownership costs

As a property owner, you're responsible for the cost of managing and maintaining your investment property. These costs may be substantial and can vary depending on the age of the property you buy, whether it is freestanding or under a body corporate structure, and the tenants who live there. You’ll also need to factor unexpected maintenance costs into your budget.

4. You’ll incur capital gains tax

If you sell your investment property for a profit, you'll be required to pay capital gains tax (CGT). The amount you could be liable for will depend on how much you’ve profited from selling your investment, how long you owned the property, and your marginal rate of tax. It can take a good chunk of any gains you make.

In contrast, a property you’ve owned and lived in as a primary place of residence is exempt from capital gains tax. The gains are all yours to keep.

Top tip to help hopeful rentvestors find success

Rentvesting can work for anyone, whether you're a first home buyer or a seasoned property owner. The key to rentvesting is making sure your specific model suits your individual circumstances and goals. Here are some considerations:

Buy the right property

Purchasing the right property is essential for successful rentvesting. In fact, it should be the number one consideration. Purchasing a property at the lower end of the market may be affordable but it can also come with inherent risks.

Sometimes such properties may be in undesirable areas that lack amenities, such as good public transport, schools, and medical facilities. While some affordable areas mightn’t appreciate in value because of such setbacks, others can see excellent capital growth coming off a low base.

Ideally, the property should be in a high-growth area with an increasing population, proximity to amenities, a strong local employment market, a low crime rate, and accessibility to public transport.

Looking at rental yields may not give you the full picture. Areas with the best rental yields are often located in regional or remote areas that are subject to vagaries of local economies and shifting demand, like mining towns.

You also need to find a property where there is high rental demand. If you struggle to find tenants, you'll be making the full repayments on your investment loan yourself while you continue to pay your rent. Chances are this won’t be sustainable.

Buy a new home - or not?

Some property experts recommend rentvesters, and other potential investors, look to purchase brand new homes as their depreciation provides for generous tax deductions compared to those on established properties.

This may be a good strategy if you’re looking to maximise your tax deductions, but it’s far more important to make sure your investment ticks more boxes than simply saving you tax.

Always keep in mind the golden rules of location, amenity, rental demand, security, and the property’s appeal to potential tenants. These may not always apply to all newly built homes. The main game is ensuring tenants will want to rent the property you buy. Any tax benefits should be an added bonus and not the main reason to purchase.

Lower maximum LVRs

Investment home loans generally demand lower maximum loan-to-value ratios (LVR), meaning you may have to produce a larger deposit than you would to buy as an owner-occupier.

Although the rules will vary between lenders, it’s common for lenders to require an LVR of 90% or less (or a deposit of at least 10%) for investor loans.

Stricter terms and conditions

Investor home loans typically have stricter lending criteria and sometimes come with more conditions than owner-occupier home loans, again due to their perceived higher risk.

Lenders' eligibility criteria is generally tighter for investors. You'll likely have to jump through more hoops to gain approval than an owner occupier might. Expect your credit score, proof of income, and rental yield projections to come under greater scrutiny than they would if you were applying for an owner occupier loan.

Interest only repayments

Some rentvesters, motivated by the prospect of capital gains when they sell their investment property, may choose to reduce their regular home loan repayments by making interest only repayments. This means they’ll pay interest on the loan without repaying the borrowed funds (the principal balance).

Interest only loans can help to maximise returns, which can make a rentvestor’s home loan repayments and rental expenses more affordable.

Many lenders will permit interest only repayments for a set period – generally up to 10 years for investor loans. This can give an investor time to realise some capital gains or give them the option of refinancing using the equity they have built up in the property over that time.

But bear in mind, lenders will want the loan paid back eventually. Ideally, you’ll have a longer-term strategy in place before taking on an interest only loan. It also pays to consider that although property can be a reliable investment, property values can fluctuate.

When is rentvesting not ideal?

Looking purely at numbers, to benefit from rentvesting you should be receiving more in rent than you pay in mortgage repayments. Those extra funds can help pay for management and maintenance expenses, and you may be able to put some of it towards paying your own rent. In other words, your investment property generates a profit and doesn’t require you to be contributing to it from your other income.

You need to ask yourself what your financial goals are. If you’re wanting to get into the property market and have someone effectively pay your home loan and see some capital growth with your property, rentvesting can be a good move. It can also work well to reduce how much tax you pay if that’s your motivation.

What to consider before rentvesting

As with any property investment strategy, rentvesting requires you to be financially prepared. On top of your deposit, you’ll need to cover the costs associated with purchasing a property, including stamp duty, lenders mortgage insurance, and other legal and bank fees.

It sounds basic, but rentvestors should be able to comfortably pay their rent while ensuring their monthly mortgage is covered. Keep in mind that variable interest rates can rise so it’s wise to build in some cushioning when you’re doing your calculations.

Make sure rentvesting aligns with your long-term goals. If you want to one day buy your own property in your preferred location, equity growth may be what you’re aiming for. If you’re looking to minimise tax, you may want to run your investment property at a loss. If you want your investment property to pay for itself without impinging on your lifestyle, you should look specifically for a property able to do just that.

Rentvesting can provide the best of both worlds provided you’re clear about how it will serve you and you do your homework.

Main image by Brooke Cagle on Unsplash. Image of Luke Harris supplied.