Does this scenario sound familiar?
You’re currently renting a house or an apartment and are keen to get a foothold into the property market.
You’re not alone. This is a situation many Australians find themselves in.
I’d hazard a guess though that most people are aiming to purchase their first home to live in. This tends to be the default option because, well, it’s the Great Australian Dream, right?
And once you have your own home, maybe – just maybe - down the track you’ll start that property investment portfolio you’ve thought about so often.
The problem with this strategy is that life gets in the way. From an investment point of view, there are definitely advantages in purchasing your own home first: specifically, it will hopefully go up in value over time and you’ll eventually be in a position to leverage the available equity to purchase your first investment property. And of course, your own home can provide you with freedom and stability we all desire.
However, there are also a few cons as well:
1. Fewer tax exemptions
Owning your own home will allow you to avoid capital gains tax, but overall there are far fewer tax exemptions for homeowners versus property investors.
Unlike a property investor, you won’t be able to claim deductions as an investor would for renovating the property or on interest payments.
2. Reduced cashflow
In most cases, you just won’t be making an income on your property. Unless you rent out a room of your home, there will be no extra regular income. You will really only make money off your home when you eventually sell it.
This means owner-occupiers sink all their earned income into paying off their mortgage. This is called an ‘opportunity cost’; it’s when your savings are tied up in repayments instead of being reinvested in other opportunities. This is not ideal if you’re trying to build your investment portfolio.
But there is another way, and it involves renting while you kickstart your property investment portfolio.
Some people call this strategy ‘rentvesting’, and the main aim is to rent for happiness and invest for growth.
In other words, you rent in a suburb where you really want to live (potentially one that’s out of your reach if you wanted to buy there) and then build an investment portfolio with the surplus money you accumulate from not having to pay down a mortgage.
A common thing I hear at this point is: "That’s all well and good Cam, but rent money is dead money!”
Sure, that can be the case if you're not doing anything else with your excess funds. But we’re all about putting those funds to good use. I won’t lie. You will have to make sacrifices: set and keep to a budget in order to free up extra cash that in turn can be used for investing, but that’s an article for another day!
Investing While You Rent
Rentvesting is the most effective way to use your cashflow to live in the location that suits your lifestyle while at the same time making capital gains through investment. The best of both worlds!
I understand most people have a finite amount of cashflow, but it’s how you use that cashflow to live the best lifestyle possible while at the same time getting the optimum financial result. Stack this up against using all your excess cashflow simply to service a mortgage that ties you up for years.
Classic example, we know that 85 to 90 per cent of Australians today unfortunately retire on the pension. Why is that? Because their investment strategy was to buy the family home as their first property. They spent a lot of time and cashflow paying it off over a number of years and as a result had little cash left over to buy anything else that actually created a passive income for them.
End result, they're relying on the pension and life's not so great.
This is where rentvesting comes in, and it can work for anyone. Investing in property while you rent your home has a number of advantages:
1. Better cash flow
If you invest in a property intelligently and collect a good rent, your tenants will end up paying the mortgage on the house, as well as the interest payments. The equity generated can be used to purchase more investment properties, allowing you to expand your portfolio.
2. Tax deductions & negative gearing
You can claim a host of property expenses as tax deductions if it’s a rental. This takes care of maintenance and renovation costs, rates, and much more that you would be out of pocket for as an owner-occupier.
If your property is negatively geared, you can also claim interest payments as tax deductions.
3. Potential for improved borrowing capacity
Interestingly, banks are sometimes more inclined to loan more if you’re receiving a rental income.
While the criteria will differ between lenders, they typically factor in some 60 per cent of your rental income when calculating your borrowing capacity.
However, rentvesting is not always ‘sunshine and roses’. It can come with a few disadvantages as well, the big one being capital gains tax.
When it’s time to sell, the capital gain accumulated on a rental property is counted as assessable income and taxed at your highest marginal tax rate. If you’ve held the property for more than 12 months, you can be in line for a 50 per cent concession.
Do your research!
It’s important to do your research: weigh up the pros and cons of each option and see how they fit with your lifestyle and financial position. Picking rentvesting over home ownership may be right for you, or it may not be.
But what I do know, is that investing while you rent really can work.
I did it, as did my co-directors at OpenCorp – Al, Matt and Boz. It’s how we got our start by allowing us to eventually buy our dream homes in the locations that we now live purely off the back of the growth in our respective investment portfolios.
Director of OpenCorp, Cam McLellan is committed to sharing his passion and property investment knowledge with everyday Australians.
Cam started investing in real estate at a young age and quickly mastered the art of building sustainable wealth. He has used the same wealth building strategy to develop a multi-million dollar business, sharing his knowledge and skill with ordinary Australians. Cam has personally bought, sold and developed numerous properties and has an extensive residential and commercial investment portfolio.
Read more Expert Advice from Cam here!
Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.