Rentvesting – renting a home where you wish to live while buying an investment property elsewhere – is often touted as a strategy for first-time homebuyers to get into the market. But with interest rates stubbornly higher, is it a worthwhile strategy?
One of the goals of rentvesting is to cash in on the capital gain of the investment property and use it to purchase your dream home in the future – either by selling the property and realizing the profit or by using the equity gained as the value of the property increases and the loan balance reduces over time.
Comparing 2019 to 2024
Let’s examine the viability of rentvesting in 2019 versus 2024 with Sarah, a white-collar worker on a base salary of $160,000.
What It Cost in 2019
In 2019, if Sarah decided to live alone and rent an inner-city apartment in Sydney for $890 per week, she would have a net annual cash flow of around $64,000 after tax and rent. This would leave her with about $1200 per week to fund her lifestyle.
Sarah has a deposit saved that is not quite enough to purchase a property in an area of Sydney where she wants to live, but she has enough to buy an investment property in Newcastle, which she believes has good growth potential.
Sarah buys an apartment in Newcastle for $735,000 (the median price for a two-bedroom apartment in Newcastle at the time), resulting in an investment loan of $661,500. She rents the apartment out for $535 per week (the average rent for a two-bedroom apartment in Newcastle at the time) while continuing to live in Sydney, paying rent of $890 per week.
In this situation, Sarah would have about $47,000 left each year, leaving her with about $900 per week to fund her lifestyle.
Should Sarah decide to purchase the Newcastle property and live in it – giving up the Sydney lifestyle she wanted but becoming an owner-occupier – her net cash flow would be about $63,000 after tax and mortgage repayments, leaving her with about $1200 per week to fund her lifestyle.
What It Costs Now
Fast-forward to this year, and the numbers have changed.
The average rent for a two-bedroom apartment in inner-city Sydney is now $1150 per week.
If Sarah still wants to live alone and rent an apartment at $1150 per week, she would have about $56,000 each year after tax and rent, leaving her with about $1100 to fund her lifestyle, $100 less than in 2019.
If Sarah decides to buy a two-bedroom apartment in Newcastle for $1,042,500 (the current median for a two-bedroom apartment in Newcastle) and then rents the apartment for $720 per week while continuing to live in Sydney, paying rent of $1150 per week, she would have about $23,000 left annually, leaving her with a budget of about $450 per week to fund her lifestyle – $24,000 less than in 2019.
Should Sarah decide to purchase the Newcastle property and live in it, her net cash flow would be about $34,000 after tax and mortgage repayments, leaving her with a weekly budget of about $650 to fund her lifestyle.
Cash Flow Squeezed
This simple case study shows that the cost to implement either of the strategies has increased significantly and has a much larger impact on cash flow. The numbers show us that compared to 2019, the rentvest scenario now costs about $24,000 more, and the owner-occupier scenario costs an additional $31,000 per year.
For simplicity, the same salary has been used in both 2019 and 2024 scenarios. However, it is worth noting that $132,000 in 2019 indexed by 4% a year would equate to about $160,000 in 2024.
If we look at the analysis using indexed salaries, the additional cost of the rentvesting strategy is about $6500 a year, while the additional cost of the owner-occupier strategy is about $12,000 a year.
In the case study, we have assumed Sarah lives on her own. Given the higher rents in Sydney and the higher interest rates, rentvesting this year could mean she may be forced to reconsider her options as she has less cash flow to fund her lifestyle.
If Sarah had $450 per week to cover general living expenses – such as groceries, transportation, utilities, and medical expenses – it would mean a pretty tight budget that had little room for lifestyle or savings.
To reduce her expenses, Sarah may be forced to change her living circumstances by sharing an apartment in Sydney or by moving into the Newcastle property and forgoing her Sydney lifestyle.
Don’t Forget About CGT
One aspect that many people don’t consider is the capital gains tax (CGT) implication of investing.
CGT is a tax paid on the profit you make from your investment. While rentvesting can be viewed as tax-efficient, you also need to consider the tax you would pay if you sell the property down the track, which would reduce your profit.
That said, capital gains is one of the most important aspects of property purchases. So you need to choose a property with enough growth potential to make the purchase worthwhile.
Rentvesters should also consider the possibility of losing a tenant and having sufficient cash flow to service both their mortgage and rent while the property is vacant.
After the RBA dashed hopes of rate cuts in the short term this week, many may be considering whether rentvesting is still worth it. Higher interest rates mean higher mortgage repayments, and rental market conditions and periods of vacancy are also risk factors. However, the strategy can still be worthwhile if the rental yield and capital growth potential are strong.
Entering the property market might be a top priority for you, and waiting to buy a home where you want to live might become harder if the market keeps heading up. Ultimately, what you decide to do will come down to personal goals and objectives, and the desire to maintain a certain lifestyle.
Even though property ownership is seen as a rite of passage for many Australians, it is not without risk. Before implementing any investment strategy, it is worthwhile identifying your investment goals, doing your research, and crunching the numbers to see if they work for you.
For tailored financial advice and to explore the best investment strategies, contact BOA & CO Financial today. Our team of experts is ready to help you navigate the current market conditions and achieve your financial goals. Call us at 1300 952 286, email info@boanco.com.au, or visit our website at www.boanco.com.au.