A Comprehensive Guide to Rentvesting
Rentvesting is an increasingly popular home-owning strategy where buyers rent a property in an area they want to live while buying an investment property somewhere more affordable.
Often, rentvesters will buy an investment property or multiple properties in rural or regional areas where house prices are typically lower than in cities. They will then rent a property in the CBD or inner-city suburbs where they can enjoy the benefits of a city lifestyle.
One of the top reasons why rentvesting is popular is because you can use the income from the property that you purchased as an investment to pay for your rent and support the lifestyle you want.
In a time when inner-city housing prices continue to rise, rentvesting is a way for people to enter the property market without sacrificing their lifestyle.
Understanding property investment
In the capital cities, there’s a significant price difference between the cost to buy and the cost to rent, particularly in Sydney and Melbourne. This makes property ownership out of reach for many people, especially if the dream is to enjoy city-based living. Rentvesting is a great alternative for homebuyers to get a foot onto the property ladder by purchasing a property in lower-cost areas without giving up the benefits of a city lifestyle.
For example, let’s say you could afford to buy in the inner-city and the mortgage repayments to do so were $3250 a month. Yet, if you were to rent a similar property in the same location it would cost you $1750. This would leave you with a ‘spare’ $1500 a month to invest.
Rentvesting gives you the best of both worlds. You can buy a property and rent it out to cover some or all of your mortgage repayment costs while continuing to rent the property where you live. You can also use the income generated from your investment property to support your rental costs.
How is rentvesting different from stock investment?
When you want to build your wealth, investment can be a good option. But what’s the difference between rentvesting and investing in stocks?
Before diving in, it’s important to note that future performance of any investment is not guaranteed. There are many things that can influence the market that you cannot predict – for example, a pandemic. This means there will always be a level of risk involved in investing.
The key difference
If you invest in property, you’re getting a tangible product. Investing in stocks is entirely different. For example, if you purchase shares of a business, you are buying a claim to a piece of the company itself.
Another key difference is that stocks are more liquid assets than real estate. It’s easier to buy and sell stocks than it is to buy and sell real estate.
One of the major differences between investing in property and investing in the stock market is the initial cost. Real estate has a much higher entry point, especially if you’re wanting to buy in an expensive location.
With rentvesting, you have to think about the home loan deposit, mortgage repayments and other costs associated with purchasing real estate such as stamp duty and loan costs.
Having said that, it does provide a passive income stream and the potential for attractive appreciation.
Is rentvesting a safer option?
When you have an investment property, you have guaranteed rental income. The only thing is that your property needs to be rented out to get this income. You’re also not always guaranteed to be able to cover mortgage repayments with your rental income. This is known as negative gearing, and, while not ideal for investors looking to increase their income it does come with some appealing tax benefits. Also, investing in real estate can actually protect you from inflation given that property values typically rise in accordance with inflation.
When it comes to rentvesting, the trick is that you must invest the difference (not just spend it) to build your wealth for this strategy to work.
Why rentvesting is a great option to consider
The major benefit of rentvesting is that you can live where you want to live as opposed to having to live only where you can afford to.
Rather than waiting years to buy with a larger deposit, rentvesting gives first-time property buyers the opportunity to buy sooner.
If you’re someone who enjoys the inner-city lifestyle but cannot afford to buy a home there, rentvesting makes it possible to rent where you can enjoy those city aspects while letting the income generated by your investment property help cover the costs of your rent and lifestyle.
Rentvesting is also great for people who are constantly moving around due to their work or lifestyle. They may want to choose to purchase a property somewhere but live in a short-term rental somewhere else.
Another clear pro of rentvesting is that you have an investment in bricks-and-mortar that is highly likely to appreciate over the years.
The pros and cons of rentvesting
Explaining the tax benefits of rentvesting
One of the main advantages of rentvesting are the attractive tax benefits. Having an investment property makes you eligible for several tax deductions - but remember, if you make your investment property your home then you won’t be entitled to claim any of them.
According to the Australian Tax Office (ATO), you can claim the following expenses:
- Water and council rates
- Home insurance
- Agent fees and commission
- Repairs and maintenance
- Tenant advertising
- Depreciation deductions for general wear and tear from natural causes
- Land taxes
- Interest on mortgage repayments
Another tax benefit is negative gearing, that can make the cost of investing in property more affordable. Negative gearing refers to a situation where expenses associated with an asset are greater than the income earned from the asset.
While making a loss on an investment property might seem counterintuitive, some people are willing to do this in the expectation that the capital gain (sale price minus cost of asset) when they sell the asset will more than offset that loss.
The financials surrounding rentvesting
Regardless of your strategy as a rentvestor, you need to buy a property with some capital growth potential and one that you can easily rent out if you want to make your investment work.
There are two things to consider before purchasing an investment property:
1. Capital growth
Capital growth represents the increase in a property's value over a period of time. Taking into account the constant fluctuations of the Australian property market, it’s clear that investing in property should be done for the long-term. Therefore, if you’re looking for a quick return, rentvesting may not be the right strategy for you.
So how much can you expect to earn over the long-term? This entirely depends on the size and type of the property, its location, and the real estate market in that local area. A suburb that has a growing population and is land-locked will have strong demand and low supply, putting pressure on property prices. A suburb that is located in the outer-suburbs may have less pressure on property prices as there is more land to be developed and less demand.
2. Rental return
To get an idea of the potential rental return for your investment property, study the rental prices of similar properties in the area. One important consideration is the yield of a property, which you can calculate by dividing the rent you receive over a year by the price you paid for the property which is then multiplied by 100. For example, if you purchased a property for $500,000 and are renting it out for $500 per week, which is $26,000 per annum, the gross yield would be 5.2% per annum.
What to consider before investing in property
Assess the risk involved
All types of investments come with risk, including property. However, property is generally considered to be one of the less riskier assets compared to other options such as shares.
Generally, these are some risks of property investment to be mindful of:
- Property is not a liquid investment: your money is tied up if you invest in property, meaning that you don’t have easy access to it if you need money in a hurry.
- Exposed to market interest rates: if interest rates rise, your mortgage repayments will increase.
- Risk of losing money if your living situation changes: If your living situation changes and you need to sell in a hurry, you may have to sell during a ‘down’ phase and risk losing money.
- Poor performance: Even though the property market is relatively stable overall, it doesn’t always grow. So, you run the risk of owning a property that doesn’t increase in value over time.
To evaluate the risk of your investment, you should conduct a cash-flow analysis. This can be done with the help of a financial planner, accountant, or property advisor.
Minimising the risks
You can mitigate the risks associated with rentvesting by actively taking the following steps:
- Diversifying your property portfolio. If possible, invest in different property types in a number of different areas to ensure that if there is an economic downturn in one city, you have other properties that are performing well.
- Ensuring you have a cash buffer to cover any unforeseen expenses.
- Consider splitting your loan or opting for a fixed-rate loan so you know exactly what your repayments will be each month.
- Do market research into the property market you’re investing in. Consider local supply and demand, local infrastructure and upcoming projects, the local demographic, and the average rental return.
Rentvestors who exercise their due diligence prior to investing can benefit from the safety, security and low volatility of property investment while avoiding undue risk.
Do your research
Doing your research thoroughly when it comes to any investment is crucial. But when investing in property, it’s really important to consider the following:
- Getting clear on your investment goal: what do you really want from an investment property? Are you looking to gain a steady income from rent? Is lifestyle important to you? If so, then rentvesting may just be for you.
- Having an investment strategy: After speaking to a financial planner or property advisor, you need to form an idea of how you will make a profit from the investment.
- Finding the right property: This is perhaps the most important step of all. You need to find a property that matches your investment goal and strategy as well as one that will appeal to renters and retain value over time.
Now that you’re more familiar with rentvesting and how it works, it’s time to come up with a rentvesting strategy.
The good thing about rentvesting is that almost anyone can do it. It’s all about exercising some discipline and making your savings work for you.
Here is a 3-step rentvesting strategy to start your property journey:
1. Save up a deposit
This will be the hardest step for most, particularly now in a time where property prices are increasing. The good news is, it is still very possible for those who really want to make it happen.
A good rule of thumb is to aim to save 20% of the property value as a deposit. Since 20% can be a lot of money, it’s best to start out with an investment property with a lower value than if you were purchasing a home to live in.
One of the easiest ways to save up for a deposit is to:
- Set your goal amount
- Track your spending and cut out any unnecessary costs
- Choose a savings account with a competitive interest rate
- Set up automatic transfers to your savings account
- Keep tracking your goal
2. Finding your first property
This is the time where it’s imperative to seek help from a professional. The three most important professionals you should get are a Buyer’s Agent, Mortgage Broker and a Property Manager.
A Buyer’s Agent can help you to source a property within your budget, a Mortgage Broker can do all the legwork for you and provide a quick and easy comparison between your lending options, while a Property Manager can take care of the typical duties of a landlord to save you from the day-to-day running of the property.
Essentially, choosing the right property will depend on:
- Potential growth
- Low vacancy rates
- Best rental yields
3. Working towards your second property
The aim of rentvesting is to fast-track your wealth by getting into the property market sooner rather than later. So the next step is to find and purchase your second property.
If all goes well, it’s entirely likely that you have managed to generate a positive cash flow from your investment property. The savings and equity held in your first investment property can help you secure the deposit for your next investment property or even your future dream home.
Invest with confidence
At first, it might seem strange to rentvest – why pay off a mortgage and rent at the same time? But if you have the budget, have done your research, considered your investment strategies, and have a particular lifestyle need then rentvesting makes a lot of sense.
For example, you might be single and wanting to enter the property market but the home you want isn’t in your price range. Alternatively, you might already be renting and are enjoying where you live, but the timing isn’t feasible for you to move right now. Or, perhaps you have a life and job in the city where you’re currently renting or looking to rent, and know that down the track you’ll want a ‘tree change’ and move out to somewhere more spacious.
Rentvesting gives you the best of both worlds. And with the right guidance from a rental property manager, you can enjoy living the lifestyle that you want right now while planning a future that is financially secure.
What do property managers do?
A property manager does exactly what the name suggests, and more. This includes marketing the rental, choosing your tenants and then managing the day-to-day activities required to manage an investment property. Generally speaking, the role of a property manager is to liaise with both tenants and landlords to ensure a property's rental value is maximised so you can get the best rental return on your investment property.
How can a rental property manager help?
There are many benefits of using a property manager if you’ve decided on rentvesting. Perhaps the most common advantage is that they are experienced in the property market and finding high quality tenants. They can also address issues including legal requirements, property maintenance and ensuring tenants pay on time to maintain the value of your rental property and to ensure you’re getting a steady rental income.
How much are property management fees?
Property management fees are between 5% to 12% of your weekly rent. This varies greatly from state to state. Some types of fees you can expect from a property manager include the letting fee to cover the property manager sourcing a new tenant for your property, along with a management fee to cover the day-to-day activities required to manage the lease.
While the thought of having to pay for a rental property manager may worry you, do not underestimate the time it takes to effectively source high-quality tenants and manage a property. Rental property agents are trained to source the best tenants and are also well-versed in the strict legislative requirements to manage an investment property.
So choosing a property manager to manage your investment property is a wise decision that may save you time and money over the long term.
At LJ Hooker, our goal is to increase your income and ensure your investment is working for you with minimal risk. If you’ve decided that rentvesting is for you, then soliciting the help of a rental property manager is the easiest way to start. Find a property manager and maximise the potential of your investment, or get a free rental appraisal today.