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Should your first property purchase be an investment?
July 21, 2016
The dream of owning your own “castle” has changed a little, with many first home buyers today buying an investment property before they buy a home. In fact, a Mortgage Choice’s investor survey last year revealed 36.6% of investors were first-time buyers – up from 21.1% the year before.
The survey found Australians increasingly want to live close to work and where the action is, which is why most people like to live close to the capital city centres, but with prices rising across most capital cities, purchasing property near or close to the city is becoming increasingly difficult for buyers – especially first home buyers.
The increasing appeal for younger generations to rent in desirable locations (where they can’t afford to buy) and buy an investment property where they can afford to but don’t want to live, is behind this sentiment shift to buying an investment property before their first home.
This trend, described as “rent-vesting”, suits the lifestyle of many millennials, allowing them flexibility in where they live, giving them the opportunity to travel and at the same time allowing them to grow their wealth.
Interestingly, this shift could mean the official statistics that show record low first home buyer activity probably understate the real buying activity of young Australians, because rent-vestors purchasing investment properties wouldn’t be documented as a first home buyer in the data.
Buying an investment property first may have some benefits for you:
Maybe you’re not ready to settle down in the suburbs or maybe you don’t have the job security you desire to purchase in more affluent areas. Renting could offer you the flexibility to easily move, upgrade or downgrade without all the costs of buying a property such as stamp duty and legal costs.
You can live the lifestyle you desire today, in or near the areas you love is without having to make the long term commitment to buying a property there. All while still growing your property portfolio in another, more affordable area.
- Someone else pays the mortgage
Imagine you find a property you’d like to call home, but can’t quite afford to buy it right now. One solution could be to initially rent it out so the tenant helps pay off your mortgage until such a time as your finances improve and you can move in yourself. You’re likely to find tax benefits, including depreciation and negative gearing, may help you manage your loan for those first few difficult years.
By using the rent coming in, plus any regular savings, your loan could be paid down much quicker than if you moved in straight away. Before you adopt this strategy, make sure you get tax advice as your investment property could attract capital gains tax in the future, even if it becomes your main residence. Estimate how much you can save here.
- The benefits of capital growth
Michael Yardney from Metropole Property Strategists believes “there’s no doubt in my mind that if I had to choose between cash flow and capital growth as an investment strategy, I’d invest for capital growth every time.”
“This is because wealth from real estate is achieved through long-term capital appreciation and the ability to refinance to buy more properties. Therefore, you should consider buying in a suburb that offers high capital growth potential, and this may not be where you’d like to live in the short term.”
Yardney states “Remember, most inner- and near-city apartments have exhibited little capital growth over the last decade, so if you’re keen to live in the center of the big smoke, just rent there and buy your investment property in a high growth suburb elsewhere. If your investment performs well, it could help reduce the amount you ultimately need to borrow to buy your new home.”
Isn’t paying rent “dead money”?
Not necessarily. George Raptis from Metropole Property Strategists in Sydney has a different view. He says: “I can see a good financial argument for continuing to rent and buying an investment property first.
Imagine you and I live in the same street, next to each other in similar homes each worth $500,000. We both pay our home mortgages, rates, insurance, maintenance bills and so forth out of our after tax dollars.
Then one day I have a brilliant idea!
I suggest that we swap homes and rent off each other. I propose you pay me $500 a week rent and I’ll pay you the same, so we’re cash flow neutral (the rental income I receive covers my expense of renting).
Sure I still have to pay my rates, insurance, maintenance and mortgage, but now these expenses are tax deductible because I own an investment property. Plus I’ll get the bonus of a further tax deduction on the depreciation of property and the fixtures and fittings inside.
Of course I’ll have to declare the rental I receive from you as income, even though I won’t pay tax on this, as my property outgoings are likely to be more than my income. But the point I’m trying to make is that the sums are nowhere near as bad as most people imagine.”
Some other important issues to consider
Before you adopt rent-vesting, or any other investment strategy, you should:
- Prepare a budget and get independent tax and accounting advice to ensure your approach is financially achievable.
- Understand the risks as well as the rewards of property investing, such as the responsibilities of being a landlord as well as the illiquid nature of property investment.
- Recognise that property prices can go down as well as up, so there may be some risk to this strategy.
- Understand your eligibility for your state or territory’s first homeowner grants or stamp duty concessions if you buy an investment property first. In general you won’t lose access to the First Home Owners Grant as long as you rent out your property and don’t live in it.
- Always keep a close eye on how your investment property is tracking in terms of cash flow and capital growth, but remember that property investment is a long-term wealth creation strategy.
So, there you have it – maybe ‘rent-vesting’ is the way to go after all.
Author: Michael Yardney is a director of Metropole Property Strategists, which creates wealth for its clients through independent, unbiased property advice and advocacy. He is a best-selling author, one of Australia’s leading experts in wealth creation through property and writes the Property Update blog.