How do I make rentvesting work?
Playing the property game isn’t that easy for gen Ys in our two global cities, Sydney and Melbourne. We have watched prices surge on the back of lower interest rates and years of undersupply. The net result is that more locations than ever before are beyond the reach of most gen Ys.
What’s more, for the past 10 years or so these professional gen Ys have rented in cosmopolitan areas, enjoying the benefits of being close to “everything” to live, work and play. So they can’t bring themselves to the idea of moving “out wide” and dealing with extended daily commute times, on top of their long work hours, or the lack of variety in the local amenity that they now have come to expect.
Our global cities come with global price tags for houses with any land content, as this limited supply is swamped by excessive demand. The harsh reality is that this trend will not stop as the population of our two biggest cities is forecast to double in size over the next 34 years to 8 million each. But all is not lost for gen Y or others who choose to rent where they want to live but still want to get onto the property ladder via a “rentvesting” strategy.
Rentvesting works best where the differential is greatest between the repayments on a home loan compared with what it would cost to rent a similar property in the same location. This is best illustrated by way of an example. Let’s look at properties in Essendon-Moonee Ponds in Melbourne, where you can find family homes worth around $1.5 million.
Let’s assume we borrow 80% of its value, meaning our loan would be $1.2 million. At a long-term interest rate estimate of 6% (principal and interest loan over 30 years) our monthly repayments would be $7195, or $86,340 annually. Yet there are similar properties available for rent in this area, and the rental yield is only 2% for a standard but functional place. That yield equates to an annual rental commitment of $30,000.
So many of these gen Y and other couples simply couldn’t afford to buy a house in this upmarket location. However, with a potential saving of over $55,000 a year in cash flow, this additional money could be used to start, or add to, a family – say $20,000, leaving over $35,000 a year available to invest. This surplus could buy at least one or possibly even two investment properties. That ensures they are getting their own money working harder for them in building their own equity and wealth story. If you are after high capital growth, focus on areas with high demand and low supply, preferably houses, townhouses or villas with some land. You might even buy in the same location where you are renting that bigger property! Let’s be conservative and use only $30,000, saving $5000 a year for repairs and maintenance. If we buy a duplex or townhouse for $900,000, assuming an 80% loan to value ($720,000 loan at 6% principal and interest over 30 years) our annual interest and principal repayments would be $51,800.
On the income side, let’s assume that with a yield of 3% our annual rent would be $27,000. Overall, and without factoring in any negative gearing benefits, the shortfall of $24,800 ($27,000-$51,800) is well covered by the $30,000 we had set aside. The bigger t he difference in out-ofpocket cash flow between owning versus buying, the more it makes rentvesting worth considering. A good rule of thumb is a differential of greater than 3% between the costs to buy versus the costs to rent.
It’s not a perfect outcome for all gen Ys or others in this situation but it does enable you to live where you and your family want to live and also put your money to work to build a portfolio of properties to provide you with greater wealth and income for retirement.