What is rentvesting and is it better than buying a home?

Is it cheaper to rent or buy a home in Sydney? We crunched the numbers to find out.

To rent or to buy? That is the question facing many Sydneysiders grappling with the housing affordability crisis. As property prices continue to rise, it’s becoming increasingly difficult for first home buyers to break into the market, prompting some to consider whether renting a home may work out to be more affordable than buying a property.

A recent Reserve Bank of Australia discussion paper revealed that there’s been very little difference in the long-term economic fortunes of buyers and renters since 1955. The paper found that despite rising rents and regular reports of property booms and bubbles, renters and buyers ended up in a similar financial position. So if you decide to ‘rentvest’ - rent somewhere to live and buy an investment property - you may come out in a better financial position than if you buy your own home straight away.

But does this mean it’s a better financial decision to buy or rent a property in Sydney? Let’s do the sums to settle the argument once and for all.

What is rentvesting?

Owning a home was once a cornerstone of the Great Australian Dream. But thanks to skyrocketing Sydney property prices, the dream is starting to take a different shape for some Sydney residents. With the median house price hovering around the $1 million mark, breaking into the property market is extremely difficult for many first-time buyers.

This has led to the rise of rentvesting: instead of buying the property they want, people rent a home and then invest their leftover money elsewhere.  For example, say you want to buy a four-bedroom home in Sydney’s inner west, but the sale prices in the area mean these homes are out of your reach.The rentvesting solution to the problem would be to rent the ideal four-bedroom house where you want to live, and then buy a property in a suburb where prices are more affordable.

The property you buy can then be rented out to help cover your own rental payments and later sold for a capital gain. This strategy lets you have the lifestyle you want now, while at the same time building a property portfolio for the future.

As another example, let’s assume that buying your dream home leads to mortgage repayments of $4,000 a month. But if you rent a home in the same area, rental payments could be $2,200 a month, leaving you with $1,800 per month to invest.

Although the traditional belief that “rent money is dead money” is a sticking point for some people, rentvesting allows you to use renting as part of an effective overall investment strategy.

Pros and cons of rentvesting

Buy or rent: which is cheaper?

To get a better idea of whether it’s cheaper to buy or rentvest, let’s look at an example.

Buying

According to Domain Group’s March 2016 quarter house price report, the median house price in Sydney was $995,804. Rounding that down to $995,000 for easier calculations, let’s assume you have saved a 20% deposit of $199,000 — meaning you’ll need to take out a home loan of $796,000.

If you borrow that amount at an interest rate of 4.50% p.a. on a 25-year loan, your monthly repayment amount would be $4,424.43. The total cost over the life of the loan would be $1,327,327.96.

In the same quarter, the median unit price was $656,166 (let’s round that down to $655,000), so with a 20% deposit saved you would need to borrow $524,000. Once again assuming an interest rate of 4.50% p.a. on a 25-year loan, your monthly repayment amount would be $2,912.56 and the total cost over the life of the loan would be $873,768.66.

Renting

Now let’s compare that with the cost of renting a property and investing elsewhere. The Domain Rental Report for the 2016 March quarter revealed that the median weekly rent for houses in Sydney is $530, while units cost $520 a week to rent.

So assuming a house in Sydney costs $2,120 per month to rent, that’s more than $2,300 less than the monthly mortgage repayment on the average house. If you rent a unit for $2,080 per month, that’s still $820 less than the median monthly mortgage repayments.

Investing the difference

Finally, we need to compare those potential investment returns with the capital gains you might enjoy on your property in the future. In the 10 years to December 2015, Sydney property prices increased by an average of 6% each year. Assuming the same increases were to occur across the next decade, in 10 years’ time your $995,000 house could be worth $1,781,893 (a capital gain of $786,893) and your $655,000 unit could have risen in value to $1,173,005 (a capital gain of $518,005).

But let’s consider what would happen if you decided to rent a house in Sydney for $2,120 per month, and use the remaining funds in your monthly budget to purchase a unit as an investment property. With more than $2,300 available to spend on your mortgage each month, you could easily afford to buy a $500,000 investment property (assuming that you have a $100,000 deposit saved and you take out a $400,000 loan).

Now let’s make another assumption: because you’re unconstrained by the need to buy somewhere you want to live, you’re able to choose an investment property in a prime location and enjoy larger than average capital gains. So instead of increasing at the city-wide average of 6% a year, over the next 10 years your investment rises in value 8% annually. Once a decade has passed, your $500,000 investment has appreciated to be worth $1,079,462 - a capital gain of more than 130%.

So not only have you been able to live in your dream home for the past 10 years, but you now also own an investment property worth more than $1 million. Although your investment property may not have reached the same value as the home you could have bought and lived in, you’ve enjoyed a significantly better return on your investment and are now well placed to buy your dream home.

It’s important to point out that there are a huge range of variables that could affect the above equations, such as differences in sale and rental prices between suburbs and the assumption that property prices will perform similarly in the next 10 years as they have in the past. Nonetheless, these calculations should help you form a clearer idea of the potential benefits of rentvesting.

How to decide on the right approach for you

Taking all these calculations into consideration, should you rent or buy? Unfortunately, there’s no stock-standard answer to this question. Instead, the right approach for you will depend on your personal circumstances.

Before you choose to buy a home or rent and invest, make sure you can afford both strategies. Just because an investment property is cheaper than your dream home doesn’t necessarily mean that you can afford it, and just because renting feels like throwing away money doesn’t automatically mean you should mortgage yourself to the hilt.

There are plenty of handy rent vs buy calculators online to help you work out the costs involved in each approach, while you can also access a wealth of information about property purchase prices and rental rates. Before deciding on either approach, you could also benefit greatly by seeking out expert advice from a mortgage broker.

In the end, there are pros and cons to both buying and rentvesting, so you’ll need to consider your own financial circumstances before deciding which option is right for you.

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