Are you trying to decide whether you should buy your own home first or whether you should you choose to rent and instead buy investment properties first? Perhaps you’re trying to advise your children on what is better for them financially? Well if you’re in this position, this article is for you.
Today, I want to look at the financial implications of each option. My hope is that once you understand this, it will be much easier for you to make an informed decision.
So let’s get to it:
Option 1: Buying Your Own Home.
Let’s say you’re going to buy a home for $700,000 and you have $100,000 deposit. To keep things easy, let’s ignore the additional costs like stamp duty and legals for each of these scenarios.
So if you have a deposit of a hundred thousand dollars for a house priced at $700,000, that means your mortgage is going to be $600,000. Now I know at the moment interest rates are at record lows but when you’re taking out a mortgage, it’s normally for 30 years. So what we need to do is look at the average long term interest rate in Australia, which is 7%.
So at a 7% interest rate, your repayment is going to be 7% of $600,000 (your mortgage) which is $42,000 per year, just in interest.
Now you’ve got the principle to pay as well because you need to keep paying off your loan, that’s going to be approximately an additional $10,000 per year. You also have additional costs such as rates and your insurances.
Let’s be pretty conservative and just say that’s about $3,000.
Therefore, the total annual cost of owning your own home in this case is:
Rates $ 3,000
That means, it’s going to cost you $55,000 per year to own your own home.
Now remember, that’s after tax dollars. So it means, you need to earn approximately $75,000 per year, pay tax and then use everything that’s left over to keep your home. This is before you consider having to pay for trivial items such as food, water and clothing.
That might seem quite a glum prospect, but unfortunately it is reality.
So now let’s look at…
Option 2 – Rentvest
Let’s assume you’re now going to rent the same property you were going to buy in Option 1 above or something very similar in the area. Based on a $700,000 price point, the rent would be about $600 per week.
So for the year, that works out to be $31,200.
Now compare the difference:
Buying your own home costs you $55,000 per year but renting a similar type of property costs you $31,200 per year.
That means that renting saves you $23,800 every year… or approximately $2,000 per month!
This is after tax dollars as well. So it’s the equivalent of saving about $35,000 per year in earned income.
Imagine if your boss gave you a $35,000 raise, without you having to work any harder?!
It would be party time, right?!
Now I bet I know what you’re thinking right now?
Isn’t rent dead money?
After all, you’re getting capital growth on your home aren’t you? And you’re “in the market”? And owning your own home is probably what your parents told you is the ultimate goal.
I understand but unfortunately (and this is where I get a little controversial), doing what your parents did thirty years ago and buying your home as a vehicle to create wealth is outdated advice.
I’ll show you why right now…
Remember, the $100,000 you put down as a deposit when you bought your own home in Option 1?
Well, let’s take that $100,000 and now split it up into two blocks of $50,000.
Again, to keep the comparisons fair in both scenarios, we’re going to ignore the additional costs such as stamp duty and legals.
You can now use each block of $50,000 as a deposit for a $500,000 property. So using two lots of $50,000 means you can now get two $500,000 properties.
This means you now own $1 Million worth of property.
Let’s assume you don’t necessarily buy well and each property ends up costing you $100 per week. That’s certainly not what I’d call an A-Grade investment property. So even if you buy badly, you’re only out of pocket $200 per week because you now have two properties.
That works out to be $10,400 per year.
Now let’s add this $10,400, the annual cost of owning two investment properties, to your annual rent of $31,200.
Your total annual cost is now $41,600 per year.
Hold on a second!
Owning your own home costs you $55,000 per year but renting and investing, even if you invested poorly, costs you $41,600?
That means that renting and investing saves you $13,400 per year in cash flow.
I’m sure you can work out what to do with an extra $13,400 per year in your back pocket! You could even put it away as savings for the deposit on your next investment property.
However, now let’s look at Capital Growth…
Let’s assume, again to be conservative, that you invest in an area that only has the same capital growth as the area you were going to buy your own home in.
So to keep the numbers easy, let’s say that if you were to buy your own home, it was going to increase in value by 10% and if you were going to buy investment properties, they would also rise by 10%.
In Option 1, you bought your own home for $700,000. After 1 year, it’s value would be:
$700,000 + 10% = $770,000
So you’ve made a gain of $70,000. That seems pretty good.
However, let’s now look at option 2, where you bought 2 investment properties, each for $500,000. So you have a Million Dollar Portfolio!
After 1 year, your investment portfolio would be worth (assuming the same growth of 10%);
$1,000,000 + 10% = $1,100,000
You made a gain of $100,000!
So when you bought your own home, you made $70,000 in capital gain but when you invested, you made $100,000 capital gain.
That means, by renting and investing you made an extra $30,000 in capital gain.
We also established earlier that you saved $13,400 in cash flow!
That means that in just 1 year, by renting and investing, rather than buying your own home, you came out ahead by $43,300.
That’s just in 1 year. Imagine what would happen after a few years.
In fact, after just 2 years, you are ahead by over $80,000. You just got your deposit for Investment Property #3, without having to work any harder.
I hope you’re starting to see why renting and investing is the fast track to financial success. I understand though that this might be different to what you have been taught. So make sure you get some guidance from someone who can provide a clear roadmap for you to achieve your financial goals.
Eventually you’ll come back and buy your own home. That’s what we all want to do. However, by renting and investing first, you’ll end up with a larger property portfolio, cash in the bank and you can buy your own home with a far smaller mortgage – and probably a better one than you can afford right now.