Welcome to my column, Young & Invested where I discuss personal finance and investing for Gen Z and Millennials. This column aims to be a resource for young investors navigating an ever changing financial, political and social landscape as they try to build wealth. Tune in every Thursday for the latest edition.

Edition 7

The word ‘mortgage’ originates from an old French word translating to ‘dead pledge’ – a discovery that I hope people find as amusing as I did.

Australia’s obsession with homeownership continues as first home buyers rush to get on the ladder. The concentration of our wealth that lies in property is substantial and sparks an interesting conversation about the next generation’s investment decisions.

Picture a friend revealing their share portfolio consists of 95% tech stocks and 5% in other industries – naturally, you’d think they were crazy or had unbelievable conviction about the industry. However, when that same friend tells you they purchased their first property for $1 million, we rarely bat an eyelid.

What is rent vesting?

Last week I explored whether you should save for a deposit or invest in shares. The answer isn’t always mutually exclusive and differs based on your goals and circumstances. It appears that amongst the shares vs housing debate, there emerges a third, enigmatic wildcard that is ‘Rent-vesting’.

Many people desire to live near capital city centres for work and lifestyle purposes. However, purchasing a property in these areas has become inaccessible for most. Whilst the housing market has appreciated as a whole, city-fringe regions often have more accessible entry points for first home buyers.

Rent-vesting refers to the practice of buying an investment property in a high growth or affordable region and renting an alternative property in an area you prefer to live, because often - these are not synonymous. It presents an alternative that may partially alleviate the cashflow-depressive nature of purchasing a primary place of residence (“PPOR”) and servicing the mortgage yourself.

Rent-vesting is on the rise with Westpac research finding that 61% of first home buyers in NSW are considering participating, followed by 54% in Victoria. This momentum perhaps speaks to the affordability squeeze many are facing to attain the home they desire in a capital city. The same survey also found that aspiring homeowners are looking to buy sooner, with 13% of Australians hoping to purchase a home to live in by the end of 2025, up from 10% the previous year. Undoubtedly, there appears to be a sense of urgency to enter the property ladder as consistent price appreciation continues across the country.

Why rent-vest?

The growing popularity in rent-vesting speaks to the architecture of Australia’s favourable tax policy and other environmental factors triggering the housing crisis.

As a first home buyer in today’s market, you’re unlikely to land that leafy 2-bedder with a parking space in Paddington. The reality is that your first home is rarely the dream home. And it is unlikely that your second home will be either. Often concessions must be made in location or size. That is where rent-vesting enters the picture. It accommodates those feeling the price growth-induced timing anxiety about getting on the property ladder, whilst allowing them to live in their desired location.

Eventually, rent-vestors may use the additional equity to purchase their ‘dream home’ or re-leverage to increase the properties in their portfolio and continue renting. Simply saving for a deposit can be challenging. In last week’s article I found that if house prices appreciate 5% every year for the next five years, saving an additional 5% for a deposit yearly would fall short of the amount required, due to the gearing.

It’s no secret that Australia is in a housing affordability crisis. This issue has been extensively discussed in previous editions of this column and may be contributing to the trend of rent-vesting among first homebuyers. Whilst many remain uncertain about if or when the property bubble may burst, it is clear that a substantial policy overhaul will be required to get us there. Given the significant proportion of homeowners within the voting population and parliamentary composition, any prospect of reform appears distant.

Rent-vestors, buoyed by the returns they’ve seen older generations make in property, find that purchasing a more accessible home and renting may help them achieve similar wealth without being locked out of the property market entirely.

Favourable tax policy in Australia has long proliferated the arms race between property investors and tormented spectators. Perhaps the most contentious one is negative gearing. Negative gearing allows an individual to offset a loss made on rental property against other income, reducing their overall tax bill. With nearly half of all Australian property investors being negatively geared, the appeal is clear. On a surface level, the government essentially subsidizes any cash flow shortfalls whilst the individual enjoys the capital growth.

There are several other tax benefits such as the capital gains discount from owning the property for more than 12 months, as well as the ability to claim losses and carry them forward to reduce taxable income.

CoreLogic reports that housing has outperformed equities in six of the past ten years and has delivered a cumulative total return of 132.6% over the past decade compared to 126.4% for shares. It is important to note that these figures may not consider the additional expenses associated with property ownership in the return figure. However, capital growth from a property listed as a PPOR is not taxable, as opposed to the tax attributable to any gains from shares.

Running the numbers

Below is an exercise that highlights the difference between purchasing a PPOR and rent-vesting. It is also important to consider a range of assumptions that may affect the expected capital growth outcome.

Scenario 1

Consider an individual on a salary of $200k a year, purchasing the median $1m house with a 20% deposit and 30-year loan term. According to the NAB home loan calculator, this would equate to $58k in mortgage repayments. We also subtract an additional $10k in annual maintenance (1% of property value). For simplicity, I exclude other associated expenses with homeownership. The cashflow attributed to living in the property would be -$68k annually.

cost of buying ppor
Figure 1: Cost of PPOR. Source: Author calculations.  
 

Scenario 2

Holding the same assumptions for a rent-vesting scenario, the mortgage repayments and maintenance expenses cost $68k. The primary difference is the $40k annual rental income (4% yield) from the investment property, meaning the investment property is making a $28k loss annually.

This $28k in negative gearing lowers taxable income and results in a tax credit of $11k, making the out of pocket expense after this credit $17k. However, since the property is being rented out, the individual incurs a rental expense of their own.

Let’s assume the rent-vestor pays $750 a week reflecting $39k annually, to live in a premium location of their choice (2.5% yield). The total out of pocket expense for home ownership in this scenario is the $39k rental expense and the $17k out of pocket after the inclusion of negative gearing.

In the rent-vesting scenario, the cashflow attributed to renting out the property is $56k annually, as opposed to $68k from living in the property. The $12k difference forms the basis for the rent-vesting case.

Additionally, if the individual wanted to capture the CGT concessions that you’d get from a PPOR for their investment property, there are certain conditions which would enable them to do so.

There is a notable difference in yield (4% and 2.5%) between the purchased property and the individual's rented residence. This is based on the pattern of more affordable, high growth areas attracting higher rental yields compared to established suburbs. We may attribute this to a lower number of high income households in growth areas, meaning property ownership is further out of reach and landlords have greater flexibility to increase rent.

cost of rent vesting
Figure 2: Cost of rent-vesting. Source: Author calculations. 
 
Note: For simplicity, this analysis excludes other expenses such as strata, council rates and insurance that can all be expensed and consequently increase the level of negative gearing.  
 

What are the considerations?

For those who are interested in homeownership, they are faced with two prospects – live in their property or rent-vest.

As illustrated above, rent-vesting enables individuals to purchase a property with less cash flow depression than they might have in a PPOR. Favourable tax conditions also bolster the case for rent-vesting. Furthermore, rent-vesting negates the need to buy and sell in the same market, as you have an existing place of residence that you rent. However, nothing is without drawbacks.

The inclusion of leverage that facilitates property ownership has benefits to investors if things go your way. That being a huge caveat. Whilst a PPOR has additional benefits on top of capital growth, investing in property is largely a numbers game.

The largest consideration lies within unreasonable returns expectations. Like many, if you are rent-vesting for the purpose of eventually buying a dream home, the return from what you invest in should exceed the growth of the area you wish to buy in the future.

For example, pre-covid property prices in Perth were reasonably flat whilst Sydney experienced significant growth over the same period. Rent-vesting in Perth with the hopes of eventually purchasing in Sydney would not have worked out.

Capital city pricing growth has since changed; however, one must have the risk appetite to stomach losses for an extended period to see the capital growth they expect.

house price growth last three decades
Figure 3: House price growth over the last three decades. Source: CoreLogic, Domain. 2024.  
 

It is important to acknowledge that Australia notoriously has some of the lowest levels of renter protection in the developed world. We tend to equate housing to a vehicle for returns, rather than its original purpose of serving as a basic necessity. Furthermore, a PPOR can serve as a symbolic source of psychological safety for those who have additional considerations such as children – the decision is largely personal.  

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