Home or Investment? Which One First? - August 2019
By Guest Blogger, Peter Koulizos, property lecturer and author
Many aspiring home buyers and property investors are in a dilemma about what property strategy to employ to get on the property ladder. People want a home in a great location that is close to work and all the great amenities. Many can afford to rent in this great location but can’t afford to buy into this great location.
What to do? Rentvesting? Living with mum and dad longer? Can you have your cake and eat it too?
To explore this dilemma, let’s imagine that there are three young people, who are on the same income but they will use three different strategies. These three young people, Abby, Jess and Harley will live/own property in three different areas, Excellentville, Goodville and Average Town.
Excellentville is a great suburb. It has all the facilities that you could ask for, top end shops and restaurants but property prices and rents are quite high. Goodville is right next door to Excellentville and even though it doesn’t have all the great amenities of Excellentville, the area is transforming and is an up and coming suburb. The property prices and rents in Goodville are lower than that of Excellentville. Average Town, as the name suggests is an average area. It is not close to the city or beach and a long way from major amenities. The housing is of questionable quality and the streetscapes are nothing to write home about. However, property prices are cheap and investors can ask for reasonable rents.
Abby is leaving home and decides that she wants to buy a home to live in. She wants the security of owning her own home and also wants to start building a property portfolio. As owning a home has expenses in addition to the mortgage repayments such as council and water rates, repairs and maintenance, her income won’t allow her to buy in Excellentville but she can afford to buy next door in Goodville for $500,000. Abby’s total home ownership expenses, inclusive of interest and other home owner costs is $700 per week.
Jess has decided to leave home and lifestyle is of primary importance to her and creating wealth is secondary. She will lease a property in Excellentville for $600 per week, which includes her utilities. However, as her serviceability is impacted greatly by the high amount of rent she pays, she can only afford to buy a cheap investment property so she will be buying in Average Town. Her unit in Average Town costs $300,000 and she is positively geared by $10 per week as her rent is $400 per week.
Harley is a bit of a home boy so he is not moving out of home. He loves travel but he also understands the importance of financial independence. As Harley is staying home, his expenses will be very low so he can afford to buy an investment property in Goodville or Excellentville. He decides to buy a bigger and better home than Abby in Goodville for $600,000. He collects $500 per week in rent and after all his expenses and tax benefits, he is negatively geared by $100 per week, but he still has money left over for travelling overseas every year.
Now let’s fast track 10 years and imagine that property prices and rents have grown by 50% in Goodville but in Average Town, the growth has only been 25%.
Abby has had the extra burden in the early years of paying off a mortgage but as time has marched on and her income has grown, council rates, repairs and maintenance have increased but because interest rates have remained the same, so have her mortgage repayments.
Abby is now paying $800 per week in home ownership expenses and her property is worth $750,000.
She hasn’t totally sacrificed lifestyle as she likes to surf and she drives 5 minutes to the local surfing beach. When her partner comes over, they can walk to the craft brewery which is just down the road from her place or they can walk in the opposite direction to the local BYO restaurant.
On the positive side, Jess is enjoying a great lifestyle in Excellentville. She can walk to the cafes and fancy restaurants and when her partner comes over, they can both walk to the beach to go surfing.
On the negative side, Jess’s property is not going up in value as much as Abby’s or Harley’s as it is in Average Town. Even though she is positively geared, that extra bit of positive cash flow has gone towards extra repairs and maintenance as the property she bought was of poor quality and some of the tenants she chose weren’t of the best quality and they have trashed her property.
Abby is now paying $815 per week in rent in Excellentville, her investment property is worth $375,000 and she is earning $500 per week in rent. She is now neutrally geared.
After 10 years, Harley is still at home. He has gone overseas every year but because of his wise choices, his investment property in Goodville is now worth $900,000 and is collecting $750 per week in rent. He is now neutrally geared.
However, his parents desperately want him out of the house because all he does is invite his mates over, order Uber Eats and are on the Play Station or Netflix all weekend!
I know there is a lot of text and numbers here so let me make the money side of this story a bit clearer for you.
Abby is $250,000 richer, owns her own home and pays $800 per week in property expenses.
Jess is only $75,000 richer and pays $815 per week in rent and utilities.
Harley is $300,000 richer, owns an investment property and has his rent has increased, he is currently neutrally geared.
It doesn’t take a genius to work out that Harley is in the best financial position but who wants their kid still living at home after they have been working full time for 10+ years!
Jess needs to ensure that she keeps her job and gets promoted so her income increases because as time goes on, her rent will continue to increase.
Abby seems to have it just right. She has her independence by living in her own, is creating wealth through capital growth and still has some money left over to enjoy herself.
It seems that Abby can have her cake and eat it too!
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