Should I buy a Principal Place of Residence or Investment Property first?

*This post is a bit of a long one - but I get asked this one a lot so thought I'd rather explain it all in one place.

Should I buy a Principal Place of Residence or Investment Property first?
A common question for first time investors is what is better – to buy their principal place of residence (PPOR), or an investment property (IP) first? The crux behind this question is generally what will help the investor achieve their goals sooner.

In determining what is better for your specific circumstances, it’s important to balance the financial and emotional factors – never discount one over the other as with any long term investment strategy for financial growth, as it’s important to make sure that any decision not only is financially beneficial, but viable for you to keep to the plan over the investment horizon.

I’ll break down the pro’s and con’s on both options of which purchase to make first to help clear whether there is a clear better option for your circumstances.


Benefits of buying a PPOR first

• Stop renting – “not paying dead money”
• Additional cash flow can be used to pay down your PPOR loan, freeing up equity to use for investment property deposit in the futures. Using an active debt recycling strategy you can fast track paying down your home loan whilst investing in property (or other types of investments), allowing you to have your cake and eat it
• You can buy a “for now PPOR” if you do not have sufficient deposit/borrowing capacity, then leapfrog onto your next PPOR in the future whilst retaining the first property as an investment – having the right loan structure from day 1 is paramount if you want to use this kind of strategy

Issues with PPOR first

• You may have insufficient funds to get into a property which could be suitable as a PPOR (ie priced out of being close to your employment or other needs, or not fit your needs)
• Purchasing a PPOR may exhaust your entire borrowing capacity making you unable to make any purchases thereafter

Benefits of buying an investment property first

• Gets you into the investment market sooner
• Allows for more flexible purchasing criteria driven by financial needs than fitting your emotional/personal requirements
• If you’re able to rent a comparable property what you would purchase a PPOR for a significantly cheaper ongoing cost, the excess cash flow will allow an increased overall borrowing capacity position AND that cash flow can be utilised into rolling into further investments/future PPOR

Issues with an investment property first

• By growing your portfolio first, you may purchase enough properties that you exhaust your borrowing capacity and are unable to purchase your own PPOR – which can be restrictive if you need/want to own a PPOR in the future
• Should this happen, you may then be forced to sell down some of your investment assets to free up cash/borrowing capacity which may be sacrificing a quality long term investment

Which option is better for me?

It depends! It will come down to a number of factors:

• Is there a personal/non-financial need to own a PPOR
• Is there a substantial cost differential between owning or renting a PPOR and renting
• How much deposit is available

If there isn’t an emotional/non-financial driver for purchasing a PPOR (preference to own your own home, find it difficult to rent due to pets or other family needs etc), the primary consideration will come down to whether the cost of renting is cheaper than the cost of the mortgage and holding costs of home ownership (maintenance, insurance, council rates).

Another factor which can influence the debate is the total funds available for a deposit. The more funds available for a deposit – the greater the likelihood that it’s financially more beneficial to purchase a PPOR compared to an IP. Due to the nature that you can re-leverage a PPOR with a debt recycling strategy to rapidly build and investment portfolio – this biases PPOR’s over the long term as you can reduce your effective PPOR ongoing costs, whilst having a growing deposit base for investments.

Comparison Scenarios

To better understand how you can look at a scenario and identify what is the better option – we will look at variances in an example to see how subtle changes impact the end results.

Example 1: Single borrower Jim, earns $100,000 a year, currently rents a house for $500wk. Jim has saved $200,000 and is looking to invest in property, but is unsure whether to buy a PPOR or IP first. After all costs Jim is currently adding $15,000 to his savings per year.

Purchase Price: $500,000

Purchase Costs: $25,000

Total Loan Required: $325,000 ($500,000 + 25,000 – $200,000)

Interest Costs per annum: $16,250

Miscellaneous ownership costs (repairs, council rates etc) per annum: $3,000

Total cost of ownership per annum: $19,250

Total cost of renting per annum: $26,000

Result

Overall the ownership cost in this scenario works out cheaper for Jim. Even if he takes on P&I repayments he will have a net cash flow surplus based on his current $15,000 excess cash flow per year, allowing him to debt recycle and use his equity to invest moving forward.

Note: the $200,000 noted in this example if not used towards a deposit would otherwise be generating a return (be it interest in a bank account, in shares etc), so it’s important to consider this and the minimum amount of return Jim would need to be receiving to justify continuing renting. In this example Jim would be able to utilise his available equity in the property to leverage into purchasing investments which would help increase the value of PPOR ownership. (should he release his equity up to 80% of the purchase value, he could release $74,000 to be used to invest)

Also note that unlike rent, the long term majority cost of ownership (interest), will not increase, whilst rent will.

Example 2: The same factors as the previous example, with a higher purchase price.

Purchase Price: $800,000

Purchase Costs: $40,000

Total Loan Required: $640,000 ($800,000 + 40,000 – $200,000)

Interest Costs per annum: $32,000

Miscellaneous ownership costs (repairs, council rates etc) per annum: $3,000

Total cost of ownership per annum: $35,000

Total cost of renting per annum: $26,000

Result

Overall the cost of ownership is $9,000 a year greater than renting, whilst also requiring the entire $200,000 in deposit funds to be utilised. As the loan is at 80% LVR, there is no effective equity to be released so the prospects of investing in property in the short term is unlikely until debt reduction which will be at a slow rate with the majority of excess cash flow going to minimum repayments on the PPOR debt.

Example 3: Jim instead of buying a PPOR, instead buys investment properties

Purchase Prices: $1,330,000

Purchase Costs: $66,500

Total Loan Required: $1,196,500 ($1,330,000 + 66,500 – $200,000)

Interest Costs per annum: $59,825

Miscellaneous ownership costs (repairs, council rates etc) per annum: $6,000

Total cost of ownership per annum: $65,825

Rent Received (4% rental yield): $53,200

Total Cash flow position: -$12,625

Result

This scenario utilises almost of the entirety of the cash flow position and exhausts all savings available. Whilst this negative cash flow position will likely result in a tax adjustment to assist in the cash flow position, it will be unlikely for Jim to make any meaningful savings for the foreseeable future to put towards a PPOR purchase. If there is no intention to purchase a PPOR in the future this may be seen as acceptable for the borrower. This scenario allows for the borrower to gain the greatest amount of property under ownership in the shortest period of time, however if a PPOR purchase is used which his below the cost of renting, the same or greater can be achieved.

Key Considerations to making better choices when it comes to buying a PPOR vs investment property first

• Establish if you are to buy a PPOR – what type of property you would buy. Is this cheaper than the cost of renting?
• Due to APRA changes, having a PPOR may allow you to have a larger portfolio over the longer term if integrated with a debt recycling strategy
• Consider a PPOR for what it is – another asset which can work towards your long term financial goals
• Balance the long term and short term needs – investing is a long term strategy which requires you to stick to the plan. Making decisions which may help you financially in the short term which are not sustainable in the longer term (ie wanting to own a PPOR, but instead buy IP’s until you cannot afford to buy a PPOR) is a quick way to make sure you deviate from your financial plan
• If you do buy a PPOR, it does not have to be the ‘forever home’. Potentially use a PPOR purchase strategy alongside a renovation strategy, which you can then upgrade to an investment property and buy a new PPOR

 

May I just throw a suggestion into the mix in regards to what I will be attempting to do in the near future.

How about Option 3: Buying a property as a PPOR (lower interest rates among other advantages such as living in it to obtain Main Residence exemption in the future) and then building a GF to live in.

Of course this will depend upon the local council and their interpretations of the SEPP.

But this way you are able to claim depreciation on the cost of the GF build, all repairs to the home/interest charges/depreciation of the main house will then become deductable against your income and the rent for the property will further sweeten the deal.

Regards,
Arc

 

I am not a tax adviser, but I can see a few potential tax issues with this proposal. Seek tax advice before doing this.

 

Why not do both?

Using some tax strategies a main residence can be rented out and negative geared without loss of the main residence cgt exemption if certain requirements are met.

You get the best of both worlds of saving tax and avoiding tax as well.

 

Also, thanks for the awesome informative post @Corey Batt!

Great job!

 

I suspect that the main residence exemption will soon change to address some of these issues. For example limit the concession only to a title that is solely used as a residnce by ALL of the owners. This would be akin to the non resident changes. eg if one owner doesnt live there NONE get a concession ?? Limit it to death or incapcity to reside together.

Perhaps even remove prorata concessions for spouses and defactos.
Remove the renovation concession
Remove the absence concession or temper it
Remove prorata concessions for rent, development and similar cases. Make is a solely and exclsuively test ???

Would be easy to do and easy to get approved. Most taxpyers see it as a scheme

All are forms of potential evasion and are frequent topics on that theme

 

For me the right choice was IP first and I rented a nice cheap flat near work. My first IP was nothing flash (cost a massive $120k in '98) but I couldn't afford to live in it and needed tenants to pay it off. Yes rentvesting was a "thing" in the 90s, it just didn't have a hipster name

When it came PPOR time I sold it (probably should have LOCd it but I didn't know about them) and it paid for 20% of our PPOR.

 

In addition to the above this will also have a lower I/R and lower stamp duty starting as a main residence.

 

Lol. When the tax is $0 it is certainly avoided!

 

An additional benefit to buying a PPOR first could also be no stamp duty and depending if the property is new, could also receive a considerable grant from the government that could help bolster your deposit, and/or buffer.

This is how it worked out for me when first buying into property.

 

Same here. First home owner grant though that extra $14k went straight into the sellers pocket I reckon.

I wonder if todays lending climate makes it more worthwhile for investors to apply as owner occ (no rental income for more favourable interest rates). Then quietly change your mind post settlement and rent it out.

 

In some states (I'm not sure if all) you can buy an IP first and still qualify for FHOG and stamp duty exemptions for a PPOR buy. It is the case in WA.

 

Great post but I feel as though PPOR first missed a number of positives.
- No stamp duty (pending state). Technically you still qualify after buying an investment first but one of the reasons your renting and investing is because you can't afford to buy in the suburb you want to live. Chances are that suburb will exceed the stamp duty concession price, ecspecially considering investing first means you won't buy a PPOR for sometime and by then likely kiddies = bigger house requirements.

- PPOR first has many more options at high LVR's meaning you can get in quicker and pay better rates as well.

- Qualify for the 6 year exemption rule.

- Build sweaty equity with a good renovation whilst you still live in the property. If you buy an investment every week you spend renovating the house is a week of lost rent. If you live in the house YOU choose how you want to live in it. If you have two bathrooms, renovate one and do the other and then switch.

Now combine these all together and you will see why personally I think sucking up living outside your desired suburb for a few years is the way to go!

Less cost to entry, Tick.
Government pays your stamps. Tick
Gain equity without any rental loss. Tick
Move out and rent it CGT free for 6 years (no other PPOR bought obviously). Tick
Claim all your renovation works. Tick

 

@albanga the stamp duty offset is only available to first PPOR purchase as far as I know, so that strategy isn't reproducible. Although it is a great starting point

 

Heya propernewb,
I never said to reproduce it, I meant to start with it.
My point is if you invest first then by the time you come to purchase your PPOR its highly likely it will be outside the price bracket to qualify. This means you will never get the concession.

My point is use it first up buying your PPOR.

 

Much of this depends on the city your in and the time your purchasing.

Younger borrowers in Sydney, without a big bank of mum and dad assisting, are likely choosing between PPOR of lower quality assets/new units in Syd or investing in areas more likely for short term growth. Faced with this choice, more and more are turning to investing as it appears as though it's a better allocation of capital. While grants help, not sure it should skew buyers to make poor capital allocation decisions. Much of the return profile is in the medium term growth, so it does make sense to consider holistically whether it's worth it in peak conditions.

In the long run though, the CGT exemption is probably the biggest tax concession for mum and dads out there - does make sense to use eventually IMO.

Personally where seeing more and more rentvestors with view to selling out in long run to buy eventual PPOR in Sydney. The market movements incentivising creativity to achieve the same outcome.

In different market conditions, this will all change. So too the 'APRA' impacts on this decision framework. Lower yielding cities likely mean renting is far better for borrowing capacity - the debt burden and capital utilisation is too high in parts of sydney where 2% yields are better. If yields are 6-7% in your city, this balance may change.

 

Nice post but it would be interesting to see the numbers today if only apples were compared. I read somewhere that a 500k property has 30-40% higher repayments for PPoR vs IP given the same % rate.

 

That doesn't make sense - if they have the same rate (and term, and payment type - P&I or IO) their repayments will be exactly the same.

Cashflow is different though, due to rental income - is that what you mean?

 

Thank you Corey! Looks like option 1 is better than 2, 2 is better than 3. What idea would you suggest to someone who is already at option 3 and wish to change things around?