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Strategy: Rent where you live and Buy Investment Properties

Discussion in 'General Property Chat' started by Terry_w, 25th Nov, 2015.

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  1. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Strategy: Rent where you live and Buy Investment Properties

    Many investors choose to rent themselves and to invest in investment properties. The reason for doing this is that to live in a house you own will usually cost you much more than it would to rent an identical property next door. This is especially the case with higher priced properties which tend to have low yields. High end properties tend to be newer and will have larger depreciation potential.


    Example
    $1,000,000 property in Sydney would rent for about $600 per week. If renting this would be the only amount you need to pay.

    Repayments on a $1,000,000 loan at 4% = $770 per week interest only. You then would have pay all the costs associated with the property such as –rates, insurance, water connection, repairs, etc etc. All these may add up to be about 20% of the rent that would be charge or about $6,000 per year.

    So living in the property would cost you about $46,000 per year, while renting the same property next door would cost you about $30,000 per year. That is a $16,000 saving.


    But wait, there is more. If you did own that property but rented it out you could negatively gear it and save tax. You might have a taxable loss as follows:

    $46,000 in expenses
    $20,000 in non-cash expenses such as depreciation
    Income of $30,000 pa

    Income less expenses equals a loss of $36,000.

    Assuming a 37% tax rate you would get back $13,320 in tax that year.

    So your rent which is costing you $30,000 per year is now only costing you $16,680 per year.


    The argument against renting is that rents will rise each year, which is generally true. But it would take many years for the rents to rise above what you would be saving. And at that point you can then move into one of your investment properties.

    There are other non-financial considerations too. Some people like to have the freedom to stick nails in walls, do minor renovations etc.

    Renting can also work well where you are running a business from home. If you are doing this in your main residence you could lose the CGT exemption, but if you do it in a rental then you may be able to claim part of the rent as an expense.

    And you can have your cake and eat it too by first living in the property, establishing it as the main residence, and then moving out again to rent elsewhere. This can give you up to 6 years CGT free while the property is rented out. see Tax Tip 23: The 6 year Absent from Main Residence Rule
     
  2. Truly Exotic

    Truly Exotic Well-Known Member

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    good post, to be honest when it comes to PI Ive been hearing that for years but only every now and again



    rent is far less then a IO loan for the most parts, plus you dont have to pay for maintenance, rates, bills etc .etc.

    so for the same amount of $$$ of a IO loan you could get a far better property and lifestyle, however there is the opportunity cost of capital growth

    depends on the circumstances I guess
     
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  3. Beyond Wealth

    Beyond Wealth Active Member

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    That's what I do - rent a modest home in a nice suburb for a fraction of the cost of home ownership (and tying up valuable capital) and invest in IP's / shares.
     
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  4. Redom

    Redom Mortgage Broker Business Member

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    Neat post Terry. Thanks for sharing.

    Adding in the big financing an investment portfolio benefit - theres a substantial impact on your borrowing power.

    Someone with $1mill worth of private, mortgage debt (Owner occupier) - the assessed expense on borrowing power calculators on that will be around $7.4k p/m (despite only paying $3.3k p/m in interest).

    If instead, that someone rented the same place at $600 per week ($2,600 p/m), lenders will take it as $600 p/w in your servicing assessment.

    Thats a $4,800 difference in your monthly borrowing power. In other words, you'll need to add $4,800 p/m in after tax income to make up the difference in borrowing power. Equating to nearly a $700,000 fall in your borrowing power under individual lender calculators.

    Cheers,
    Redom
     
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  5. JohnPropChat

    JohnPropChat Well-Known Member

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    The only downside other than the hassle of renting is loosing CGT exemption. Can always use the 6-year rule to an extent on the most expensive IP, I suppose.
     
  6. turk

    turk Well-Known Member

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    Spent 2005/06 in the UK on a 2 year holiday and have been renting for the last 9 years whilst investing.

    Lucky to have a great owner, has renewed the bathroom, kitchen, internal blinds and carpets plus painted the outside.

    The yield would be around 1.4% with rent only increased once at $20 per month in the 9 years plus our daughter starts at one of the top High Schools in the state next year saving us private school fees.
     
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  7. norwoodman

    norwoodman Well-Known Member

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    I don't think tax breaks and exemptions should ever really be justification for investing or not.

    Rentvesting makes sense financially (I myself do this), but it's not for everyone. As a young professional who often moves from city to city being a rentvestor makes perfect sense, but for a family with kids who are looking for stability in location and situation this likely isn't a feasible option for lifestyle reasons.

    Horses for courses.
     
  8. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    CGT is not necessarily that bad long term. If you moved into an IP you can then claim all interest and other costs, while you were living in it, against the CGT when it is eventually sold. Tax Tip 76: Calculating the Cost Base for CGT purposes.

    And if you can die in the property with the highest capital gains your heirs will be putting flowers on your grave for years to come as that property will be CGT free.

    But it is a good idea to use the 6 year rule to your advantage as well.
     
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  9. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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  10. teetotal

    teetotal Well-Known Member

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    Hahaha :p this is most positive outcome of all.
     
  11. Jayy

    Jayy Member

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    What about taking into consideration the growth of your PPOR which can be used as equity for future purchases? How will this change the figures?
     
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  12. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    With this strategy you are not avoiding a main residence, just not living in one of your properties yet as a main residence. So you will have properties which you can tap into as they grow. Ideally, depending on the circumstances, you would be saving all cash into an offset account and not using any of it. After you do move into one of the IPs you will have a large cash buffer which will significantly reduce non deductible interest.
     
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  13. JohnPropChat

    JohnPropChat Well-Known Member

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    Indeed. I follow this strategy myself but was just pointing out a potential downside as I considered that before I moved out of my PPOR.
     
  14. JohnPropChat

    JohnPropChat Well-Known Member

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    Not for me. No kids and I fully don't trust the girl I am currently dating.

    Would that heir thing also work backwards? Say, if passed to my parents or siblings?
     
  15. MTR

    MTR Well-Known Member Premium Member

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    Huge, for example imagine sitting on a blue chip property in inner west Syd, purchased some 10 years ago, the ability to access equity due to growth.

    I guess it's also lifestyle, some will never be happy renting

    mtr
     
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  16. Jayy

    Jayy Member

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    That makes more sense to me now. Once you have significant funds in the offset to make the IP your main residence you can come close to or even better the price of renting
     
  17. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Anyone you leave property to will have to same tax consequences. Doesn't matter what their relationship is to you.
     
  18. melbz

    melbz Member

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    I might be asking the obvious here... That means, if I rent out my property for $600/week and rent someplace else for $600/week (or even more, say at $650/week). My serviceability will be perceived as better by the bank and i can borrow more then ? Is that right?
     
  19. Redom

    Redom Mortgage Broker Business Member

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    Depends on your loan size @melbz, i used a $1mill example of a loan size that Terry had in his post.

    Banks treat your rental expense at the actual rate you pay it. So $600 p/w is what goes into their calculators. That is, $2,600 p/m.

    Most banks will treat your your mortgage debt that you have at roughly 7.5% P/I over 25 years. That means a $350,000 loan will have a $2,600 p/m expense against it.

    So if your loan is more than $350k, then yes, your borrowing power should increase by moving and renting. If your loan is less than $350k, than it won't effect it too much as your yield relative to your mortgage on your property is very strong.

    Note these are general numbers, negative gearing addbacks, some individual lender calculator differences (like NAB), will change the equation. But thats a general answer that'd apply to a number of different lending calculators.

    Cheers,
    Redom
     
  20. BuyersAgent

    BuyersAgent Well-Known Member Business Member

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    Solid theory, and it works in practice we did it for 10 yrs but the emotional pull of the "place to call home" got too strong for us eventually, particularly my wife. I think if tenancy laws allowed for long term leases we could all feel more stable in rentals like Europe etc but with current norms in Oz it doesn't really let you settle in enough, some people want that.