When I came to the realisation that I would move out of my first property, I started to weigh up my options. Rent or buy? Live by myself or with friend(s)? Near the city or in the suburbs?
Like a lot of Australians, I grew up with the notion “rent money is dead money” being drilled into me. It’s scarily engrained into our pro-property culture. But is it a fallacy?
In such instances, I try to be cognisant of mob mentality, and instead do my own extensive research, then apply the rational logic of maths to my financial decisions. Maths does not lie.
I’ve heard and read a number of prominent financial personalities recommend renting over owning property. Which in my circumstance would be considered rentvesting, since I already own a property. Rentvesting is where you purchase a property where you can afford, and instead rent where you want to live.
So, who is correct? Depends. There are several influential variables – property price, deposit, rent, but interest rates play the lead role.
Let’s circle back and work through my three original questions…
Firstly, live by myself or with friend(s)? Easy, by myself. I’ve rented for years with friends and recently owned with siblings. Despite the fact that I thoroughly enjoy company, I’m at the point that I want my own space.
Near the city or in the suburbs? People tend to gravitate to where they’re familiar with, and I grew up close-ish to the CBD. There are a few suburbs on the outskirts of the CBD, increasing in popularity, that caught my interest. There was an area I had my sights on due to location, lifestyle and friends within walking distance. Definitely ticking a number of boxes.
The lifestyle was a massive attraction for me. Everything in walking distance – everything. From supermarkets to an endless selection of cafes, restaurants, bars and gyms. Then there’s the river walk/bikeway and parks. The area is a vibrant scene of social activity, which I ultimately value. But it meant living in an apartment. Something I hadn’t experienced. But that in itself had an appeal of low maintenance, declutter and somewhat minimalistic.
Finally, rent or buy? Now, based on my second response above, you can tell there was emotional bias being baked into my decision, which I acknowledged at the time.
How do I disconnect the emotional bias to make a rational decision? Do I even have to? What about a real-life experiment to test my hypothesis? Like try-before-buying? Seems simple enough. Seems low risk.
Let’s breakdown what I mean here. My hypothesis would be testing if I enjoyed living in an apartment, in my area of choice. The worst outcome of renting for a year would be finding another place, moving and potentially paying double-rent during the switching period, which is slightly painful but manageable. Conversely, the worst outcome of purchasing would be the additional transactional costs in and out — think stamp duty, conveyancing, real estate agent fees, etc. So even if the numbers initially stacked up in favour of buying, there is a financial and administrative risk trade-off to test the waters with renting first.
Spoiler alert! When I ran the numbers over a year ago, with my mortgage interest rate 1.07% higher than it currently is, it was more economical to rent (by thousands!).
Also, the added advantage of renting for at least a year allows time to research the market, make offers and negotiate on price, with less pressure and the leverage to be able to walk away.
So, I pulled the trigger on my experiment. Now 6 months in to a 12 month lease and I’m not looking back. Love the area, the apartment and the lifestyle. To be honest, I am paying what most would deem a premium for rent, but in my mind it’s what I value.
Bringing me to the next chapter – do I buy now?
Ever since I started looking for rental apartments, I did keep my eye on sales too. Just to get a feel for the market. Though I would look at options available nearby, I was emotionally attached to my apartment building due to the location, floor plans, design and construction. Again, my emotional bias, no doubt, having a strong influence. For me to even consider buying an apartment, the economics had to stack up, and not just a marginal saving.
I would occasionally jump on the realestate.com.au app and get a general feel for the area I was interested in – price, volume, turnover etc. I by no means profess to be a property expert, actually far from it. I’m not dialled into the property asset class as it’s not my investment of choice, and not my strategy here. Buying an apartment would be a strategic savings play i.e. property expenses (transactional plus recurring) must less than the rent.
A strategic play to burn less in the ‘earn more, burn less, invest the rest’ equation.
4 months into my rentvesting journey, I noticed an equivalent apartment to mine for sale, but on the 20th floor and eastern facing, both positives in my mind. Out of interest I organised an inspection with the agent. On face value the agent was quite forth coming with information. Apparently, the apartment was bought off the plan, as a group, by an investor and has never been occupied. It was recently ‘independently valued’ at $580k with a subsequent offer of $549k falling through. This discounted offer was negotiated due to an 11-story commercial building under construction in front of the apartment, until the end of the year. A considerable discount for a short-term inconvenience.
This apartment did fit my bill. But it meant I had some homework to do. I had to run the hard numbers to determine if it made financial sense to buy instead continuing to rent.
Crunching the numbers…my favourite part. Rather geeky, but I love a good spreadsheet. I went through a number of iterations both mathematically and its layout. The inputs to the model are self-explanatory, whereas the transactional costs required some research to confirm figures and that I didn’t omit anything. (If you click on the image, you will be redirected to another page that includes notes for each figure, in the right-hand column.)
Let’s check out the first simulation with the initial $549k price tag, the P&I mortgage rate on my investment property (IP) and without any deposit i.e. I will use equity in my IP for the 20% loan deposit.
The result: $2,043 p.a. saving when buying, over renting. $2k is not to be sneezed at.
Strong start but is there enough fat in there, you say? That interest rate is pretty sharp, what if it bumps up? Fair question.
A key point to note here is that the RBA has cut the cash rate to a record low 0.25%, and though Governor Philip Lowe spoke about negative interest rates a few months back it doesn’t look like he will pull that trigger and instead recently implemented unconventional monetary policy in the way of a historic quantitative easing package targeting 3-year government bond yields in line with the cash rate (see here). Yeah, so… what are you getting at? In summary, given the RBA’s action I don’t expect mortgage interest rates to move much, if at all for the next 3 or so years. To reinforce this confidence, banks are now offering fixed mortgage interest rates at 2.29% p.a. for 2-3 years. That’s impressive! Therefore, I’m comfortable with the 2.84% rate used in my model.
What I didn’t show in the previous model was that I currently have $130k cash in my IP mortgage offset account. Which means, I am offsetting tax-deductible interest when it could be deployed more effectively elsewhere i.e. non-deductible interest on a new PPR. Applying this deposit to the model results in a $5,735 gross saving. However, I need to take into account that I have reallocated cash that was against my IP mortgage, now costing me an extra $2,252 (= $130k x 2.84% x (100 – 39%*)) in additional interest expenses, after tax. Therefore, the net saving is actually $3,483 (= $5,735 – $2,252).
*Note: 39% = 37% marginal tax rate plus 2% Medicare levy.
Ok, ok, so it’s starting to add up. What next? Well another month passed and I noticed the apartment was potentially still available. Hmmm, a signal to make a lower offer. I texted the agent and confirmed it was still available. Starting to look more realistic. Armed with my spreadsheet I consulted my financial advisor, to sense check I was thinking rationally and not just emotionally. She supported my thinking and strategy. Another box ticked.
Later that day, I contacted the agent and offered $530k. The following day, after another round of inspections without any offers, the owner deliberated only to return with $535k. I felt I had the leverage, so walked away from the deal, only to be called back 5 minutes later with the owner accepting my original offer. Some might say that I left some money on the table, and sure I very well could have but I felt I walked away up $19k.
So, with the accepted property price of $530k, below shows the final simulation. A gross saving of $6,276, less the IP interest expense results a net saving of $4,024 (= $6,276 –$2,252). Remember, that this net saving will gradually increase as the principal of the mortgage reduces.
There we have it folks, the numbers speak for themselves. This cost-benefit analysis, for my particular case, proved that both the cost and benefit, now, stack up in the favour of buying. The benefit side of the equation, clearly emotional, is low maintenance apartment living, in a prime location with the social lifestyle to match. On the other hand, the record low interest rate environment has considerably reduced the greatest recurring expense, plus I was able to transfer excess cash offsetting deductible debt (IP) to non-deductible debt (new PPR).
What I have learnt about myself, is how I behave towards debt. Likely both consciously and subconsciously my mindset changes when I have considerable debt, compared to saving. It’s all phycological — despite my unchanged net worth, the visual of a large negative number when I open my bank account can play on my emotions towards financial insecurity. That’s why I feel I am far more motivated and disciplined in (over-)repaying debt than if I was just saving. Though some might see this as unnecessary stress, I embrace it as a superpower to building wealth, provided the debt is used for such purposes.
The main objective of this comparison analysis was to determine if it was more cost effective to buy rather than rent. Which has been proven in this particular instance – recognition must go to record low interest rates. What I didn’t consider was capital appreciation. This was intentional. The purpose of buying was not a capital growth play, it was for cost saving at the core, even though this would be the icing on the cake. A consolation is that the apartment will be able to stand on its own legs in the future, with rental income covering all expenses, when I eventually move out. I’d like to say at that point it would be a ‘set-and-forget’ investment property, but I’m not kidding myself because properties are not a purely passive investment.