Part 1: Which is better for financial freedom -buying a home or renting and investing?
02 Sep 2013
By Darren Higgs
It used to be the 'Great Australian Dream'.... finish school, build a career, meet the love of your life, buy a home and start a family.
It sounds like a pretty good dream to me, with a few possible exceptions:
- More and more 20 – 30 years olds are ticking off their bucket list early in life. They do not want to stay in the same home or suburb for life;
- No more working for one company for life. Younger employees are active in the workforce, necessitating flexible living arrangements;
- Over the last two decades, the average property price has increased more than average salary increases, making property in certain areas less affordable.
Buying vs Renting
So, is it actually better to buy a home or rent and gear / invest your monies instead? The answer is (drum-roll please) it depends on your circumstances. However, I can make a really strong case that renting and investing will give you a better result than buying a home, because:
- interest paid on an investment loan is tax deductible, whereas the interest paid on a home mortgage is not. Furthermore, if you purchase an investment property, you can claim repairs, rates, insurance and property management fees as a tax deduction;
- the rent you get from an investment property, or dividends and franking credits from a share portfolio, cover a good proportion of your holding expenses;
- you are using other people's money (thank you, banks) to your advantage earlier, allowing you to benefit from the compounding annual returns. By investing in growth assets, that is shares or property, the compounding returns are better than leaving your money in cash;
- you could potentially afford to live in a better property as a tenant than you could if you bought a property. For example, a $400,000 property may rent for $400 per week, however a $1,000,000 property may rent for $650 a week;
- renting is a great option in your 20's-30's if your life is changing in that period, you wish to work and travel, you haven't met your life partner or your haven't had children. You could probably move every 2 to 3 years if you were renting. It would be too expensive to do this if you bought a property;
- ten years of full tax benefits, gearing and franking credits (shares) or depreciation on property will set you up for the future far better than buying a first home earlier in life; as the property is more affordable due to a tenant and the taxman helping you, it allows you to get your foot into the property market more easily. Sydney, Melbourne and Perth are among the world's most expensive cities to live in, so it makes sense to increase your cash flow;
- once you have equity in the initial investment, for example your first investment property, you can then use this equity to purchase more investments, such as diversifying into shares. This will create wealth and provide financial freedom for your family.
Some home truths about renting and investing
Renting and investing is not for everybody. It is hard not to be influenced by your family and friends who have probably followed the traditional route of buying their first home. Therefore, you will need the following mindset:
- Fear of debt – there is good debt and bad debt. Know the difference;
- 'Rent is dead money' – this is nonsense. In today's world, there is a cost of living, whatever option you choose. If you bought your own home, non-deductible interest expenses and rates would also be dead money on this rationale. Renting is simply having access to a safe home to live in with access to utilities. It also potentially frees up money for investment;
- 'If you decide not to buy, you will rent until you die' – this may or may not be true however, what is the matter with renting and investing for life? It allows for greater flexibility in your life and work. In Part 3 of this blog series, I will describe how you can have the best of both worlds;
- 'Property is too expensive' – this may or may not be true. It is more affordable if a tenant and taxman are helping you, especially if you are not paying too much on your own rent;
- 'I don't want to miss the First Home Owners Grant' – this is a nice handout, but should not be a determinant in the decision to buy or invest. It is not that much money;
- 'It is too high a risk' – a financial adviser can help you understand the pros and cons of gearing. Picking an investment matching your financial capabilities, retaining a cash buffer and insuring against bad events will help minimise risk;
- 'Do not forget that you are purchasing an investment' – personal preferences should not come into account. It must be a good investment, providing a growing income stream and the ability to grow in line with inflation. Again, seek financial advice on suitable investments for your circumstances;
- Be prepared to hold your investment for at least seven to ten years. Growth assets should be held for at least this long.
Stay tuned for Part 2, where I will provide a cashflow example of the different options, and Part 3, where I will give a friend's personal system for achieving the best of both worlds.
To learn more about Darren, view his online profile.
If you are seeking financial advice please contact us on 1300 308 440 or enquire online.