Buying an investment property while renting: The pros and cons

Owning your own home may be a dream, but is it the best first move?

Many first time buyers aren’t looking for a home to live in – instead, they’re seeking investment properties.

If you can purchase an investment property while living with your parents – and are happy to continue living there – you can generate a tidy secondary income or build equity with few outgoing costs.

Some prefer not to live with their parents, or are unable to do so. For those eager to get into the property market, it may seem the pressure is on to settle down in a permanent home. The other option is to rent – but rent money is dead money, right?

Not necessarily. In fact, renting while building an investment property portfolio is a well worn strategy. But what are the pros and cons of buying an investment property and renting before purchasing your first home?

Firstly, it’s useful to consider the reasons many choose to make their first property purchase their own home.

OWNING YOUR OWN HOME FIRST:

THE PROS

• FIRST HOME OWNERS GRANTS AND CONCESSIONS

Depending on the type of property you are hoping to purchase and where you live, you may be eligible for a first home owners grant.

In order to claim a first home owners grant, most buyers will have to live in their home for at least six months (12 months, in some places).

In some states, including Queensland, you will not be able to receive the first home owners grant for a property purchase that isn’t your first, even if your first property buy was an investment property.

You may also be able to claim land tax concessions on your first home purchase.

• CARING FOR YOUR OWN HOME

Owning your own home also allows you to dodge many of the worst parts of renting. You’re free to decorate, upgrade and make alterations to your own property. Home owners don’t have to wait for a property manager to give them permission to make improvements or have that faulty plumbing fixed.

You can also keep pets and welcome additional inhabitants without seeking your landlord’s approval.

Property isn’t all about money – homes have emotional value. The appeal of owning one’s own home is obvious to many.

• STABILITY AND SECURITY

Another downside of renting is the lack of security or a consistent lifestyle. Within three months, you could find yourself without accommodation, at the whim of your landlord.

Purchasing a home does not guarantee you will always be able to live there. You may be uprooted for work or be unable to make your repayments. However, generally speaking, you are responsible for ensuring you can continue living in a home you own.

While renting, the length of your stay in your home is totally at the discretion of your landlord.

If you’re making your mortgage repayments comfortably, you can then use the spare money to invest in other assets, knowing that you have a stable home.

• CAPITAL GAINS TAX EXEMPTION

When upgrading and selling your primary place of residence, you don’t need to pay capital gains tax – something you will have to do if selling an investment property.

THE CONS

• FEWER TAX EXEMPTIONS

While owning your own first home will allow you to dodge capital gains tax, you also have fewer tax exemptions available to you than you would if investing. As your home is divorced from your income, you won’t be able to claim deductions for interest payments or upgrades to your property.

• NO INCOME

Unless you rent out some parts of your house while you live in them, your house will only deliver you cash on the day you sell – and even then, it may not.

What you gain by owning your own home, you lose in cash flow.

• THE GROWTH/LIFESTYLE TRADE OFF

Some are willing to sacrifice a lot to live near the CBD, or their parents, or their friends, or their child’s school.

Unfortunately, the best places to live may not be the places you can afford, or places that have good investment potential. If you’re sure you won’t be happy unless you live in the inner city, but can only afford to buy in the far western suburbs, buying a home may not be for you.

The places that make the best places to live – for many reasons – are not necessarily the best places to invest. Nine years down the track, you may realise your dream home hasn’t appreciated in value at all in the time you’ve lived in it.

BUYING AN INVESTMENT PROPERTY AND RENTING

THE PROS

• CASH FLOW

An income generating property, if managed properly, can pay for itself (literally). If cash flow positive, the rental income you receive could cover outgoing costs and your mortgage payments (including interest). If it’s generating a healthy rent, it could even cover your own rental payments.

Not all investment properties will be positively geared, particularly if they’re recent purchases. As your investment property is an income generating asset, you can claim interest payments as tax deductions if your property is negatively geared. If you back your property to appreciate and generate capital growth when you sell it, and your taxable income is considerable, this could be a worthwhile strategy.

• TAX EXEMPTIONS

Beyond negative gearing, an investment property has many other tax benefits. Outgoings including maintenance, improvements and repairs can be claimed as deductions, as can depreciation. Speak to your accountant before making an investment to see what you will be able to claim.

• FLEXIBLE PURCHASING ARRANGEMENTS

If you’re purchasing a home to occupy, it’s unlikely many people, beyond your co-inhabitants, will be willing to contribute. But if you’re buying an investment property, you may be able to work with family members, or friends, splitting the income generated. If you’re considering this option, make sure you know the potential draw backs.

• EQUITY

If your investment property is positively geared, you can use the income to pay off your mortgage, building equity faster than you may be able to if you were paying off the mortgage of your own home using just wages.

That equity can then be used to expand your property portfolio.

THE CONS

• FIRST HOME OWNER GRANTS

Many grants and concessions will not be available to you for your first purchase if it is not your primary place of residence. Even if you do buy a home to live in later on, you may find that you are no longer eligible for a first home owner grant due to your first purchase.

Some first time investors choose to live in their newly acquired property for six or 12 months to get the first home owners grant before moving out and renting the home. However, if the tax office can successfully prove you never intended to make the property your principal place of residence, you may be required to pay back the grant.

• VOLATILE COSTS

Part of the allure of renting is never having to pay for maintenance (unless, of course, an issue is your fault). Leaks, mould or flooding isn’t your problem, it’s your landlords. Of course, if you rent and buy an investment property, suddenly you are a landlord – and all those problems with your investment property are now your own.

Don’t underestimate the time and cost of maintaining a rental property. If you have a good property manager, you may have relatively few surprise costs. But for some unlucky property managers, the first time they hear about a leak is six months after it was reported, when the pipe has burst and the ceiling is ruined – blowing a small cost into thousands of dollars.

If you’re purchasing an investment property, make sure you have plenty of time and money to deal with maintenance.

When renting and owning an investment property, you get all the frustrations involved on either side of the fence.

As a renter, you also face uncertain costs. Mortgage payments are generally quite regular, even with rate changes. The rent your landlord chooses to charge is not necessarily so consistent. If your landlord decides not to renew your lease, you are also tasked with finding new accommodation (and, normally, paying bond and a month’s rent up front).

• CAPITAL GAINS TAX

You will be required to pay capital gains tax when it’s time to trade any properties that are purely investment assets. You aren’t required to do so when selling your primary place of residence.

• RELINQUISHING CONTROL

As many renters can attest to, living in a property you don’t own can be a frustrating experience. Maintenance seems to take double the time it should, costs can go up unexpectedly and you can’t customise your home the way you would like.

• WHICH IS A BETTER STRATEGY?

The answer will, of course, depend on the property you’re hoping to purchase, your priorities, and your investment goals.

For some, the first home owners grant is negligible when compared to potential rental income. For others, the frustrations of maintaining a property that you don’t have control over just isn’t worth it, especially if you have no experience in property. Negative gearing benefits may not make a difference to someone on a low income, and if you’re disinterested in renovations, you may be very happy to rent for the rest of your life.

Purchasing your first property is a complex investment and big financial responsibility – make sure you do your research. Speak to an accountant and be honest about your personal goals before jumping into the property game.

This article originally appeared on Property Observer.