Should I Buy or Rent?

Jack is confused. And the more he chats with other people the worse it gets.

Jack arrived in Australia about twelve years ago and is now in his mid-forties. He’s a diesel mechanic for a truck and tractor mob out in the western suburbs of Sydney and has about $200k in savings.

He’s not hitched either, but I expect his luck will change anytime soon, just because he’s a good guy. But right now, that’s the least of his worries.

His clock is ticking for other reasons.

Jack begins our first meeting by telling me he’s trying to bust into the Sydney property market, but he’s also thinking about the fastest way to get the property paid off as well. He doesn’t want a mortgage hanging around his neck like an Albatross when he’s in his sixties.

He’s been pre-approved to buy a place for $800k and has his sights set on a nice three-bedder near where he works. He then discusses his plan with a mate of his who then suggests something else to him.

Said mate reckons Jack should buy two investment properties (IP’s) for $400k each up in Qld where he’ll get a lot more bang for his buck and make a lot more money. Plus, the IP’s will be tax deductible!

It’s at this point Jacks dream turns into a headache.

Does he buy a place in Sydney to live in for $800k with a big fat mortgage (non-deductible) or should he buy two investment properties in Qld for $400k each and potentially make a lot more money long term…plus get some juicy tax benefits.

The idea of investing in Qld and renting in Sydney is very attractive to Jack for four reasons:

1. The rent from the IP’s would fund the mortgages and any shortfall would be tax deductible (negative gearing). This would also reduce his marginal rate of tax. Jack likes!

2. If he buys the IP’s in high growth areas and then sells them later on, he expects the potential capital gain would be more than the house in Sydney. Therefore, he assumes he would have enough to buy a home with cash, later on.

3. Property doubles every 7-10 years, so he can’t fail. Especially in Qld! (apparently)

4. He’s also thinking of setting up a small business (fixing diesel motors) where he currently lives which would make some of his existing rent tax deductible.

By the end of the first meeting, Jack has some compelling reasons to rent in Sydney and invest up north, so we agree to a second meeting in about a fortnights time.

The purpose of the second meeting is just to present a proposal with an outline of what our approach would be, if he we worked together. Most importantly, I explain to Jack he won’t be signing or committing to anything in the second meeting. I just want him to sit and listen.

He thinks this sounds great and he gives me one and a half thumbs up! (He lost half a thumb in an accident at work. Fan belt)

The Sunshine Coast
The second meeting goes really well but as is often the case, Jack throws a curve ball. To be honest, this is to be expected because the first meeting often creates a lot of afterthought for clients. It’s a bit like digging up a vege garden and finding a heap of earth worms alive and well. It’s a very healthy sign.

Anyway, Jack floats the idea of moving to the Sunshine Coast in the next 5-10 years and wants to know if that will bugger up our plan if he buys in Sydney now. He’s looking at a place on the Sunny Coast for approx. $500k.

Recommendations
Jack’s situation is not uncommon. i.e should a budding property owner rent or buy?

These were the three scenarios I modelled up for Jack to make my final recommendations:

Option.1 – Buy. In most circumstances, I would recommend a client buy and live in the same house with a P+I loan.

In Jack’s case this would have meant buying the three bedder in Sydney and getting it paid off asap. Reason: a client should get rid of their non-deductible debt (mortgage, personal loans, cards, etc) as soon as possible because as the name suggests, the debt is not tax deductible.

Option.2 – Rent and Invest. Jack had some very compelling reasons to continue renting in Sydney and buy two investment properties in Qld. At face value, the numbers seemed to stack reasonably well. But, by the time I included the ‘friction’ (buy and sell costs including capital gains tax), plus his out-of-pocket costs along the way, the argument to invest began to weaken.

There was also the Sydney rent he would have shelled out during the interim. Even if he operated a small business from home and collected the tax deductions, the rent paid in Sydney over a ten-year period made quite a dent in any cost benefit analysis to invest instead of buying.

The final blow for me was around property prices. ‘Rent and invest’ strategies rely on property prices appreciating over time and in some areas, this doesn’t always happen. Also, the idea that property doubles every ten years has a lot of holes in it as well. Its an argument I don’t necessarily buy. Qld is a very good example.

Option.3 – Invest and Live. In the end, my recommendation for Jack was to buy an investment property on the Sunshine Coast with the expectation of living in it later on. What made this a better option than the first two was the Sunny Coast property was cheaper to fund (while still paying rent in Sydney) plus, he would not have any ‘friction’ (buy sell costs) later on because he intended to live there. The absence of friction was the difference.

Equally important, Option.3 does not on property prices going up to make it work. A major downside of Option.2.

In summary, I would say that in approximately eight out of ten situations, a client is better off buying rather than renting and investing.

I appreciate a lot of people rent and invest which only highlights how personal each individual case is. However, the one caveat I would flag is, don’t invest just for tax purposes. It’s a bit like starting a meal with desert, it might be appealing but its not the best approach.

If this has raised any questions for you, feel free to contact us and we can set up a time to have a chat.

Have a great weekend!

Adam