By Paul Mahoney, Managing Director of Nova Financial
Rent-vesting: The act of continuing to rent whilst investing in property.
Conventional wisdom says that it is financially savvy to buy and own your own home, but is it really that financially savvy?
When it comes to comparing the cost of renting, especially in a high-value, low yield location like London and the South East of the UK, compared to buying in that same location, it’s quite clearly cheaper to rent. For example, the average property price in Greater London at the moment is approximately £500,000 and the average yield is approximate 3.5%. This means that the average rent is approximately £1,460 per calendar month. Compare this to the average mortgage repayment on that same value property, assuming a 10% deposit and therefore a mortgage of £490,000 at an interest rate of 3%, monthly repayments would be £2,323 per month. So, an extra £863 a month to buy your own property. Is it worth it – it’s your property after all?
Remember that you don’t own the property, the bank does and, in taking this mortgage, the buyer has committed themselves to a 90% loan-to-value (LTV) mortgage on a particular property and those high repayments, over a 25-year-plus timeframe. They have also committed a £50,000 deposit plus Stamp Duty and legal fees for a property that has been selected using very emotional criteria.
The emotional criteria refers to when buying a property that is to be your home you need to be comfortable, you need to love the place and, therefore, the fundamentals of your decision-making process are extremely different to if you were investing in a property for the sole purpose of making money.
The location will be selected based on things like the proximity to your work, facilities and amenities that you personally prefer, and the style and design of the house that you personally like. This may be completely different to what makes the most sense as an investment, which really should be determined by what the greater target market in the area wants and prefers to generate, as much as possible demand in both the rental market and the resale market. Therefore, often the property selected with a commercial and unemotional mindset will perform better from rental yield and capital growth perspective than the property selected with an emotional and personal mindset.
I can hear some of you asking: “But isn’t renting a waste of money?”
I’m not inferring that people should just rent and do nothing with the £50k-plus they would’ve used to buy a home. Rent-vesting is all about investing rather than buying a house to live in. Often, renting in an area where you’re comfortable and happy and/or an area you can’t afford to buy and/or it may be cheaper to rent, as described above, can be the best option both financially and from a lifestyle perspective.
There is a very strong trend toward rent-vesting for millennials who live and work in London, can’t afford to buy or don’t want to commit to where they want to live right now, so they invest elsewhere. Renting then investing in an area that makes the most sense to best utilise their money. For example, using the £50,000 described above to invest in a more affordable location like Manchester that yields 7%-plus gross and, based on current interest rates and general expenses, this property could be achieving a 10%-plus return on investment (ROI) on the money invested. That is £5,000 post-expenses and pre-tax, which is a good chunk towards the rent on their London property.
Then let’s assume that property also does well from a capital growth perspective, they are most certainly utilising the money in an efficient way whilst living in an area that is convenient and flexible for them.
As London property continues to become more unaffordable, and the gap between wages and property prices has extended beyond ten times versus Manchester, for example, where it is 4.5 times, we expect this trend to continue, and more and more rent-vesters to continue to rent in London and invest in the north. This is just one more contributing factor driving areas like the North West property market to do extremely well in recent years and expected to continue over the coming years.
Far too many people buy the biggest and the best house they can afford far too quickly because ‘that’s what people do, isn’t it?’. They spend their whole life paying the house off, which is nice but, if they pay off their dream house by the time they retire and all their money had gone into it so they don’t have any investments, they have somewhere to live in retirement, but they don’t have any investment/retirement income aside from a dwindling pension, which isn’t very useful. We meet with far too many people who are asset rich and cash poor in retirement. This often means they’ll need to sell that dream home they’ve worked so hard to pay off and then invest to generate income, which they could’ve done years ago and therefore achieved a lot more financially.