Mark LaMonica loves where he lives. The Sydney local, who lives in the heart of Surry Hills, is surrounded by restaurants and bars, cafés and parks, and he relishes the fact that he can walk to work. His wife’s commute is just a short bus ride.
The 44-year-old chartered financial analyst and director of personal finance at investment research firm Morningstar is renting, and not planning to move.
The couple work long hours and aren’t keen on compounding that with an arduous commute, which means they’re limited to where they would want to buy.
So they’re staying put and investing the difference.
Mark LaMonica doesn’t want to buy, and he’s happy with his decision.
As LaMonica found once he ran the numbers, there’s no reason you can’t build sufficient wealth even without owning a slice of the Australian dream – as long as you have discipline and a strategy.
While this is a lifestyle choice for LaMonica, there are many others who may be contemplating the same strategy as they’re priced out of the market.
The hardest part of building wealth as a renter is in staying the course, says Brenton Tong of Financial Spectrum.
“Something I explain to clients when we’re exploring ideas is how companies manage their assets and balance sheets compared to individuals,” he says. “A company typically will lease the space needed and put money into product development and business expansion. Money invested into property is seen as ‘dead money’ as they can extract a better return by investing it into the business and the rent is just an operational expense.
“So if a company can create a billion dollar value without owning their ‘home’, so can people.”
In his early years as an adviser, Tong would talk to many clients about how to make money by renting and investing the difference. They’d sign up but some years later, they’d come back saying they wanted to buy.
According to analysis by financial advice fintech Otivo, renters need roughly an extra 40 per cent in super than their home-owner counterparts to sustain a comparable retirement.
To begin to answer the question as to how much you’ll need in retirement, LaMonica says a good first step is to determine your current expenses. This is a decent proxy for the expense level you’ll need in retirement, if you don’t foresee any changes in lifestyle.
Then, figure out how big your portfolio needs to be to safely pay out that level of income.
Common reference points are $1 million and 4 per cent. The idea is that someone could draw down 4 per cent of this at $40,000 a year, but their portfolio will be making more in returns, so it’s self-sustaining.
LaMonica gives a hypothetical scenario similar to what he’s modelled for himself.
Say you’re renting an apartment for $40,000 a year that would cost $1 million to buy. If that rent were to increase at 5.5 per cent per year for 30 years, the annual rent would hit $200,000. If LaMonica planned a 4 per cent withdrawal rate in retirement, he’d need a whopping $5 million in assets just to cover the projected rent.
But rather than having bought the property with a 20 per cent deposit, the $200,000 would be invested for 30 years with an assumed 8 per cent return – resulting in $2 million. So, he’s still $3 million short of the sum required to cover his rent.
But this is where investing the difference comes in.
At current interest rates, LaMonica would be paying about $60,000 a year on mortgage repayments, compared with $40,000 rent. Investing the annual $20,000 on top of the initial $200,000 would earn him $4.2 million in 30 years, he says. Although that’s still $800,000 short, investing another $7500 a year would get him to the $5 million.
He’s also saving about $10,000 a year in maintenance costs. Investing that would bring his total to $5.4 million, covering the rent and a little more.
LaMonica’s projected rent is based on an average 1.1 per cent real increase in rents per year over the last decade, before adding on another 3 per cent for inflation, and then adding his own buffer to take it to 5.5 per cent. “This number is likely way higher than the actual increase in rent will be over the long term, and it is significantly lower than my rental increases have been over the eight years we’ve lived in the apartment,” he says.
“The key to this whole strategy is not to pay too much take home salary in rent. This is hard when you are younger but as you make more money, the percentage decreases – unless you let lifestyle creep take over,” LaMonica says.
Rent v buy
The idea is to mimic the forced savings that come with paying off a mortgage, and use that to build your wealth by investing instead, says Keryn Batsilas of Your Life & Money Matters.
“I have a client toying up whether to buy or rent,” says Batsilas. “They’ve got a secure long-term rental, which is something like $900 to rent per week. If they were to buy that property, they’d be looking at around $1.1 million.”
Assuming a $220,000 deposit, their loan would be around $880,000. At 6 per cent, monthly repayments would be $5680.
Paying rent of about $3900 per month, they’ve got a spare $1780 a month to invest.
Let’s say they invested the $220,000 and made monthly investments of $1780 as well. In a high-growth portfolio earning 7 per cent, in 10 years they’d wind up with a $750,000 investment – before fees.
By comparison, says Batsilas, if they bought the property, and it grew at 7 per cent, in 10 years it would be worth $2.6 million, with a mortgage of $736,000 remaining.
So, property wins. But that’s before factoring in house maintenance and council rates. If you took the money spent on that and also invested it, the gap starts to close.
“Buying looks more attractive, but it really depends on what return rates you use. And no extra costs like house maintenance, rates or water access are calculated in this,” she says.
But that’s just the thing, says LaMonica. His goal isn’t to match the wealth of a homeowner or to have a piece of land to pass down to kids but flexibility and an income-producing portfolio that supports his lifestyle.
What do you invest in?
Batsilas says that because it will end up being a significant amount invested, she favours ETFs and managed funds.
The challenge with investing and renting, rather than owning, is that you’ve got a smaller sum exposed to markets and available to amplify.
That is, if you’ve got a $700,000 home, that could be $200,000 of your own money and $500,000 from the bank.
That’s all exposed to the property market, so growth will be amplified. That’s the idea of leverage, after all.
If you’re not buying and borrowing, then you’ve got a smaller starting sum – say $200,000. You need that money to work even harder, she says.
Investors could be looking at international and Australian listed property, and geared investments, she says.
Consistent investing rather than trying to time the market is LaMonica’s tip. “Success is not based on intelligence or following the market or any other factor other than consistency – consistently saving and investing throughout market cycles and consistently following an investment strategy.”