Is Buying a Home the Best Way to Build Wealth? - September Market Update

By Rich Harvey, CEO & Founder, propertybuyer

Written by: Rich Harvey, CEO & Founder

propertybuyer.com.au

The age-old debate of whether to rent or buy a home has been a cornerstone of financial planning discussions for decades. As a buyer's agent, I frequently encounter clients grappling with this decision, wondering if homeownership truly is the best way to build wealth. While there are compelling arguments on both sides, it is crucial to examine various factors such as equity gains, rent savings, financial discipline through mortgages, and alternative investment strategies to arrive at a well-rounded conclusion.

Renting vs Buying

One of the first considerations in the renting vs. buying debate is the financial commitment involved. Renting provides flexibility and requires a lower initial outlay compared to buying. Tenants are not responsible for property maintenance, council rates, or major repairs, which can be a financial burden as a owner. As a renter you could live in a larger house much closer to the city or beach for a much lower weekly figure that if you had to repay the mortgage. For example, living in this house at Wyndora Ave Freshwater (which recently sold for $4.2m) will cost you $2500pw as a renter, but as an owner occupier with a mortgage (at 60% LVR) will cost you whopping $15,912 a month in Principal & interest repayments (or circa $13,000 month interest only).  However, renters miss out on the opportunity to build equity (tax free capital gains), which is a key advantage of owning a home.

Gaining Equity by Holding the Home for More Than 10 Years

Homeownership allows individuals to build equity over time. By holding a property for more than 10 years, homeowners can benefit from property appreciation and the gradual repayment of their mortgage principal. Historically, real estate in most Australian capital cities has appreciated at an average rate of around 5-8% per year, although this varies significantly based on location and market conditions. In the above Freshwater example, that property previously sold for $1.85m in May 2016 (so that’s a healthy increase of $2.35m over 8 years). 

The annual rate of capital growth for Freshwater was circa 10% pa over the last 10 years. This appreciation, combined with paying down the mortgage, can significantly increase your net worth as a homeowner over time. In the above example, if your interest costs were $13,000pa, ie $156,000 pa, this compares to $293,750 in capital gains pa so you would be $137,750 better off owning than renting (if you can afford the repayments). 

Not Paying Too Much in Rent

While renting may initially seem less expensive, rent payments can increase annually, often outpacing inflation. CoreLogic report that rents have risen around 8.2% year to date nationwide. Over a long period, renters may end up paying more in rent than they would have in mortgage payments for a comparable home. Additionally, unlike mortgage payments, rent payments do not contribute to building wealth. This is a critical point where homeownership often has the upper hand, as each mortgage payment reduces the loan balance and builds home equity.

Having a Mortgage provides Financial Discipline

A mortgage acts as a form of forced savings. Each mortgage payment includes both interest and principal repayment, with the latter contributing to building equity. This forced savings mechanism ensures that homeowners are consistently investing in their property, which can serve as a financial safety net. In contrast, renters must rely on self-discipline to save and invest any surplus funds, which can be challenging without a structured savings and investment plan. In my own experience, my wife bought a home and added value and through the increased equity, were able to start buying investment properties. 

Investing the Difference Between Rent and Mortgage Payments

One of the counterarguments to buying is the opportunity cost of tying up funds in a property. By renting and investing the difference between rent and mortgage payments in other assets, you might potentially achieve higher returns. For instance, investing in a diversified portfolio of stocks, bonds, or managed funds could offer significant growth over time. However, this strategy requires a disciplined approach to investing and a thorough understanding of the market, which may not be suitable for everyone. 

Investing in the Right Assets

Whether you choose to buy a home or rent and invest, selecting the right assets is crucial. Real estate, while generally a stable investment, is not without risks. Market downturns can erode property values, and liquidity can be an issue during tough times. On the other hand, financial markets can be volatile, but they offer the advantage of liquidity and diversification. A balanced approach, combining both real estate and other investment vehicles, might provide the best of both worlds, mitigating risks while maximising returns.

Rentvesting

Rentvesting is an emerging trend where you rent a home in your preferred location while investing in property elsewhere. Many of our first home buyer clients that can’t afford a home right now are using this tactic. With a budget of just $500k, you can still afford to buy a quality investment property interstate with yields 5% to 6%. 

This strategy allows you to live in a suburb where you might not afford to buy while still gaining exposure to the property market. Rentvestors can purchase properties in more affordable or high-growth areas, benefiting from capital gains and rental income. This approach offers flexibility and can be a smart way to build wealth without compromising on lifestyle choices.
Using Equity as the Foundation for Getting Started with a Portfolio
One of the significant advantages of homeownership is the ability to leverage home equity to invest in other assets. The equity you build in a home can be used as collateral to secure loans for further investments, such as purchasing additional properties or investing in stocks and businesses. This leveraging capability can accelerate wealth building, provided it is managed wisely and with a clear understanding of the risks involved.

Conclusion

The question of whether homeownership is the best way to build wealth does not have a one-size-fits-all answer. 

Here’s the rub – it really depends on your current income and future goals. There are multiple ways to achieve solid wealth. In my own experience I have chosen to walk the property path and grown a sizable portfolio. I chose this path because property provided the best financial leverage available. Property is in short supply in Australia and will continue to be for decades. Banks love property and you have ability to add value and develop it. 

I recommend you don’t chop and change strategies all the time – this will just chew up transaction fees and cost more in stamp duty. Getting your first property can set you up for success in life in so many ways. 

It doesn’t matter if it’s a home or investment property. But getting on the property ladder is the first step and many people procrastinate and over-analyse while the market continues to rise. Getting that psychological feeling of ownership is also important. 

Renting and investing the difference can also be a viable path to wealth, particularly for those who value flexibility and are disciplined in their investment approach.

Ultimately, a diversified strategy that combines real estate with other investment vehicles provide the most robust path to wealth creation. As a buyer's agent, I encourage clients to carefully consider their financial situation, long-term goals, and risk tolerance before making a decision. By doing so, you can choose the path that aligns best with your personal and financial goals.

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