Should I buy a Principal Place of Residence or Investment Property first?

Should I buy a Principal Place of Residence or Investment Property first?

A common question for first time investors is what is better – to buy their principal place of residence (PPOR), or an investment property (IP) first? The crux behind this question is generally what will help the investor achieve their goals sooner.

In determining what is better for your specific circumstances, it’s important to balance the financial and emotional factors – never discount one over the other as with any long term investment strategy for financial growth, as it’s important to make sure that any decision not only is financially beneficial, but viable for you to keep to the plan over the investment horizon.

I’ll break down the pro’s and con’s on both options of which purchase to make first to help clear whether there is a clear better option for your circumstances.

Benefits of buying a PPOR first

*Stop renting – “not paying dead money”
*Additional cash flow can be used to pay down your PPOR loan, freeing up equity to use for investment property deposit in the futures. Using an active debt recycling strategy you can fast track paying down your home loan whilst investing in property (or other types of investments), allowing you to have your cake and eat it
*You can buy a “for now PPOR” if you do not have sufficient deposit/borrowing capacity, then leapfrog onto your next PPOR in the future whilst retaining the first property as an investment – having the right loan structure from day 1 is paramount if you want to use this kind of strategy

Issues with PPOR first

*You may have insufficient funds to get into a property which could be suitable as a PPOR (ie priced out of being close to your employment or other needs, or not fit your needs)
*Purchasing a PPOR may exhaust your entire borrowing capacity making you unable to make any purchases thereafter

Benefits of buying an investment property first

*Gets you into the investment market sooner
*Allows for more flexible purchasing criteria driven by financial needs than fitting your emotional/personal requirements
*If you’re able to rent a comparable property what you would purchase a PPOR for a significantly cheaper ongoing cost, the excess cash flow will allow an increased overall borrowing capacity position AND that cash flow can be utilised into rolling into further investments/future PPOR

Issues with an investment property first

*By growing your portfolio first, you may purchase enough properties that you exhaust your borrowing capacity and are unable to purchase your own PPOR – which can be restrictive if you need/want to own a PPOR in the future
*Should this happen, you may then be forced to sell down some of your investment assets to free up cash/borrowing capacity which may be sacrificing a quality long term investment

Which option is better for me?

It depends! It will come down to a number of factors:

*Is there a personal/non-financial need to own a PPOR
*Is there a substantial cost differential between owning or renting a PPOR and renting
*How much deposit is available

If there isn’t an emotional/non-financial driver for purchasing a PPOR (preference to own your own home, find it difficult to rent due to pets or other family needs etc), the primary consideration will come down to whether the cost of renting is cheaper than the cost of the mortgage and holding costs of home ownership (maintenance, insurance, council rates).

Another factor which can influence the debate is the total funds available for a deposit. The more funds available for a deposit – the greater the likelihood that it’s financially more beneficial to purchase a PPOR compared to an IP. Due to the nature that you can re-leverage a PPOR with a debt recycling strategy to rapidly build and investment portfolio – this biases PPOR’s over the long term as you can reduce your effective PPOR ongoing costs, whilst having a growing deposit base for investments.

Comparison Scenarios

To better understand how you can look at a scenario and identify what is the better option – we will look at variances in an example to see how subtle changes impact the end results.

Example 1: Single borrower Jim, earns $100,000 a year, currently rents a house for $500wk. Jim has saved $200,000 and is looking to invest in property, but is unsure whether to buy a PPOR or IP first. After all costs Jim is currently adding $15,000 to his savings per year.

Purchase Price: $500,000

Purchase Costs: $25,000

Total Loan Required: $325,000 ($500,000 + 25,000 – $200,000)

Interest Costs per annum: $16,250

Miscellaneous ownership costs (repairs, council rates etc) per annum: $3,000

Total cost of ownership per annum: $19,250

Total cost of renting per annum: $26,000

Result

Overall the ownership cost in this scenario works out cheaper for Jim. Even if he takes on P&I repayments he will have a net cash flow surplus based on his current $15,000 excess cash flow per year, allowing him to debt recycle and use his equity to invest moving forward.

Note: the $200,000 noted in this example if not used towards a deposit would otherwise be generating a return (be it interest in a bank account, in shares etc), so it’s important to consider this and the minimum amount of return Jim would need to be receiving to justify continuing renting. In this example Jim would be able to utilise his available equity in the property to leverage into purchasing investments which would help increase the value of PPOR ownership. (should he release his equity up to 80% of the purchase value, he could release $74,000 to be used to invest)

Also note that unlike rent, the long term majority cost of ownership (interest), will not increase, whilst rent will.

Example 2: The same factors as the previous example, with a higher purchase price.

Purchase Price: $800,000

Purchase Costs: $40,000

Total Loan Required: $640,000 ($800,000 + 40,000 – $200,000)

Interest Costs per annum: $32,000

Miscellaneous ownership costs (repairs, council rates etc) per annum: $3,000

Total cost of ownership per annum: $35,000

Total cost of renting per annum: $26,000

Result

Overall the cost of ownership is $9,000 a year greater than renting, whilst also requiring the entire $200,000 in deposit funds to be utilised. As the loan is at 80% LVR, there is no effective equity to be released so the prospects of investing in property in the short term is unlikely until debt reduction which will be at a slow rate with the majority of excess cash flow going to minimum repayments on the PPOR debt.

Example 3: Jim instead of buying a PPOR, instead buys investment properties

Purchase Prices: $1,330,000

Purchase Costs: $66,500

Total Loan Required: $1,196,500 ($1,330,000 + 66,500 – $200,000)

Interest Costs per annum: $59,825

Miscellaneous ownership costs (repairs, council rates etc) per annum: $6,000

Total cost of ownership per annum: $65,825

Rent Received (4% rental yield): $53,200

Total Cash flow position: -$12,625

Result

This scenario utilises almost of the entirety of the cash flow position and exhausts all savings available. Whilst this negative cash flow position will likely result in a tax adjustment to assist in the cash flow position, it will be unlikely for Jim to make any meaningful savings for the foreseeable future to put towards a PPOR purchase. If there is no intention to purchase a PPOR in the future this may be seen as acceptable for the borrower. This scenario allows for the borrower to gain the greatest amount of property under ownership in the shortest period of time, however if a PPOR purchase is used which his below the cost of renting, the same or greater can be achieved.

Key Considerations to making better choices when it comes to buying a PPOR vs investment property first

*Establish if you are to buy a PPOR – what type of property you would buy. Is this cheaper than the cost of renting?
*Due to APRA changes, having a PPOR may allow you to have a larger portfolio over the longer term if integrated with a debt recycling strategy
*Consider a PPOR for what it is – another asset which can work towards your long term financial goals
*Balance the long term and short term needs – investing is a long term strategy which requires you to stick to the plan. Making decisions which may help you financially in the short term which are not sustainable in the longer term (ie wanting to own a PPOR, but instead buy IP’s until you cannot afford to buy a PPOR) is a quick way to make sure you deviate from your financial plan
*If you do buy a PPOR, it does not have to be the ‘forever home’. Potentially use a PPOR purchase strategy alongside a renovation strategy, which you can then upgrade to an investment property and buy a new PPOR

If you would like to have a discussion about whether it’s better for your strategy to buy a PPOR or an investment property first, click here to connect with us today