Leveraging a property investment deposit to ramp up returns
A few days ago, when I wrote about the 7 reasons why investing in property beats all other investments, I mentioned something called ‘Leveraging’. Let me explain the benefits of leveraging to the property investor in a little more detail.
What is leveraging in property investment?
Leveraging is sometimes called ‘gearing’, and both words describe pretty well what this property investment strategy does. Put simply, leveraging is the ability to put a small amount of deposit into a property and use ‘leveraging' or mortgage finance from a bank or other institution.
When you borrow money as a property investor and use it when investing in property, you’re leveraging the power of someone else’s money to make a gain for yourself.
Let’s say that you’ve saved an investment property deposit. You couldn’t put that money to work unless you borrowed the balance from a bank or elsewhere. It’s the mortgage that gives you the ability to buy an investment property – without it, your money would be sitting in the bank earning next to nothing. And it’s that mortgage that unlocks the benefits of gearing in property investment.
The power of leverage
Engineers, builders, and technicians use leverage every day. If you’ve ever tried to lift a heavy object, you’ll know that it’s impossible unless you have a long enough lever resting on a pivot. That’s sort of how cranes work on building sites.
Even sportsmen and sportswomen use leverage: think of how much easier it is to cycle faster and use less energy as you move up through the gears, or how much further and faster a ball travels when hit by a cricket bat. This is leverage – the batsman on the cricket pitch is using the bat as an extension of his arm, and receiving maximum power for minimum input.
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Leveraging your deposit money when investing in property
When you borrow money to fund a property investment, you are immediately accessing the benefits of gearing when investing in property. If I could borrow 100% of the cost of my property investment, I’d do it every time. Let me show you why:
Let’s say that I have £200,000 to invest, and I’ve decided to do so by investing in property. I do my research and due diligence, select a property and buy it for £200,000.
- Now, let’s say that the property increases in value by 10%. I make £20,000.
- If the rental yield on the investment is, say, 7%, I’ll make an income of £14,000.
If I sold the property now, I’d have a total of £220,000 in the bank. (before costs)
Now let’s see what happens if I use that £200,000 as a 30% deposit on a property portfolio worth around £650,000:
- A 10% increase in value gives me a £65,000 profit. Instead of making 10% on my £200,000 original investment, I’ve made a 33% gain. If I sold the property now, I’d have £265,000 in the bank.
- And the effective gross rental yield isn’t 7% − the rental income of around £45,000 translates into an income yield of 22%!
Of course, I haven’t accounted for the cost of the mortgage in these calculations, but even if I pay a mortgage interest rate of, let’s say, 4%, the interest payable on my mortgage would be £18,200 (£455,000 x 4%). Deducting this from my gross income leaves me with income of £26,800, or 13.4% on my original investment of £200,000.
Using a buy-t0-let mortgage is pretty standard practice and these days it's very safe as long as you are following the principles that we talk most of all not overcommitting yourself and buying with good solid fundamentals.
Give the team a call and discuss what this means in your circumstances and how to take advantage of leverage without the sleepless nights on +44 (0)207 923 6100. – we’re happy to help.