The power of leveraging property
It could be argued that the main reason people invest in property is to build wealth, right? It might seem like you need to already have huge amounts of savings before you can start investing in property, but that isn’t necessarily the case. While it is a good idea to have cash flow and money to fall back on, there are ways to use your money wisely to optimise your investment strategy.
Most people don’t begin investing with enough to cover the entire cost of a property. And chances are, you don’t have a tidy million sitting idly in your bank account just waiting for the right property to pop up.
So, what are your options then? A little thing called leverage.
What is leverage and how does it work?
Leveraging is an investment strategy, whereby you use borrowed money to finance an investment that you couldn’t afford to buy without those borrowed funds, and hope that it increases in value over time so that your return on investment (ROI) also increases.
Although some investors see it as risky, leveraging property allows you to purchase more property, thus increasing the size of your portfolio, than you would otherwise be able to afford.
When you invest in property, a financial lender will require you to put in, or pay, an amount of money towards the investment, but this amount is usually just a fraction of the overall value of the investment. Then, as the investment increases in value over time, so does your future ROI.
Let’s look at a common property scenario. If an investment property is $400,000 and you need to put down 10% for a deposit ($40,000), then you’re using a relatively small percentage of your own money to finance this purchase, with the majority of funds being borrowed. Assuming this investment has everything going for it and appreciates by 5% per year, your net worth from this one investment would grow to $420,000 in just one year.
If you then compare this to an unleveraged investment, where a $40,000 property is purchased outright (and if you find a $40,000 property, let us know!), and the same 5% rate of appreciation occurs over one year, your net worth would be $42,000.
A difference of $18,000!
Now figure out those figures over multiple years, and it’s easy to see why so many investors choose to leveraging property to build their portfolios and net worth.
The benefits of leveraging property
Using the $40,000 as an example again, if you placed that money into a term deposit at a bank, you could feel safe and secure knowing exactly what your interest rate is and what you will earn from this investment. This is a hassle free investment option with virtually zero risk involved.
However, to really maximise your wealth, you need to be able to take risks. As risky as leveraging may seem, the financial rewards can also be far greater than other investment strategies.
The main benefit of leveraging property is that it frees up your capital because you only have to front a fraction of the property value. This also means that you have the potential to have more than one investment going simultaneously.
You also get to enter into these investments faster than if you had to save for the entire property, meaning you can get into the property market at today’s prices, but benefit from them in years to come.
The risks of leveraging property
Just as leveraging property can increase your wealth, it also has the potential to decrease it. If your investment property drops in value, that extends to your overall net worth. If property prices fall low enough, you can even end up owing more to your loan than what the property is worth! Choosing the right property in the right area is a good way to minimise this risk.
In an ideal world
It’s important that you have a clear plan for your investment strategy. Leveraging property is quite common, especially when you consider that most people require a mortgage to purchase a home. To get the most out of your leveraged investment strategy, ensure that you have a financial buffer in place for unexpected costs, and consider buying in metro areas where property demand is higher.
Ideally, you would buy below market value and only properties with a strong yield so that they are also paying themselves off.
To learn more about how you can make leverage work for you, contact us today.
