Making your first Property investment raises many questions and dilemmas. What location should you choose, what type of property, who will manage your property? All key issues to consider before investing. Perhaps one of the most important issues which you need to consider is how you will finance the purchase of your investment. Read more in our article about how financing your property in the most effective way can dramatically increase your return on investment helping you to grow a successful income-generating property portfolio.
What do we mean when talking about Financial gearing in terms of making a property investment? Whilst it may sound a complex financial strategy, gearing is, in fact, a very simple concept. If you are looking to grow a successful property portfolio it is essential that you make your money work as efficiently as possible, ultimately this will lead to a far higher return on your investment which allows you to expand your portfolio at a much faster rate.
So how do you financially gear your investment and what are the benefits of doing so? In simple terms, financial gearing means you are using a small amount of your own capital combined with the majority of your investment being funded via a mortgage. For example, instead of purchasing a £100,000 property using cash and tying up all your capital, you would place £25,000 as a 25% deposit, and the remaining £75,000 will be covered by an interest-only buy-to-let mortgage. This is a highly geared investment with the ratio of equity to debt being heavily weighted towards the debt with a high loan to value. This concept can be applied with varying ratios depending on how much you want to “gear” your investments.
Why would you want to encumber yourself with the liabilities of large amounts of non-essential debt? Here we need to debunk the common misconception that all debt is bad. Debt can be good, particularly in this time of record-breaking rates of low-interest mortgage lending.
Property Investment should always be looked at as a mid to long term investment meaning that capital growth is just as important as the rental yield for any investment property. Using gearing allows you to take even greater advantage of any capital growth in the value of the property. If we look at our previous example, purchasing a £100,000 property highly geared at a 25/75% loan to value (LTV) and theoretically, based on current market research, over a ten year period you would be looking to achieve 25% capital growth over this period. The property is now worth £125,000 meaning you have made a 100% return on your £25,000 invested capital. Looking at the same example but this time as a cash purchase, this would have only given you a 25% return on your invested capital. As you can see your money works more efficiently when it is strategically geared.
One of the major advantages of financial gearing is that it decreases your risk exposure by allowing you to spread your capital across different locations and markets. Staying with the above example. If you initially had £100,000 capital to invest in a property but have now geared it as above with only 25% equity and 75% of borrowing you still have £75,000 left to invest in 2 or 3 other properties using the same strategy. By maximising the way you spend your £100,000 in this way, you are not only minimising risk but will also be benefitting from multiple rentals; income and capital growth potential, significantly enhancing your investment.
The above examples, I hope have given an insight into why any property investor should seriously consider financially gearing their future investments if they are looking to quickly acquire a successful income-producing property portfolio.