Maximise Your Investments with Property Leverage Strategies

Becoming a property investor isn’t like investing in stocks and shares. You can’t just invest a little bit in one property and some more in another and become a property owner. You need capital to purchase a property or build a portfolio; this can take a long time to accumulate.

But is there a way to build a property portfolio by increasing your net worth? Property investors can use leverage to their advantage by putting little to no money down and allowing the debt – the bank’s money – to help them maximise a return.

Within property investing, leveraging is renowned as one of the best ways to grow a buy-to-let property portfolio and increase profit. So what is leverage?

What is Property Leverage?

Property leverage is an investment strategy which uses borrowed money from a lender, usually from a bank or building society through a mortgage, to purchase a property instead of using your capital. Leverage is using other people’s money to make higher returns.

Leveraging allows you to borrow money for a buy-to-let property that costs more than the capital you have or by allowing you to spread the capital across several rental properties.

How to Leverage a Property?

To leverage a property, an investor must first apply for financing from a lender – typically from a bank or building society through a mortgage.

The lender will consider the following when deciding whether to lend you the money, the amount of the purchase price they will cover and their terms:

• The value of the property,
• The estimated rental income the property is expected to produce,
• Your financial position.

Once they have considered the above factors, the lender will decide not to lend you the money or make you a proposal.

The lender may offer you 85% of the total purchase price, meaning you will need the capital to cover the remaining 20%. For example, if the property you were looking to purchase was £200,000, the lender would loan you £160,000, and you would pay £40,000.

Why Should You Leverage Property?

The main benefit to leveraging for property investment is the potential to increase your returns on your capital investment. This is because you will inherit the capital appreciation on the total property value, not just the capital you put into the property.

For example, suppose you put 20% of the value of a property down and used leverage to get an 80% loan-to-value mortgage. In that case, you could spread your capital much further than if you purchased a property in cash.

Your capital would have the opportunity to achieve a much higher return on investment if you spread that across several properties.

Investing in Property: Cash vs Mortgage Leverage

Let’s use an example to showcase how using mortgage leveraging compared to cash is optimal when investing in property.

Let’s assume these properties are next to each other and will perform in the same way. The average increase in house prices in the UK has been 6.7% a year since 1982.

But for this example, let’s say that both property values increase at 5% per year for the next six years. That would mean that the value of both properties is now £335,024.

This example shows that despite paying 4% interest on the property over six years, Investor B had more than doubled his return on investment compared to Investor A.

Building a Property Portfolio With Mortgage Leveraging

Let’s take things further and assume that investor B had the cash equivalent of 250,000 but chose to use mortgage finance rather than paying for the house outright like Investor A.

Investor B had £175,000 remaining and decided to build a property portfolio by investing in additional properties.

With his £250,000, Investor B purchased three properties valued at £250,000, with 30% equity (£75,000 each). As we know, Investor B’s rent will cover the mortgage payments for each of those properties.

Following the same principles as the example above, in six years, investor B would have a property portfolio valued at £1,005,072.

With equity of £480,072 – made up of the £225,000 initial investment plus £225,072 of capital growth – and a return on investment of £345,072 -120% more than Investor A.

How Inflation Affects Property Investment

Inflation also plays a significant role when investing via leveraging – learn why property is a smart hedge against inflation. However, most investors consider inflation a negative because it devalues your money in the bank year on year.

And for those who are saving, it does act as a barrier to wealth creation. However, if you have debt in the form of a mortgage, then inflation can work for you in two ways:

1. Inflation can help by rising house prices and rent – because rental prices tend to increase in line with inflation.
2. Combining leverage with inflation can reduce your debt.

Let’s look at what inflation has meant for the purchasing power of £100,000 in the last 22 years.

The average rate of inflation since the year 2000 has increased by 2.9% each year. Due to inflation, £100,000 in the year 2000 now has the purchasing power of £56,000 today. Therefore, you can see the effect it has on our savings.

But if we have a £100,000 mortgage, inflation doesn’t discriminate between debt and savings. So that £100,000 mortgage in 2000 is worth 56,000 today due to inflation. So even if the investor never pays off the mortgage, inflation is paying that debt down for you year-on-year.

Risks Associated With Property Leverage

As a property investor, you must understand the risks associated with property leverage if property prices fall.

This was a problem in London during the credit crunch in 2008, where investors had purchased properties with large mortgages in the hope that they would see capital growth in the future.

The rent they received did not cover their mortgage payments, and they were forced to sell the properties at a lower price than they bought them with the mortgage higher than the asset value. This is known as having negative equity.

For example, let’s say Dave invested £100,000 to purchase a £500,000 investment property. Over the next three years, the house prices in the area depreciated by 5% per year.

After three years, Dave will have suffered a £71,373 loss in equity. In property markets where prices fall significantly, investors can end up owing more money than the property is worth – negative equity.

For investors, declining prices can reduce or eliminate profits. If rents fall too, the result can be a property you can’t rent at a price that will cover the cost of your mortgage and other expenses.

How to Avoid Property Leveraging Risks

It’s fundamental when using mortgage finance to ensure the rent you receive is at a minimum covering your mortgage payments – known as sensible borrowing.

If you can understand sensible borrowing, you can use mortgage finance to accelerate the growth of your property portfolio and overall wealth.

You can minimise property leverage risks by making well-informed investment decisions. For example, it would be best to consider different scenarios for mortgage repayments, the rental market, void periods, bad tenants and the economic outlook.

Ultimately, you’re responsible for the mortgage payment, so run the numbers and ensure you can afford to pay it in any situation.