The more properties in a well planned investment portfolio, the more access to equity you’ll have from capital growth. More assets means more fat to leverage and gear from.
You’ll have heard investors throw around terms related to positive gearing, neutral gearing and negative gearing.
To baffle you further, did you know you can unlock equity from your own home to buy investment properties and grow wealth?
Let’s demystify some property investment speak for you, so you can talk the talk, and walk it! It’s time for a read.
On the go? Here’s 30 seconds of key take outs:
- From the moment you buy any property with capital growth potential – it could be the home you’re living in – the equity you build could be your ticket to buying your next one.
- What makes property investment affordable is having regular rental income that covers your asset’s holding costs. Best to set aside time to read this article to understand what that means and how it can work for you.
- The younger you start investing, the higher the capital growth potential.
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What does gearing mean?
Gearing means producing income to offset an asset’s holding costs. In property investment, your asset is the property you’ve bought. Your asset will produce income from rental that your tenants pay to live in your property.
The holding costs are all expenses associated with holding your property – that includes the cost of borrowing or the interest payments on your investment loan; as well as associated costs such as bank fees, council rates and repairs. Holding costs are calculated before tax.
If the holding costs exceed what you are receiving in rent, you need to tip in some of your own funds to cover the gap. That is called being negatively geared or negative gearing.
If the rental income, covers all the costs associated with holding your asset – your property investment is neutrally geared.
If you end up with money back in your pocket after paying out holding associated expenses, and receiving rent – then your investment is positively geared.
Why is gearing important to me as an investor?
There is nothing wrong with any of these gearing positions provided the outcome works best for your personal financial situation, your goals and your time line for reaching them.
Boost your property investment education and success by reaching out to property investment experts that can help tailor an outcome to suit your individual goals.
What does leveraging equity mean?
As an investor, you might use a small amount – 5 to 10% of the current market value of a property – as security or equity for your next property investment loan, provided you satisfy the lender’s criteria.
Equity is the portion of your property that you actually own on paper, when you calculate the current market value of the property, less the amount of money you owe your lender. Equity acts as security for your lender or bank and gives them confidence that if your strategy went pear shaped (unlikely if you’re taking the time to read articles such as this one!), they could still recover the money you owe them by selling your assets at their current market value.
This is why capital growth is so important to help you build your portfolio, more on that later.
You can use some of the equity to borrow money to buy your next investment property. You have leveraged or unlocked equity in one property to borrow for the next one.
Leveraging equity in your property portfolio is a strategy you can duplicate again, and again.
This approach is accessible to anyone driven to stay the path, no matter where you’re at. It does take patience and time, as well as some initial cash or security (equity).
Leveraging equity as an investment strategy
This property investment approach requires a step by step approach to be successful.
You can start from where ever you are financially, provided you have cash, equity or security to borrow for your first property, and enough borrowing power to repay the loan – as assessed by the lender.
Most importantly, you need to understand what you are doing. The simpler the method the more likely you’ll achieve success.
Leveraging equity to invest in your next real estate purchase requires:
- Regular and sufficient income: to offset the cost of the asset’s holding costs.
- Equity to leverage: that is, a security value increase sufficient to raise financing through a line of credit to buy more real estate.
- Capital growth: it is the capital growth that enables you to leverage equity, to build wealth.
Let’s break this down further.
Capital growth builds wealth
Capital growth requirement #1: regular and sufficient income
Income for your property investment is your strategy’s lifeblood. You’ll need the right level of rental income to achieve the gearing results you need.
As a guide, an adequate income early on in building your portfolio is around a 5% rental yield plus tax benefits to support the property’s interest loan repayments and fees, and other holding costs.
When investing in the right property market locations, I’ve found that the rental value tends to grow with the asset value, to eventually pay for itself or become neutrally geared [Depending on interest rates]. True neutral gearing covers the asset’s total holding costs before tax.
You’ll need to chip in a little out of your pocket at the start. You need to be prepared for that, but what you pitch in will be mostly offset by tax benefits with new[er] property.
Tax benefits are effectively another form of income.
Capital growth requirement #2: leveraging equity to invest
Leverage means to use a small amount of money, equity or security to control a larger amount of debt secured to an investment.
With a small cash deposit of 5% or $20,000, you can be controlling a larger amount of asset – a $400,000 property. An investment property of this market value doesn’t need to work hard to gain good returns.
Lets look, for simple example $400,000 growing at 8% in a year would become $432,000. So what is your actual return? From chipping in $20k, you’ve grown your asset by $32,000 – a 60% return on what you put in! Or you can choose the conservative view – 8% capital growth on your asset.
Leverage is also referred to as a security position or as having equity in an existing property. You can use a portion of the equity you’ve grown in a property as an equity loan or line of credit, to buy more property. You’re simply transferring the security from one asset to another. The amount you draw down is what you pay interest on.
By keeping your entry costs down and using other people’s money (that is, the lenders) you can retain what we call, a buffer.
A buffer is having cash in reserve. A buffer lowers your risk.
Another cool thing about investing in houses, as opposed to other asset classes in property is that banks love houses and tend to lend you more money towards them.
Capital growth requirement #3: increase in market value over time
Capital growth is the amount of market value growth over a period of time that a property attracts. Capital growth is one of the most fundamental investment objectives.
Generally, the better the expected long term growth, the lower the income returns at purchase. This works in the reverse in that the higher the rental returns from the outset, the lower the expected capital growth.
Higher capital growth continues to be more prevalent in major capital cities with greater population growth driving up housing demand.
Capital growth is the not-so-secret to success for young property investors
The younger you are able to invest in the right property, with expert guidance, the greater the capital growth potential to leverage equity, to grow wealth through a portfolio of property assets producing passive incomes.
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