How does the power of leverage work when investing in property?

Leveraging the resources of others can significantly accelerate your financial planning goals.
Here’s how using other people’s money (specifically from banks, tenants, and the tax system) can enhance your investment strategy

The Power of Leverage

Why some property investors build wealth significantly faster than others.

Two investors may earn similar incomes.

They may purchase property at the same time.

They may even invest in the same market.

Yet twenty years later one investor has accumulated millions of dollars more in wealth than the other.

Why?

One of the biggest reasons is understanding the power of leverage.

Used wisely, leverage allows you to control a larger asset with a relatively small amount of your own capital, enabling your wealth to grow on the value of the entire asset—not just the money you contributed.

It is one of the most powerful wealth creation principles available to property investors.

Leverage Magnifies Outcomes

Leverage is neither good nor bad.

It simply magnifies the outcome.

If you secure the right investment-grade property…

Leverage accelerates wealth.

If you purchase the wrong property…

Leverage accelerates mistakes.

That’s why selecting the right property matters just as much as understanding leverage itself.

Good Debt

For those who fear debt, they ask “how can there be good debt?” They then ask “isn’t debt money you owe and have to pay back?”

An investor who has a healthy relationship with and to money will look at the same borrowings and be comfortable knowing that this is ‘good debt’ working hard for them. We call this Productive Debt.

Bad debt is used to buy a depreciating asset.

Good Debt is borrowings to acquire an Appreciating Income Producing Asset.

Leverage Doesn’t Replace Good Decisions

Leverage is one of the most powerful wealth creation tools available.

But leverage alone doesn’t create wealth.

The quality of the asset you purchase ultimately determines the quality of the outcome.

Buying the wrong property with leverage simply magnifies the wrong investment.

Securing an investment-grade property backed by strong market fundamentals allows leverage to work in your favour over time.

Here’s how each component plays a role:

1. Using the Banks Money (Leverage)

Definition: Leverage involves borrowing money to invest in assets, allowing you to control larger investments without needing to provide the full purchase price upfront.

Borrowing Power: When you take out a mortgage to purchase a property, you’re using the bank’s money to invest. This allows you to acquire assets that you might not be able to afford outright and thus leverage up into your Investment.

Asset Appreciation: As property values increase, your equity grows. This can lead to substantial compounding returns on your initial investment, allowing you to reinvest or fund other financial goals. Equity is where you grow your wealth, which also gives you the opportunity to draw down on equity as a deposit on your next investment property … and go again!

Leverage : Widely referred to as “The 9th Wonder of the World”, for all the right reasons

How It Works:

Sarah has saved $70,000.

She could leave it sitting in a savings account.

Or…

She could use it as a deposit to control a $700,000 investment property.

If the property increases by 10%, she doesn’t make 10% on $70,000.

She benefits from the growth on the entire $700,000 asset.

That’s the power of leverage.

Example: If you invest in a property worth $700,000, you might use a bank loan for $630,000 (90% of the property value), while only investing $70,000 of your own money.
Impact: If the property appreciates by 5% in a year, it’s worth $735,000. Your equity has increased by $35,000, but you only invested $70,000, resulting in a 50% gross return on your investment ($35,000 gain on $70,000 equity).

2. Tenant Contributions

Definition: Rental income from tenants provides a consistent cash flow, which can help cover mortgage payments and property expenses. Where Interest Rates and Rental Income meet – could result in your Investment being Cash Flow Positive in your hands. Meaning your original $70k invested into this $700,000 investment is now funding itself.

How It Works:

Example: If your mortgage payment is $3,000 per month and you charge $3,500 in rent, you have a positive cash flow of $500.
Impact: This cash flow not only covers your expenses but can also be reinvested into other properties or used for personal financial goals, effectively using “other people’s money” to build your wealth.

3. Tax Benefits

Definition: The Australian tax system provides various deductions related to property investment, which can enhance your overall return on investment.

How It Works:

Deductions: Expenses such as mortgage interest, property management fees, maintenance costs, and depreciation can be deducted from your taxable income.
Example: If you earn $100,000 a year and have $20,000 in property-related deductions, your taxable income drops to $80,000, potentially reducing your tax liability. Meaning you are paying yourself first, then the tax man afterwards. Over the life of the investment, this tax efficient strategy could save you many thousands of $’s.
Impact: The savings from tax deductions can be reinvested into your property portfolio or other investments, further accelerating your wealth-building process.

Combining All Three for Accelerated Growth

When you strategically combine these three components, you can create a powerful financial strategy:

Increased Cash Flow: Positive rental income can provide ongoing cash flow, which, combined with leverage, allows for more substantial investments.
Growth in Equity: As property values increase, your equity grows, which can be accessed for further investments through equity loans.
Tax Efficiency: Utilising tax deductions can enhance your cash flow, allowing you to reinvest more effectively.
Maximising Leverage : Using the Power of Leverage intelligently to grow your investment property portfolio.

Compounding

Compounding : a Powerful Principle that when harnessed correctly,

can turn your modest investment, into Significant Wealth over time !!

Example Scenario

Let’s say you invest in a second investment property for $800,000 using a bank loan for $720,000 (90% LVR).

Annual Rental Income: $41,000
Annual Expenses: $20,000 (including mortgage, maintenance, and management fees)
Tax Deductions: $12,000 (from depreciation and other expenses)

Financial Outcomes:

Cash Flow: $41,000 (income) – $20,000 (expenses) = $10,000 positive cash flow.
Depreciation: Include $12,000 appreciable benefits.
Tax Benefit: Reduced taxable income due to deductions, can save you significant amounts in tax, which you would have paid to the tax man if you did not have this investment, can now be reinvested.

Conclusion

By leveraging bank financing, benefiting from tenant contributions, and utilizing tax advantages, you can effectively accelerate your financial planning goals. This strategy not only enhances your wealth-building potential but also positions you for long-term financial security and growth. If you’re interested in exploring this approach further, I’d be happy to discuss specific strategies tailored to your situation!

NB : Not all property is worthy of your Investment Dollars !

Speak with us to help you identify which are ‘best fits’ to your own personal circumstances and purpose for the investment. It is imperative to match a ‘best fit’ investment vehicle (the property), to your budget, strategy and reason for the investment.

Following this strategy will vastly increase your own financial wellbeing over the life of the investment / compared to getting your investment decision wrong from the outset!

Compounding Growth
Referred to as the 8th Wonder of the world