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Power of Leverage For Property Investments

TL;DR: Using leverage, say 80% loan-to-value, a property investor can enjoy a gross return on equity of approximately 100% (before fees and expneses) when the property price increases by 20%. 

One of the “best investment gain” that I have made was in property, where I benefitted from the use of leverage to make a decent return on equity over an investment period of 2 years.

One thing to note is that you would typically make a gain on property only if you own more than one property, otherwise you will be “selling high and buying high”, where the profits from your single property sale made during a property up-cycle are likely to be “passed on” the seller of the next property that you will be purchasing from. Exception to this rule would be in scenario described in Strategy 2 of the Quick Overview of Property Investments Strategies.

 

Power of Leverage

For property investments, we can leverage up to 4x equity (at 80% loan-to-value) to amplify potential returns on equity. Although some brokerage houses also provide financing for stocks at 2.3x equity (70% loan-to-value), the other advantage for property mortgage financing vs typical stock financing leverage is that there would not be “margin call” in times where property prices drop, as long as the borrower is able to fulfill the mortgage installment payments promptly, whereas for share financing the investor are typically asked to “top up” additional equity during “margin call” when the underlying collateral share price has declined below 20-30%.

Using leverage of 80% loan-to-value, a property investor can enjoy a gross return on investment of approximately 100% when the property price increases by 20%. Also, given the significant capital outlay required for the property investment, the absolute quantum of gains is impressive.

For example, during the recent property up-cycle, it was common for investors to make gains of $200k on a $1 million property purchase with just a $200k downpayment. For the investors who were fortunate to be able to borrow at 90% LTV previously before the various property cooling measures was introduced, they would to achieve an approximate 100% return on equity (before stamp duties and agent commission expenses) with just a 10% increase in property price. For those who managed to take advantage of the Deferred Payment Scheme (when it was available in early 2000) which allowed investor to buy a property with 0% downpayment, the return on equity had been incredible.

Note: Financial leverage can cut both ways, and may subject the investor to massive losses. The usual advice from the industry professionals would be to borrow within your means, and keep at least 6-12 months of debt servicing quantum as cash to act as a buffer in case of job changes and other unforeseen circumstances.

 

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