How Debt Helps You to Build a Property Portfolio | Part 1



Save, save and save some more – and eventually you’ll have enough money to plough into an investment property. Then you can purchase outright and enjoy the profits – avoiding major debt completely in the process. This is the way many landlords new to the industry approach property investment – but when it comes to this kind of business, debt is not actually a bad thing. In fact, it can help you to grow your portfolio more quickly in a way that is more financially profitable.

Many of the most successful property portfolios are built on leverage – the term given to the practice of borrowing money from external sources in order to fund and control a much larger asset than you could afford if you were going it alone.

 

This blog is in two parts – to continue reading please click here.

 

How can leverage help?

The easiest way to demonstrate the merits of leverage is to illustrate two examples – one with debt, and one without – taking into account the relative benefits and drawbacks of each.

In scenario one, you have $100,000 in cash saved. It returns $10,000 per year, so at the end of the year you’ve earned $10,000 profit – and since you have no debt, 100% of it belongs to you.

In scenario two, you take the $100,000 and borrow $400,000 with it. This enables you to buy a property worth $500,000 with a return of 10%. This means that the property is worth $550,000 after a year – but you’re paying 5% interest on the portion you borrowed. So out of the $50,000 total profit $20,000 goes to the lender, whilst you retain $30,000. That’s tripled your income - with the same investment of $100,000. This is how leverage works in your favour.

 

Things to consider when choosing to use leverage

There are a few things to consider when thinking about building your property portfolio using debt.

 

  • In order to work effectively, your expected capital return must be higher than the interest rate you’ll pay on the money you’ve borrowed. In simple terms, you won’t make money on an investment returning only 8% if you’re paying 8% interest on the funds you’ve borrowed.
  • As your investment will grow much more quickly using leverage, you’ll be free to use the funds generated to invest even higher amounts and therefore maximise profitability further.
  • There are different types of debt – some are useful, others are potentially destructive. More on this below.

 

Choosing wisely – three types of debt

There are essentially three different types of debt you can choose to engage with as a property investor. Each has its own characteristics, benefits and drawbacks depending on the situation. As many of these are fairly complex we’ve dedicated a second blog to go into these in more detail about each in turn – click here to go there now.

Do you know the value of your home?

Request An Appraisal