Property has historically been a leveraged investment, with most people acquiring property with the help of a mortgage. At Property Moose, we have acquired all of our properties, except one, using cash from the crowd. However, as we recognise the value of using debt to finance property investment, we have recently decided to launch a Property Moose Mortgage.
If you have the capital, why might you take out a mortgage?
Traditionally, one of the most common reasons for taking out a mortgage is the need for cash. Put simply, some investors might not have the liquid capital to purchase a property, leading them to take out a mortgage which is secured against the property. However, even when investors do have access to the cash, they may still choose to use financial leverage. Here are 2 reasons why investors may wish to use debt to finance property investment, besides needing the cash:
- Expanding your portfolio: Some investors may choose to use the loan to buy additional properties. By spreading the borrowed capital across many assets, the overall portfolio risk can be lowered. (1)
- Increasing overall returns: This is arguably the key reason. Using financial leverage has the potential to increase the total return on investment. (1) Take a look at the table below to understand how this works.
How using debt to finance property investment could increase overall returns?
Using debt, i.e. mortgaging a property in this case (also known as financial leverage), can increase the investments overall returns. (1) Buying a property using a mortgage means that less equity investment is required, and this should lead to an increase in returns. Here is a simple example:
| Cash Purchase | Mortgaged (50% LTV) | |
| Purchase Price | £100,000 | £100,000 |
| Cash Required | £100,000 | £50,000 |
| Rental Income | £10,000 | £10,000 |
| Mortgage Costs (5%) | £0 | £2,500 |
| Net Income | £10,000 | £7,500 |
| Income Yield | 10% (£10,000 / £100,000) | 15% (£7,500 / £50,000 |
| Capital Value after 5 Years | £110,000 | £110,000 |
| Repayment of Debt | (£0) | (£50,000) |
| Repayment of Equity | (£100,000) | (£50,000) |
| Net Capital Profit | £10,000 | £10,000 |
| Capital Growth Rate | 10% (£10,000 / £100,000) | 20% (£10,000 / £50,000) |
For Property Moose members who choose to invest in the equity side of the investment, mortgaging a property does increase the risk. However, it also greatly increases the potential returns, as the interest payable on the loan should be less than the gross rent. As a result, any capital growth can be magnified.
The potential risks of leveraged investments
Many of the risks associated with traditional leveraging relate to the behaviour of the lender, however, please remember leveraged investments do carry a higher level of risk. Banks for example, have the power to call in the loan at any time. However, by using the Crowd to provide the loan, Property Moose investors control the whole of the process. By attempting combat this risk, we believe we are moving one step forward to democratizing the entire property investment proposition.
Written by Jenna Kamal
Sources
- https://thinkrealty.com/4-reasons-investors-use-debt-and-how-leverage-can-increase-investment-returns/
Disclaimer and Legals
Property Moose does not provide any advice in relation to investments and you must rely on your own due diligence before investing. Please remember that property prices can go down as well as up and that all figures, rates and yields are projections only and should not be relied on. If in doubt, please seek the advice of a financial adviser. Your capital is at risk if you invest. This post has been approved as a financial promotion by Resolution Compliance Limited.
Property Moose is a trading name of Crowd Fin Limited which is an Appointed Representative of Resolution Compliance Limited which is authorised and regulated by the Financial Conduct Authority (no: 574048).
