The whole idea of investing, whether it be in property, shares or anything else, is to make your money work so that you don’t have to. Leverage is when you use someone else’s money to achieve the same result.
Now some will say that all debt is bad debt but that’s a generalization and not necessarily true. If you go into debt to buy something that is going to lose value over time, then maybe that’s not so good. Perhaps you would be better off waiting until you had saved up enough to buy the item outright with cash. Otherwise, you end up paying the purchase price as well as interest but get no return beyond your enjoyment of the product for a limited time. Using debt to purchase something that is going to appreciate in value, like property is different. What you need to do is make sure that any outgoings are going to be covered in the long run and that there is still profit available after all expenses.
Upfront, we are not financial advisors and we strongly suggest that you get expert advice from an accredited and credible source that is applicable to your unique situation. However, a quick feasibility study will help you to decide whether further research into a potential investment is going to be worth your time, effort … and money.
First of all, you need to include all of your upfront and ongoing expenses for the lifetime that you foresee yourself holding that investment. For property, this includes but is not limited to purchase price, stamp duty, gst (if applicable), council contributions & rates, water rates, common property utilities, maintenance costs, property management fees, interest payments/holding costs, real estate agent sale fees etc. You then need to offset this against rental returns. In an ideal world, your investment property will be positively geared. That is, your rental income covers ALL of your expenses with some to spare; which is your profit. Some people prefer to go down the road of negative gearing but I would rather earn a dollar and give 30c to the government than lose a dollar to get 30c back.
Next, you need to take into consideration the potential for capital gains. How likely is the property to increase in value of the lifetime of the investment? By how much are you expecting values to grow? This all requires market research. Once you have a fair idea of how much value to expect to gain, I would then halve it. As the pandemic has proved, we never know what is around the corner and working on best case scenarios is setting yourself up for disappointment. Now, if you can see that there is money to be made both in terms of rental return and capital growth opportunity, the investment is worth investigating further.
The one key message about leverage and making money work for you is that you need to do the work first! Then, once you have made a savvy investment because you have done your due diligence, you can sit back and reap the rewards.