Leverage or leveraging is simply a term to describe borrowing money to buy investment properties, rather than using your own cash holdings.  It’s also known as gearing. By borrowing, you could buy more investment properties than if you were using your own money.  Because you use less of your own cash, this multiplies the return if the value of your properties increase (although it also multiplies your losses if the value decreases).

Here’s an example:

• You buy a rental property for $200,000 using your own money.  It goes up in value by 10% ($20,000).  That gives you a capital gain of $20,000 – a 10% return on your $200,000 investment.
• However, if you buy the same property using only $20,000 of your own money and borrow the rest, your capital gain is still $20,000 but it is a 100% return on your investment of $20,000.

Even taking costs into account, over time it may be possible to make significantly higher returns through leveraging. Although interest payments will reduce the return on your investment.  

Leveraging also allows you to build up a large portfolio of investment properties quickly.  For example, if you had $200,000 to invest you could buy one property for $200,000.  Alternatively, you could buy four $200,000 properties by putting a deposit of $50,000 on each and borrowing the rest (provided you have enough income to service the interest payments on the money you borrow).

The risks

While leveraging can increase your returns, it also means you have to manage a significant level of debt.  For many people this can be very stressful. There are also some risks involved which you should consider carefully before choosing this approach.

• For highly leveraged investors (those with very large debt) any increase in home loan interest rates can make it very difficult for you to meet your repayments.
• A prolonged vacancy between tenants (with no rent coming in) can also make it difficult to meet repayments if you are highly leveraged
• If there is a downturn in the property market, you may have to sell one or more properties at a loss.  If you are leveraged you could end up still owing money on your home loan even though you no longer own the property.

For an example of a leveraged investor, see the case study: Julia’s property investing story.

As with any investment decision, you should consult your accountant or financial adviser first.

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