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What is gearing, and why do property investors need to know about it?

If you’ve been doing any kind of research into property as an investment, you’ll doubtless have come across the term “gearing” at one point or another. It’s widely regarded to be one of the main reasons property is such an attractive investment.

But what is gearing? And how does it actually work?

property investment gearing“To explain what gearing is let’s first take a look at a conventional investment like a savings account. If you want to earn interest on R1000, you have to put R1000 into the account. Your money is the only money that is working for you. This applies to most investment types – but not to buying property.”

That the difference with property is that you can finance your investment at least partially through a bank, giving you access to an asset worth far more than you could afford on your own. In other words, to buy a house worth R1 million, you may only have to put down R100 000 in cash. Should that house increase in value over time, any profit on the sale (after paying back your loan) is yours. It’s a little bit like getting the interest on R10 000 in your savings account, even though you only put R1000 in. Why? Because it’s no longer just your money working to earn profits; gearing allows you to put the bank’s money to work for you as well.

“A recent example of a successful gearing investment,” Rawson elaborates, “can be seen at Rawson Developer’s “The Beaumont”, in Rondebosch. A buyer purchased a property off-plan – before the building’s construction started – for R1.5 million. He had to put down R150 000 as a deposit and he used R1.35 million of the bank’s money in the form of a mortgage bond. 18 months later, once the development was built, he sold the property for R2.5 million. The buyer had to pay a deposit, his credit for the 18 months, and a few related fees for things like attorneys. In return, he made upwards of R700 000 in profit.”

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That is the essence of gearing – using other people’s money (or financing) to increase the size of an investment in order to increase the returns on your own capital outlay. Preferably without incurring too many additional costs to eat into your profit at the end of the day.

Speaking of costs, it’s important to acknowledge that gearing isn’t a guaranteed money-making machine.  “Borrowing money isn’t free,” Rawson points out, “and not every property will increase significantly in value over time, so it’s very important to investigate your costs and risk factors before committing to a purchase. Things like interest rates can impact on the profitability of gearing quite dramatically, as they directly affect the cost of property investments.”

According to Rawson, a great way to mitigate risk and decrease your costs is to use gearing to purchase an investment property with the intention of renting it out. “This not only gives you access to all the gearing benefits of a mortgage,” he says, “but it also allows the property to cover a portion (or all) of its own expenses.”

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Ideally, the rental you charge on the property should be equal to or greater than your mortgage repayments. This can be difficult to achieve, however, and is not essential for the investment to be a profitable one.

Done right, gearing can be the leg-up you need to invest in a high-value asset and achieve high-value returns. It’s an opportunity limited almost exclusively to property, which is why property can be such a great investment choice.

It’s still important to invest wisely, so do your research into the property market before you buy. Contact your nearest Rawson Property Group franchise for expert advice on trends and opportunities near you.

 

http://www.propertytribe.co.za/index.php/what-is-gearing-and-why-do-property-investors-need-to-know-about-it/2153/ – Propertytribe

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