buy-to-let property portfolios: With a rise in interest rates looming and the Bank of England recently citing buy-to-let property debt as a risk to financial stability in the UK, it seems an appropriate time to talk about leveraging debt to develop your portfolio.
Debt itself is a way of life. Many of us have a mortgage on our homes, cars on finance, credit cards and mobile phone contracts for example. We use it to smooth out the peaks and troughs so that our income can manage the bills. We also use debt as an investment tool. In relation to property, leverage is the ratio between debt and equity and the thing with leverage, like most things in life, is that it's good and bad so were going to discuss a really important part of buying more property by leveraging your buy-to-let property portfolios.
In a buoyant market where house prices are rising and tenant demand for buy-to-let property is healthy, then leverage can be great because it means your return on investment is higher because there is less of your own money involved.
Your buy-to-let mortgage payments could rise to such a level that any rental income (even with rent increases) doesn't cover the costs. And, if you then factor in other rising costs such as property maintenance, you could find that you are unable to break-even.
That said, leverage is one of the best ways to fund the growth of a buy-to-let property portfolio.
If you put down a deposit of 25% and take out a mortgage at 75% loan-to-value, then you can make your money go further and you will achieve a 4x multiple on your equity. All of the uplift is related to the money you actually put in, not the amount you borrowed. That's how gearing works and that's a good aspect.
If you follow the strategy of buying well, developing well and adding value, you can very quickly build a much bigger property portfolio with the view to downsizing later.
But, you can't assume that the market will be kind to you or that your equity in a property will only go up. A high income strategy, such as Houses in Multiple Occupation (HMOs), is one way to mitigate this risk, but it's not a fool proof way of ensuring that you won't fall victim to interest rate rises or circumstances out of your control.
What if you found yourself in a situation where you'd bought and developed a property with a ceiling value and were forced to sell because of a divorce for example? If your investment is too highly leveraged, you could find yourself making a loss - think about estate agent fees, capital gains tax and refinancing costs.
Using leveraged debt can be dangerous if you don't consider all of the potential consequences. The key to successful leveraging, then, is careful planning.
If one of the reasons that you're investing in buy-to-let property is to plug a gap in your pension income, then you need to consider paying off the equity and aspire to owning just a few unleveraged properties. Ask yourself how many properties you will need to fund your retirement - i.e. what income do these properties produce and is that enough? It might be a cash flow strategy now, but will it give you what you want and need in the future? Not nearly enough people give this enough thought, or indeed, even think about their end goal.
It's also important to consider the impact of recent budget announcements. De-leveraging a portfolio in the way we have discussed could in fact have hidden benefits on income tax liability in the long-term.
Perhaps the reason you started investing was so that you could leave an inheritance for your children. There is an alternative strategy if you conduct the right kind of inheritance planning, which is a win-win for both parties. Whatever your plan - and you need to have one - the sad fact is that we are all going to get older and there may come a point when we can't getmortgages, or at least not the best rates.
Buy-to-let property portfolios: Our verdict
So, the moral of the story is that safe and intelligent leverage can accelerate your position and enable you to build a large and profitable property portfolio. However, unplanned leverage can leave you at risk.
