Robert Kiyosaki said, “In the broad definition of the world, the word leverage simply means 'the ability to do more with less'." In terms of investment, leverage is defined as 'the degree to which an investor or business is utilising borrowed money'; UK banks tend to refer to it as ‘gearing’. It's also a key reason property is probably the world's greatest money-making machine.
Ask a bank for a loan of £50,000 to invest in the stock market and they'll laugh you out of the building, but ask for £50,000 towards the purchase of a £100,000 property and the strong likelihood is they'll give it to you, subject to affordability and/or rental income. Property has always been, and will almost certainly continue to be considered one of the world's safest investment vehicles, and that's why institutions and individual passive investors are so willing to lend against it. And that willingness of 3rd parties to lend is what helps make me and you money.
If you invest £100,000 of capital in the stock market, you have £100,000 worth of assets, and if the market goes up by 10%, you make £10,000. That's a 10% return on investment.
But if you use that same £100,000 to put down 25% deposits on buy-to-let properties, it gives you £400,000 worth of assets. And when the property market goes up by 10%, you make £40,000 – a 40% return – because you don't just profit from the growth on your own money, you also profit from the growth on the bank's money.
Leverage, or being highly geared, acts just like a magnifying glass. When the market moves upwards - and in your favour - leverage massively improves your returns. However, when we experience a market fall, a high level of debt can leave you exposed, especially if you do not have adequate profit margins built into your investment model. If you are going to gear up highly then using a robust, proven and very profitable model like PPP's HMO strategy is advisable. Failure to do this is what has caused thousands of highly geared investors to get repossessed in the last few years.
In August 2007, when Amstrad's merger with BSkyB was announced, Sir Alan Sugar told The Sunday Times he was planning to turn his attention to his property portfolio, which he deeply regretted not spending more time on in the 'golden' 10 years from the mid-'90s:
“Throughout my career I have invested in property as security and seen the electronics as the risky part of my business. I’ve got £300m of property, mostly in trophy buildings around London, and I don’t owe a penny. If this were leveraged properly it could be £3 billion overnight. I need to put these assets to work, raise equity and become a proper real-estate trader.”
(Source: The Sunday Times, 5th August 2007)
What needs emphasising is the phrase in the middle of that quotation – "If this were leveraged properly…" – because it's imperative that you do your homework and have a solid plan for servicing the debt you'll be taking on, before you rush out and start looking to remortgage your home. It's a simple principle, but not an easy strategy to execute.
Financial Freedom
This is the key motivation for the vast majority of property investors, and it means different things to everyone. For some, simply reaching the first level of financial freedom is enough, i.e. having your leveraged (passive) monthly income exceeding your monthly expenditure. So if your home mortgage payment, bills and all other outgoings add up to £4,000 a month, you need to be generating over £4,000 net income every month, from a source which doesn’t require you to trade your time for that money. From a return on capital point of view, you need to have the income-generating asset financially leveraged as highly as possible, and you also need to be leveraging other people's time.
Case Study
Here's a real-life example of someone successfully using financial leverage:
Back in 2005, Neil Mansell was working in the City as a business development manager, earning £37,000 a year. By using PPP's tried, tested and proven system, he bought his first PPP HMO in September of that year. Neil had been left some money by his grandparents and he used that for the deposit and other purchase costs. Once it was refurbished and rented out, that property gave him cashflow of over £700 a month, after the mortgage, all bills and other related expenses had been paid. Neil spent just over a year building up his property business part-time until, in January 2007, he was able to give up his city job and move into investing full time, as the income from his properties had matched his salary.
By the time he had bought his 6th property, Neil was in a position to be able to employ a property manager, allowing him to spend more time focusing on further acquisitions, incorporating different strategies and developing a diversified portfolio. It also gave him the opportunity to begin helping others, and Neil now mentors numerous clients around the UK, from first-time buyers to established investors. He has also now employed a few staff to support the running of the business which allows him to delegate the tasks he doesn’t enjoy and spend more time on those he does.
As at mid-2010, Neil's portfolio currently stands at over £3m in value, and his properties, together with other related income streams are bringing him an annual gross profit of well over £100,000. Through leveraging other people's time and money, Neil has built a business that makes him nearly four times what he would have been earning in paid employment, and effectively achieved financial independence: he doesn't have to go to work every day to pay the bills.
Leverage enables you to build a business which can essentially run without you, and it means your capital goes further. The more you earn, the more you can invest, and if you’re leveraging correctly, your portfolio of assets will grow exponentially, as you use other people’s money and time to increase your own wealth.
Summary
Make sure you use leverage to acquire assets, not liabilities.
Embrace the idea of 'good debt'.
The first level of financial freedom is having your leveraged (passive) income exceeding your expenditure.
Leveraging other people's time and money will allow you the freedom to choose how you spend your time.
Think of leverage as an accelerant of your timescale to achieving your financial and personal goals.
This is an abridged excerpt from Steve Bolton’s acclaimed book, ‘The 7 Biggest Mistakes Made by Property Investors and How to Avoid Them’, which is available to buy from Amazon.co.uk.
