Getting to grips with Geared Property
‘Gearing’ is essentially the use of borrowed capital (i.e. debt) to part fund a property purchase. It’s also known as ‘leveraging’, though many would refer to it as a mortgage. It’s attractive to many investors because it offers the opportunity to enhance returns; debt increases both risks and rewards.
At Property Partner, we take a considered attitude when it comes to risk, and will only list certain kinds of property with gearing, in order to reduce these potential risks.
The advantages and the risks of gearing
People use gearing two ways: in the form of a mortgage to purchase their own home (often because they don’t have the capacity for a 100%-equity purchase) or because they would like to enhance returns on an investment property.
The use of debt enhances returns by increasing the investor’s exposure to property price movements. If property prices rise, capital gains are increased, and if the market falls, the investor will see greater losses.
The graphs below show the effect on total returns for a sample property with 50% gearing, both in a growing market, and a declining market.
Note: Illustrative returns are based on our Drayton Heights block at launch, exclusive of the capital discount secured on purchase (which enhances returns further). All figures fully account for purchase costs, furnishings, forecast maintenance, annual voids, mortgage interest at 3.99%, corporate taxation and all fees
Another risk of gearing is rising interest rates that reduce investors’ returns. We are currently mitigating much of this risk by only sourcing mortgages with five year fixed-interest rate terms. This term aligns with our 5 yearly exit protection mechanics. At this point we can ‘go to market’ to renew the debt at current market rates – with those investors that choose to continue holding their investment presented with an updated returns forecast.
Types of property investments that we will leverage
We will only use gearing on certain kinds of property investments to ensure that our investors are not exposed to unnecessary levels of risk.
Firstly, we do not offer geared investments on individual properties. Whilst it is possible to accurately forecast net income for an individual property on an annual basis, the same isn’t true for monthly returns, which can be volatile e.g. during void periods when the property is untenanted, and produces no rental income. This makes leverage less appropriate, as there are a number of non-recoverable outgoings including council tax and utilities, which make monthly interest payments difficult to cover.
However, the risk is lessened for multiple units – whether they be groups of properties from the same development, or whole blocks of flats. With a larger number of units, there is a more stable stream of income as there are multiple tenants providing rental income. Whilst there is a large possibility that a single property could stop producing an income entirely for a short period (between tenant switch over), it is increasingly less likely the more units there are. With this reduced income volatility, debt and interest payments become much less risky to take on: the likelihood of negative cashflow months is substantially reduced.
For this reason, we only offer gearing as an option for groups of properties. The more properties in a group, the greater percentage of leveraging we will be comfortable using, for example, 60%. If there are fewer properties, we would only feel comfortable with a smaller percentage, for example, 50%. Furthermore, we are only offering properties on our platform where the gross rental income forecast is comfortably higher than 1.25 times the cost of interest.
It is important to note that, as with ungeared properties, under no circumstances are Property Partner investors required to contribute further capital. Unexpected costs are recovered through Gross Rent, mitigated through insurance, and explained further in our FAQ’s here.
The tax benefits of a leveraged SPV
As Property Partner lists all properties as SPVs (special purpose vehicles – a UK Limited Company), we pay corporation tax at the SPV level. This means that we are able to offset all interest payments against rental income. This is beneficial relative to traditional buy-to-let investors, who are disadvantaged by the cuts in tax relief on interest payments, announced in George Osborne’s budget of summer 2015. These cuts are not applicable to property investments through SPVs (the structure we adopt). In fact, the new dividend allowance should reduce the tax burden for most of our investors. While many individuals are being advised to set up SPV’s for property investment, they are particularly difficult to administer and secure mortgages within. The fact that Property Partner is able to do this provides further value to our investors.
Giving our investors the power of institutions
Never before has debt-financing been offered with crowd-funded property in Europe, and we are delighted to offer this new opportunity to our investors.
Now you can not only benefit from the buying power and expertise of an institutional investor, and build a diversified portfolio of your choice – but you also have the option of geared returns potential.
If you find the potential for enhanced returns attractive, with the bolstered security of multiple units, then why not explore some of the geared property investments we have available.