Gearing an investment property
When taking out a mortgage, the natural considerations are how much you can afford, and the level of risk you’re comfortable with. We make the same assessments at Property Partner. Here are some of the things we consider when it comes to geared investments.
How does gearing affect my investment?
Gearing (ie, a mortgage) enhances returns by increasing the investor’s exposure to property price movements. If property prices rise, the investor’s capital gains will exceed market growth, but if the market falls the investor will underperform the market. Find out more about gearing, here.
How much gearing?
At Property Partner, we take a very considered attitude to risk, and will only list properties at 50-60% loan-to-value (LTV) of the purchase price. In our case, we’re buying multiple units at a discount compared to purchasing the units individually –adding further downside protection. Reducing risk further, we only gear multiple unit properties as these have a more stable rental income stream to service the mortgage.
How long should I fix for?
Mortgages fixed for longer periods are currently priced higher; you are paying for increased certainty, foregoing income today to mitigate uncertainties in the future. So there is always a balance – how much do you mitigate uncertainty, and how much performance do you take away from that investment?
Responding to investor feedback, we introduced our first geared investment, a three unit block in West Drayton, at the end of September. The speed of that raise demonstrated the depth of investor appetite for considered, yet enhanced risk. So far, we have only used 5-year fixed rate mortgages. Following ongoing consultation with investors, we are now planning to introduce a 2-year fixed mortgage option for use in most instances, as we judge the risk/performance balance to be more appropriate at this time.
It’s also worth comparing how much interest rates could increase, with how much rental income could rise in the coming years – as the two can somewhat offset each other. Again, Property Partner takes a conservative view. We assume no rental growth over 5 years in our forecasts (though we will increase rent on our properties where appropriate), as well as conservative LTVs of 50-60%.
Here is a simple example of how potential rental growth could provide a buffer to interest rate rises.
George owns a 4-unit block in Whitechapel worth £2m. He has a £1m (50% LTV) mortgage on the properties, with an interest-only rate of 4%, or £40,000 per year. As a landlord he earns a gross rent of £100,000 per year on the block. Now if the interest rate on his mortgage were to rise to 4.3% (an increase of 7.5%), his annual payments would increase to £43,000. But if his rental income went up by 3% in the year taking the gross to £103,000, that £3,000 gain would help offset the increase in his mortgage interest rate. Savills predict an annual growth in rent of 3% across the UK for the next four years.
Does a mortgage affect income?
Yes, it does. Properties from different areas will yield different levels of income from rent, depending on the purchase price, so it is important to consider this when gearing an investment property.
If the ungeared net yield of a property is higher than the cost of debt, the mortgage will increase the income yield of the property. Similarly, if the ungeared net yield of a property is lower than the cost of debt, the mortgage will decrease the income yield of the property. Property Partner takes this into account when assessing gearing.
If you’d rather not have to spend the time researching and securing mortgages for investment properties – you don’t have to. At Property Partner, we take care of that for you. Why not take a look at some of the geared properties available on our marketplace? Look out for the geared icon.