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THE MIRACLE OF GEARING

January 31, 2019

Property is the cornerstone of any successful portfolio among investors serious about building wealth outside the traditional workplace or personal pensions.

There are many explanations for this. Property is tangible – no flashing numbers on a screen here. We all have rented at least once in our life - we see that rental debit coming out of our accounts month on month and understand how income is generated for the property owner, and we’d like some of that.

Further, there is an almost religious faith in the fact that property will always grow in value, building that residual value and cashing in at the top of the market. 

All valid and time-tested reasons.

But do these explain the strength of our connection to bricks and mortar as an asset – that level of reliance, of trust, even?

After all, one could argue that the returns from property – the monthly rental and the price appreciation to sell at a profit – are mirrored in other asset classes.

Bonds – essentially chunks of debt – do give you that regular income, though the risk-return can vary depending on the issuer. Equities would be the closer comparison. Company shares that pay a dividend provide a quarterly return, a nice little rental income of sorts just for holding them in your portfolio. The long term appreciation of equities – far outstripping the returns from bonds, for example, over decades – also bears comparison with property.

Those who favour the stock market may remark that equities are a great deal more liquid than property. Want to cash out? Place a trade yourself online. By comparison, you can’t take a brick to the bank when you need to liquidate.

So why is property such a popular investment asset internationally? Simple - gearing. The ability to put down a fraction of the property value, say 20%, and still benefit from 100% of the value of that asset. 

Put simply, this super charges the return on investment and makes property an incredibly unique asset. 

You can of course leverage within equities – buying on margin, as they say, with the broker spotting you to a certain multiple of what you have to spend. But embedded in this approach is a very real risk that the market encounters short-term volatility, with your shares potentially taking a hit, just at the time that this margin is ‘called’ – ie, the broker wants their loan back. Not a nice scenario.

With property, the bank underwrites the risk of the investment through the mortgage, removing a great deal of the borrowing risk. 

Gearing not only enhances the return on investment, but it also creates the extraordinary situation whereby a stranger will dutifully pay off the money you have borrowed on your behalf.  So the Second Party (ie, bank) loan that helped you purchase the asset gets settled by the Third Party (tenant) – and you’re the one sitting back with your name on the Title Deed.

This scenario, and the leveraged returns mentioned above, is the reason why property investment is so popular, and why so many people can point to property as being the reason for their wealth. 

It is this miracle of gearing that we believe investors should embrace and use to their advantage. 

At TMP, we are able to create bespoke answers to all of your property requirements and, in particular help you benefit from gearing.

Please contact us if you would like to arrange an initial conversation. 

 

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