How much should a property investor borrow?
I am often asked what Loan to Valuation Ratio (LVR) I recommend, and, unless I know the complete financial story of the person asking me, I can’t really say. There’s no ideal or recommended LVR for the general investor – rather each investor has a specific debt level which suits their own needs for income, growth and risk.
The term ‘gearing’ relates to the process of borrowing to apply a leveraging effect to your own funds to invest in a greater number, or wider range of assets. The higher you gear an investment portfolio, the more you multiply the risk of loss, as well as the return.
Understanding how gearing impacts on risk and return is important for all investors, so that you can match your own needs and risk profile to suitable levels of gearing. An investor with a long time till retirement, a good income and sufficient excess funds has more appetite for risk, and so can probably afford to more highly gear, while an investor who may need the funds sooner and who has little chance of replacing lost funds, should adopt a lower gearing strategy.
Let’s take a look at a number of different gearing levels which an investor might choose and explore the type of investor that these levels might suit.
A borrower who is borrowing 80% or more of the total property they own is one who shows an appetite for risk. It means that you only have a small margin for value swings. If your property falls in value by 20%, you will own nothing. You should not borrow to these levels if you are nearing retirement, have job instability or if you currently have no capacity to save or invest in additional assets besides the property you are borrowing for.
Borrow 60 – 80%
An investor with a medium time frame in which to invest, relative job security and an income which can facilitate additional debt repayment or additional investing, as well as a mid range attitude to risk, can choose an LVR within this range. A fall in value of the security property is unlikely to result in total loss of personal wealth, and at these levels of gearing there is still a good amount of leveraging which enables the purchase of more assets, and so the exposure to higher levels of growth and wealth creation.
Borrow less than 60%.
An investor with a short time till retirement, a limited amount of years available to work and a small amount of savings is well advised to keep their gearing levels below 60%. At this level, a good margin is built in to ensure that family home assets are not likely to be at risk and that, should property values fall, a nest egg in the form of remaining equity would still exist. This nest egg could then be used to undertake an alternative investing strategy to compensate for any losses which may have been incurred through a poor choice of property investment or through market value decreases.
My advice to all investors is to treat any advice or invitation to invest using high levels of gearing with the utmost care and consideration, and know your personal appetite for risk.
Wise investors usually maximise their gearing levels at 80%, and attack debt reduction with vigour and commitment to reduce this quickly. Remember that for every $1 of property you own, that’s $5 more you can buy with leveraging, so constant debt repayment and acquisition of equity is a crucial part of every property investment strategy!
Published: Thursday, August 09, 2018