A beginner’s guide to property gearing

What is it? How does it work? And is it a viable option for everyone?
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Anyone getting serious about property investment will have come across the term “gearing” at one point or another. Gearing is widely regarded as one of the biggest contributors to property’s popularity as an investment vehicle. But what is it? How does it work? And is it a viable option for everyone?

What is gearing?

In its simplest form, gearing is just the practice of funding a property purchase using borrowed capital. That means any homeowner who has borrowed money from the bank – usually in the form of a bond – to fund their property purchase, is effectively gearing their property investment.

Why is gearing special?

If the majority of homeowners are gearing their properties (whether they know it or not), is gearing really as important as investors make out?

If you think about it, there are very, very few asset types that you can finance with borrowed money. Generally, if you want to benefit from the growth on a R1 million asset, for example, you need to have R1 million to buy that asset with.

With property, however, it’s possible to invest in a R1 million asset with only R100 000 – or less – of your own money. And every cent of appreciation on that property goes to you when you sell, minus any outstanding debt, of course.

Does gearing always make money?

While gearing is a very successful and widespread property investment technique, it’s not a guaranteed money-maker.

Remember, borrowing money comes at a cost. Properties also incur expenses like taxes and maintenance. Not all properties will appreciate enough over a set period of time to offset those expenses and still leave you with extra cash in your pocket when you sell.

To give a geared investment the best chance of paying off I urge investors to do thorough investigation before diving in.

You need to know what finance will cost you, what running costs your property will have, and what its growth potential is like in the current market,” he says. “An experienced real estate partner can be an invaluable asset during this cost/benefit analysis process.

How to maximise the benefits of gearing

The power of gearing lies in its ability to make other people’s money work for you. It stands to reason, then, that the more of other people’s money you can use – without increasing your own costs or liabilities – the greater the benefits of your geared investment will be.

No surprise, then, that the most successful geared property investments are usually in the buy-to-let space.

Using rental income to offset the expenses of a property investment helps investors minimise their own capital outlay and financial risk while still enjoying the full benefit of their investment’s growth potential. Once a rental property becomes cashflow positive, or there is enough equity in its bond, it’s also possible to use this capital to gear another property investment to add to your portfolio.

Can anyone gear a property investment?

There is really only one qualifying criterion you need to meet in order to gear a property investment. That is the ability to access property finance, typically via a bank.

Your appetite for risk may influence how heavily you are willing to gear your investment, but gearing is an option for every property owner, and an incredible opportunity to maximise the return on your investment.

David Jacobs, Gauteng regional sales manager for the Rawson Property Group.

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Know the property clock and get the timing right. Gearing when asset prices are falling is not the right time to gear, but if asset prices are climbing then it’s ok.

But many have been left in the invidious position of having to sell properties for less than what they paid for them and still owe the bank lots of money.

Capital gains in property investments are a function of the movement in bond yields. Declining bond yield causes a rise in property values and rising interest rates cause the stagnation or decline in property values.

This implies that a property investor is a de facto bond speculator. If you want to speculate in bonds, why do it in a roundabout and expensive manner by paying transfer duties, commissions, municipal rates and taxes, insurance premiums, private security firms, and lawyers to squeeze rent from recalcitrant tenants?

There is only one reason. The bank is willing to lend you the money because you pose zero risk to the bank. The entire risk is yours, and yours alone.

That brings us to the point. The important issue is the relative risk/reward ratio of the investment. The risk/reward ratio is different for every investor. It depends on the range of opportunities, available cash flow, capital, experience, and risk management skills of the investor.

Gearing is like a very expensive hunting rifle. You will be stupid to hunt mice with it.

Some people own 5 properties while others own none. Some citizens own a thousand, or even ten thousand hectares, while others don’t even own the shack they live in.

Some commentators look at this arbitrary arangement and they call it unfair and unsustainable. This unequal distribution of property will cause social unrest, they say. The fact that a specific demographic group owns 80% of farmland will lead to anarchy, according to the popular mantra. The uneven distribution of property restricts economic growth, according to them. Therefore, in order to alleviate inequality, the government has to interfere in the process that allocates property, they conclude.

This is exactly what Robert Mugabe did. Zimbabwe does not have an economy, its GDP per Capita is the lowest on earth, there are no employment opportunities, and malnutrition is a constant epidemic, but they do have equitable distributions of farmland. It is clear that nobody can eat farmland. Property means nothing without an economy. Consumers alone determine the value of a property. The property owner is a slave to consumers. He has to constantly satisfy the needs of consumers, or the consumers will stop supporting him and he will lose that property. The owner has to apply that property for the benefit of consumers at all times, or the losses will lead to his eviction from that property.

ALL property owners are mandataries of the consumers, bound by the operation of the market to serve the consumers best. Capitalism is the consummation of the self-determination of the consumers.

That is why the system of redistribution of farmland is the road to slavery for consumers. If the redistribution of farmland was important to consumers they would pay a higher price for the produce of emerging farmers. Consumers care more about free-range chickens than about land redistribution. A free-range egg has more value to them than an emerging farmer has.

In a free market, where consumers are king, there is no demand for the socialist redistribution of property. The market mechanism of supply and demand is the only fair, just, and efficient allocator of property.

End of comments.

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