We discover if ‘hook and flick’ is a viable strategy in this market. Pete Wargent gives us the lowdown.
Kevin: Gearing is a term we use that’s quite commonly used in property investing. Not a lot of people understand it, or if they do, they probably don’t use it. Let’s try and find out why. Joining me to talk about this, Pete Wargent. His blog again is PeteWargent.blogspot.com.
Pete, tell me firstly, what is gearing? Let’s explain it first, and then we will talk about why it’s not used all that often.
Pete: Yes, in a financial sense, gearing typically means borrowing or leverage. So, a company that is highly geared is one that has a sizeable amount of debt on its balance sheet.
From a property investor’s point of view, gearing tends to relate to borrowing money to invest. So, mortgages against investment properties, typically.
Kevin: It’s not just for property, is it? It’s for any type of investment where you have some equity that you can actually use and leverage?
Pete: Yes, that’s right. The idea behind using gearing is that it can magnify the results that you achieve. So, in property, the capital growth in particular is what you are looking for. But obviously, the downside is that gearing or borrowing magnifies good results and bad results, so you need to make sure you choose carefully what you buy and also you use debt carefully.
Kevin: Can you give me a practical example of gearing and how it does work, let’s say in a property sense?
Pete: If you borrow to invest in, let’s say, a $500,000 property, you might put in a 20% deposit and then borrow the balance from the bank. Therefore, you have only invested a $100,000 of your own money, plus costs, but you are investing in an asset that’s worth $500,000. Therefore, if you get capital growth on that property, the results are effectively magnified. So, let’s say, a 20% capital growth on the property could actually see you double your money.
Kevin: How do the banks look at this? And should you deal just with the one bank, or should you be working with different lenders?
Pete: You need to be able to demonstrate an ability or repay the loan, and that’s especially true in the current environment where serviceability rules are tighter than they were. So, banks will look at your income from various sources to determine how much money you’re able to borrow.
Kevin: What sort of language do you use when you go to the bank? Say I was with NAB and I wanted to go and invest with ANZ in a different property. What kind of language would I use with them?
Pete: When you’re approaching a bank to invest in property, you would tell them exactly that. You would tell that you have an amount of money saved up, you’re interested in buying an investment property, and you’d like to look at some of the loan products that the bank could offer.
Kevin: I would imagine that most banks would then try to get you to switch that loan across to them as well. Is that such a good idea?
Pete: It depends on personal circumstances really. There are pros and cons to using one bank or a range of banks. You sometimes find by shopping around that you can get better products and better mortgage rates. There’s no one-size fits all when it comes to which lenders to go to.
Kevin: Are you finding that more and more investors are tending to deal with brokers, so they can almost keep an arm’s length relationship with the banks?
Pete: Yes. It’s becoming increasingly popular, particularly for serious investors to use brokers to shop around, to look at all of the various products that are available, and to negotiate the best terms that are possible for each individual investor.
Kevin: I guess the good brokers would be able to sit down and help you work through that scenario too. If you went to them with your portfolio, they can sit down and say, “Well, look, you have a certain amount of gearing here, and I know that this particular bank at this point in time is probably the best one to go with, and these are the reasons why.”
Pete: Yes, that’s exactly it. The thing that investors need to be aware of is that while the broker can help you with the choice of loan, ultimately, the choice of asset to invest in is your own. So, you want to try and find the properties that will generate a reliable cashflow to cover those borrowing costs and something that generates a reliable long-term income. The income growth allows your property to become positively geared over time.
Kevin: Always good talking to you Pete. Pete Wargent, and his blog site, of course, is called PeteWargent.blogspot.com. You can get some details there about the no-nonsense financial education program that Pete’s running in Sydney, on the 7th of October.
Pete, thank you very much for joining us. All the best on the 7th, and we will watch out for that new book too, coming out in October, The Wealth Way. We will look forward to talking you about that when it comes out, Pete.
Pete: Pleasure, Kevin. Will do.