20 Jun Get your gearing right – Michael Yardney
What’s the correct level of gearing at this time in the property cycle? Michael Yardney says it depends what your strategy is. He explains.
Kevin: What’s the correct level of gearing at this time in the property cycle? Let’s have a look at that. Michael Yardney joins me from Metropole Property Strategists.
Gearing your way up the property ladder, Michael. How much gearing is sensible at this time?
Michael: Kevin, it’s a good question at a time when interest rates are starting to creep up and people are wondering how they’re going to cope. Let’s talk of some big picture principles first, if we could.
It depends what your strategy is. Some people are interested in cash flow-positive properties. My strategy is strong capital growth. Firstly, that will influence your gearing levels because if you’re hoping for positive cash flow, you either have to buy secondary properties with better return or lower your loan-to-value ratios.
But Kevin, when you start off, we all need money. Unless you win the lottery, none of us have a big windfall that you can actually invest with without any borrowing. I think beginners really have to just accept the fact that they start with as low a deposit as they can.
There are still some banks lending at 90% loan-to-value ratio where you’re putting 10% down, but the majority of the time, you have to put in 20% and borrow 80%, and even if you don’t have that financial buffer we talk about, I guess the first step is to get in the market, and to do that, you usually have to borrow as much as you can, Kevin.
Kevin: Michael, what about midway up the ladder? Does that strategy change?
Michael: Yes. I think as you start to build your portfolio, you now have to take fewer risks and start securing your assets by giving yourself slightly lower loan-to-value ratios and putting some money aside in those cash flow buffers, whether it’s in your offset account or in some other form, like a line of credit.
The concept is to keep something there for the rainy day. But still, if you’re at the asset growth stage of your investment career, you are going to have to stick to an 80% or so loan-to-value ratio.
Kevin: What about when you reach the top, Michael?
Michael: When you get to the next level, your aim is to start living off of your property investments. I believe in living off of equity; other people talk about living off of your cash flow. Either way, your job is to lower your loan-to-value ratios so that you can slowly transition from one stage to the next.
Kevin: Michael, how do you make that transition?
Michael: It doesn’t happen overnight. Some people say sell a property. There are people saying to buy ten properties and at the end, sell five and keep five without any debt. It doesn’t work because when you sell the properties, you pay capital gains tax, you pay agents’ costs, and you only have about 20% equity in your property anyway because you have a loan against it. So, you don’t end up being debt-free that way.
The way I would propose it is just don’t do anything; basically let your properties grow in value and your loan-to-value ratios slowly drop as the properties increase in value and you don’t take on more loans. Or you can add some value to the property by doing renovations or development and getting better cash flow that way.
Now, I’m not allowed to give superannuation advice, but I know some people take some money out of their super when they retire – and that can be in a tax-free environment – and pay off some of their debt, again lowering their loan-to-value ratios.
Look, sometimes you do have to sell a property to get out some extra equity to lower some debt. Another thing people can do as they transition to that stage where they’re now going to live off of the cash flow of their properties, Kevin, is to add some commercial properties to their portfolio.
Commercial real estate has higher yields but lower growth, so it’s inappropriate to do it too early in your investment journey, but near the end, that makes a good adjunct to your capital growth properties, Kevin.
Kevin: Well said, Michael. Thank you very much, and some very sound advice there.
Michael Yardney, of course, from Metropole Property Strategists. Thanks, Michael.
Michael: My pleasure, Kevin.