Leverage and Luck
“Give me a lever long enough, and a place to stand, and I will move the earth.” - Archimedes
In my 15 years as an investor, I have avoided leverage, it's a huge multiplier both on the upside and downside like a double-edged sword. Part of the reason to hate leverage was a lot of bad outcomes I saw for people who used leverage.
After doing my own studying and encouragement from fellow investors, I made an exception - I used leverage for the first time to buy an asset - An investment property (real estate/ house) in 2021.
I have written many articles on not getting into property investment and sticking to shares, in fact, I have gone to an extent by creating a calculator which shows investing in equity will have superior returns to property all things equal.
The theory is theory and it is why practice varies, an investment property can be brought for $0 cash outflow, especially in Western countries. I will take you through my personal practical example and conclude on why you should re-think if you have a negative view on leverage and or property investing.
How can you acquire an asset for $0?
The main qualifying condition is to have an existing home whose value is more than what is owed on it + You can service a loan much bigger than the existing loan on the house. As an example you live in a house that is worth $400,000, your loan on the house is $200,000, the next-door bank is willing to give $300,000 cause you work in a stable job.
In the above scenario, you can borrow an additional (or draw equity in common terms) from your house $100,000 and use that $100,000 as a deposit to buy another home.
after the transaction, you will have two homes - Home A where you live, and Home B which you rent, your total debt be $600,000 (200+100+300)
So without spending a dollar out of your pocket, you have an asset worth $400,000, of course not to forget a liability of $400,000 too
What type of asset to acquire?
I had two primary conditions
Interest payments on loans could be made from rent
I am getting a deal where I am able to buy below the real market value of property
I used an agent to help me find the deal, after several options the below home came for my evaluation
between 1986 and 2008 this property has done about 6.65% CAGR (keep this number in mind) also the returns have been very zig zag with most of the returns coming in short bursts, I was offered this for an implied growth of 2% in 2021, numbers stacked up and my two primary factors were met I was buying under market and rent would take care of my next 3 years of interest payments as I had locked a fixed interest payout to the bank.
How real property when done well creates wealth?
Remember that 6.65% CAGR number, historically property in that town has grown at this rate for the last 80-100 years stats for the whole of Australia are also in a range of 7-8%. What happens when you have practically bought at $0 cash outflow and the value of an asset implicitly grows 8%? Wealth is created - a $100 value home becomes $135 at the end of 4 years (at 8% compounding), Doing this for 20-25 years can set you up.
Is it easy?
Requires hard work and like equity selection of assets is key and trying to find deals isn't easy, also apart from numbers stacking up there are a host of other factors that are very important to select an investment property (house).
Luck found me
My long-term expectation from this investment was about 5-6% CAGR from this investment, my exit plan was to gain 20% in 3-4 years and then evaluate. In less than 10 months I was offered a 17% increase to my buy price -
I sold
my 4-year expectations were met in less than a year, and some secondary factors which I liked about property are unlikely to come out true in a 3-4 years timeframe.
What are my thoughts on property investing today in 2023?
use your savings to build an equity portfolio
use your income's borrowing power to buy an investment property
I will continue to experiment and do deals and write more in this space, like retweet and share if you found this useful and learned something.
Until next time happy investing, leave your comments below or @betankrich on Twitter