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,” says David Jacobs, Gauteng Regional Sales Manager for the Rawson Property Group. “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,” says Jacobs. “Generally, if you want to benefit from the growth on a R1million asset, for example, you need to have R1million to buy that asset with.
“With property, however, it’s possible to invest in a R1million rand asset with only R100k – 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,” says Jacobs. “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, Jacobs urges 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,” says Jacobs. “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,” says Jacobs. “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,” says Jacobs, “but gearing is an option for every property owner, and an incredible opportunity to maximise the return on your investment.”