So you think you’re a Property Investor, a Guru, the Jedi of Returns, the Master of Capital Appreciation. If you are buying with anything but as much debt as you can then you are still an amateur.
Maybe you’re rich, obscenely wealthy, money is nothing to you – if you’re buying with cash you are mere beginner on the property scene, level one, I don’t care how big your portfolio is.
Why? One simple word, Leverage. Leverage means using debt as opposed to your own cash. To most people this is a mortgage or “finance”. You can use leverage to improve both your rental gains and your capital gains as well.
If you have read my articles “Why is Property Such a Good Investment” and “How Buying Property Halves Your Rent” then you will understand what a great investment property is and if you take a look at “How to never Lose Money on a Property Investment” You can insulate yourself from market fluctuations.
The principal is simple. If you use debt at a lower interest rate than the return you are getting on your property, then you are making money from someone else’s money. Most people get mortgage because they can’t afford to buy cash but if you read this article you will see that even if you can buy a property cash, you never want to.
Let’s use a nice easy example of a one bed apartment for sale at AED 1m, renting for around AED60,000 per year net (after service charges) which looks on the face of it like a 6% net return. Using leverage you will get a massive 12% return on cash invested. If you use leverage and your property increases in value if you use leverage you will make three times more money than if you use cash. Sounds crazy? Let me prove it:
I will assume a buyer with a 25% deposit which is AED250,000, with the remaining AED750,000 financed at 4% over 25 years (FAB is currently (May 2018) offering 3.99%).
If you buy the property your finance repayments would be AED48,000 per year (you get to pay this monthly, so just like 12 cheques). In addition, in the first year about one third (or about AED18,000 in our example) of your finance payment to the bank goes to paying off the principal of your loan (the other two thirds or about AED30,000 is interest payments). You can see an amortization schedule here.
So to recap, you receive AED60,000 in rent and you pay AED48,000 in finance charges. You then get a credit of AED18,000 by reducing your loan amount by that. So your notional income/profit is AED30,000 per year.
You have used AED250,000 cash to buy this property so in earning AED30,000 your return is a huge 12%. Yes, 12% on the cash you have put down (30,000 over 250,000). If you had bought it cash you would be earning only 6% on your million dirhams. What other saving scheme can compare to this? Don’t believe me? Do the sums yourself.
Not only that leverage improves your capital gains. Let us assume for ease that the value of the unit doubles to 2m and you sell it. If you have used AED250,000 and the rest debt then after paying back the loan you are left with 1.25m – you have increased your original AED250,000 by 400%. If you used 1m cash you now have 2m cash but that is only an appreciation of 100% on your investment.
The moral to this story? If you have 1m cash then buy three properties instead of one.
Crompton Partners is the largest Property Agency in Abu Dhabi and we would be happy to talk to you about anything regarding sales or leasing in the Nation’s Great Capital. Please feel free to call me on 050 6145199 or email at firstname.lastname@example.org.