Leverage: how does it work?

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Property leverage allows you to increase your assets significantly and quickly.
We can hear you from here: “What? But how? Why didn’t I know about this?”. We explain everything, but there is no magic involved and this practice is not without risk.
Leverage allows you to take on debt to increase your capacity to invest in property. Taking on debt to acquire an asset provides an opportunity to boost the investor’s return.

Let’s take a concrete example: Louis wants to invest and has capital of 200 000€. Would it be better for him to commit all of his capital (scenario 1) or take out a loan and invest only a fraction of it (scenario 2)?

Scenario 1: he uses 100% of his capital to invest in a flat of equivalent value.

In this case, Louis’s net return will be equal to the rental yield.
Let’s imagine that he buys a property for 200 000€, and his monthly rental income is 1000 €; this equates to 10 000€ in annual rental income (we always deduct two months as a safety buffer). His return will therefore be 10 000 €/200 000 € =5%.

Scenario 2: he decides to take out a loan so that he does not use 100% of his current capital.

Of his 200 000 €, he uses only 50 000 € and therefore takes out a loan of 150 000 € from his bank.

Assuming bank interest of 3% on his loan (equating to 4500 € per year) and the same annual rental income of 10 000 €, he will be left with rental income of just 5500 €, but will have invested only 50 000€. This therefore gives him a return of 11% (5500 €/50 000 €).
Let’s also not forget that, thanks to his income, Louis may be able to take out further loans and make additional property investments. Provided, of course, that his bank allows him to do so.

Don’t rush in headlong!

We have reviewed the positive aspects of this system, which are highly attractive from a financial perspective. But beware: this method is not without its drawbacks, as that would be too good to be true. A lack of knowledge in this area can lead to substantial losses. Quite simply, the more leverage you use, the greater the risks.

This well-known leverage effect carries risks where building works are required or the property remains vacant. Some properties require work beyond the initial estimates. It is therefore essential to calculate the cost of the work accurately to guard against this type of risk. To avoid rental voids, you need to choose a property in a suitable location. You should therefore invest with a full understanding of the implications.

In conclusion, leverage allows you to grow your property assets quickly. Note that leverage will apply as long as the rate of return on the capital invested is higher than the interest rate payable on the debt. But be careful before getting started, as there are many risks to consider. The expression “you have to take on debt to become wealthy” takes on its full meaning.