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The Magic of Leverage

By January 10, 2018 No Comments

NO MAGIC WANDS NEEDED HERE.
DO MORE WITH LESS MONEY.

Robert Kiyosaki said, “In the broad definition, the word leverage simply means the ability to do more with less.” In one of my previous articles: Be Prosperous – The Myth of Property Prices Growth, we discussed the total return on your property investment, which proved the exceptional returns one can achieve with a low-risk investment.

Today we are looking at how using leverage can increase those returns even more. When looking at a property investment, the most important formula is the Geared Internal Rate of Return (IRR). The Geared IRR measures what the return is on the cash you invested out of your pocket. This is important because now you can compare apples to apples when comparing the cash you had to invest in one property investment with another investment.

Let me give you a personal example. I recently purchased a lower middle income property in Johannesburg for R750 000, which I financed 100% through the bank. I only had to pay the transfer and bond registration fees (about R30 000). The rent income I receive on this property is R7 500, the levies are R1 200, and the rates and taxes are R350.

Let’s assume the following:

  • The property will grow at 6.2% a year (actual growth figures for lower middle income properties from FNB).
  • The rent would increase at 7.62% a year (actual rental growth figures for lower middle income properties from Pay Prop).
  • The levies and rates and taxes grow at 6% per year.
  • The interest rate is at the current prime rate of 10.25%.

Working on the 10-month principle mentioned in the previous article, i.e. one month a year is dedicated to vacancy, and one month for maintenance, my return on cash invested (Geared IRR) is an average of 20.4% PER YEAR over a 10-year period if interest rates remain constant!

Over a 10 year period, I would have had to take a total of R94 950.96 out of my pocket and would have made R710 045.83 on that investment.

Beat that 😉

Property is an exceptional investment, and the above numbers prove this. The above example did not even take into consideration that you can buy property at a discount, which makes your returns even higher. You can find out more about this in our previous article: Be Prosperous – Ready, Set, Negotiate!

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