Gearing Strategies: Margin Lending v Borrowing for an investment property.

What is gearing?

Gearing simply means borrowing money to invest. You can borrow to invest in a range of financial assets like shares, managed funds or Exchange Traded Funds (ETF’s). Gearing can also be implemented for property investment.

Gearing aims to boost investment growth by using borrowed funds. Ideally, the investment return should outpace the loan costs in the long run, leveraging the power of compounding returns growing your investment faster. Borrowers will typically need to provide initial equity with a lender. The lender may then provide the remaining funds for the asset to be purchased.

When the costs incurred in holding the investment are more than the income produced by the investment, the difference is generally tax deductible. This is known as negative gearing and can be a tax-effective way to access funds to invest into growth assets, like property or equities.^*

Gearing can magnify both gains and losses, so it is important to understand the risks.

Margin Lending v Borrowing for Property Investment

Both margin lending and borrowing to invest in property can be negatively geared.

Margin lending is borrowing to invest into financial products such as shares, managed funds and ETF’s. Borrowing to invest in property is also a common method of implementing a gearing strategy. Both seek a tax effective strategy with the general intention of capital appreciation.^*

Property owners may encounter extra costs such as insurance, repairs, taxes, council rates and utilities. As a result, gearing into shares may be a lower cost alternative.

However, there are benefits and risks to each strategy, and differences in their simplicity. The below summary shows the benefits and risks of both strategies as a well as the potential costs incurred for both.

Benefits of a margin loan

• Access to capital increasing your investing exposure compared to using only your own funds.
• Potential for earning regular income with assets held via distributions, dividends and franking credits.
• Liquidity. Access liquid assets such as shares and managed funds. Assets such as shares can generally be liquidated to cash in three business days.
• Tax deductible interest. Interest paid on a margin loan may be able to be claimed as a tax deduction. If interest is prepaid any tax deduction can be brought forward to the current year.*
• Diversification. Invest into multiple industries, asset classes and/or international markets. Diversification is a common strategy to reduce volatility.
• Barriers to entry are lower with lower minimum investment amounts and lower transaction costs than property. For example, the Stamp Duty on property.
• Access to investment products such as Exchange Traded Funds. This can be a less expensive and simpler strategy for the investor, with consolidated reporting.

Risks of a margin loan

• Margin calls: Should your portfolio value fall or there are changes to Lending Ratios by the lender. You may be required by the lender to restore the loan to an acceptable lending level. This can result in realised unplanned gains or losses if you are required to sell securities.
• You may be required to repay some or all of the loan at short notice.
• Losses can be magnified using gearing compared to using own capital.
• Interest rate risk. An increase in the interest rate will also increase your borrowing costs.
• Investment risk. Your investment may not perform as expected.

Benefits of an Investment Property

• Potential access to rental income
• Tax deductibility. Most property expenses including interest on any loan used to buy the property may be offset against rental income.*
• Lower volatility. Property investing can be less volatile than shares or other equity-based investments.
• Tangible asset.

Risks of an Investment Property

• Higher transaction costs than those of a margin loan (stamp duty, conveyancers, lender fees and charges).
• Longer liquidation time.
• Ongoing charges, such as real estate commission for management, insurance, maintenance, repairs, strata fees and sinking funds.
• Potential for unexpected large expenses. For example, rewiring, underpinning, re-roofing.
• Tenancy risk, non-payment of rent, risk of damage to property.
• Interest rate and investment risk. Lenders may increase interest rates leading to higher repayments or the value of the property fall.
• More detailed record keeping requiring receipts for works, depreciation schedules, and rental statements.^*

This is not an exhaustive list.

In conclusion

When considering the most appropriate strategy, the benefits and risks need to be considered by the investor.

Margin lending offers a gearing strategy where the main consideration is which assets you wish to purchase. With a Margin Loan, there may be potentially no ongoing costs other than interest.

If you have an existing portfolio but have not implemented gearing, or you are an adviser or investor interested in the strategy and how it can work for you, we would like to talk to you. Please complete our Contact Us form and we will be touch to discuss your borrowing needs or call us today on 1300 307 807.

If you are financial adviser and want to learn more about recommending gearing to your clients, contact one of our Business Development Managers.

* We recommend you obtain your own independent professional and tax advice on the risk and suitability of these types of investments and to determine whether your interest costs or other related expenses will in fact be fully deductible in your particular circumstance.