Leverage in Property Investing: Returns and Risks
December 18, 2024
Leverage in property investing means using borrowed money alongside your own cash to buy an asset. It can make a substantial difference to the return on your deposit, which is why I use mortgages in my property business. It can also make a disappointing investment much more painful.
In my December 2024 video, I explained why I see borrowing as a major part of property’s appeal. Without it, I’d find the comparison with index funds much harder to justify, given the work involved in owning and managing buildings. That is my view of the trade-off, rather than a claim that everyone should borrow or that property is automatically the better investment.
The useful question isn’t simply whether leverage increases returns. It’s how it changes the whole investment: the cash you need, the monthly commitments, the potential upside and your ability to survive a bad period.
You can watch my original explanation of property leverage alongside the numbers below.
What happens when you buy with a mortgage?
Take a straightforward illustration. A house costs £100,000 and you contribute a £25,000 deposit, with a £75,000 mortgage covering the rest. That is a 75% loan-to-value mortgage: the borrowing equals three-quarters of the purchase price.
You own the property subject to the lender’s security. You benefit from changes in the value of the whole house, even though you haven’t supplied the whole purchase price yourself. Equally, the mortgage does not absorb a share of your losses if the property falls in value. You still owe the debt.
The £25,000 is only the deposit. A real purchase also needs money for legal work, any applicable transaction tax, mortgage fees, surveys and possibly refurbishment. Those costs matter when calculating the return on your actual cash investment.
I use round numbers to make the mechanism clear. I wouldn’t use those same simplified numbers to decide whether to buy a particular house. For that, I’d need the full acquisition budget and a realistic operating forecast.
Why growth has a bigger effect on your deposit
Suppose that £100,000 house eventually becomes worth £200,000, while the mortgage balance remains £75,000. Your equity would be £125,000 before selling costs and any tax: £200,000 less the £75,000 debt.
The increase in equity is £100,000. Relative to the original £25,000 deposit, that’s a 400% increase. The £125,000 total equity is not £125,000 of profit, because it includes the £25,000 you put in at the start.
Compare that with buying the same house entirely in cash. The property still rises by £100,000, but that gain is measured against £100,000 of purchase money rather than a £25,000 deposit. The underlying building has performed identically. The financing changes the return on the owner’s cash.
Of course, this example assumes a doubling in value. It doesn’t tell you when that might happen, whether it will happen, or what you’ll spend while waiting. Mortgage interest, maintenance, tax and other costs have to be included before calling the result your investment return.
The same mechanism works against you
Now reverse the direction. If the £100,000 house falls to £90,000 while the loan remains £75,000, your equity drops from £25,000 to £15,000. A 10% fall in the property price has removed 40% of that initial equity.
If the house falls to £75,000, the simple calculation leaves no equity at all. Selling costs could still leave money to find. Below that value, the mortgage exceeds the property’s value, which is negative equity.
That’s why I don’t treat leverage as free extra return. It magnifies your exposure. A relatively modest change in the property’s value can represent a much larger change in the cash you originally invested.
Not every fall forces a sale. But you need enough financial resilience to keep meeting the obligations while deciding what to do. Being unable to refinance, facing an expensive repair or losing rental income can turn a manageable valuation problem into a much more difficult cash problem.
Rental income has to support the borrowing
In the video I used an example of £700 monthly rent and £350 mortgage interest. The difference is £350, but it isn’t automatically £350 of profit. The other costs haven’t disappeared because the lender has been paid.
Management, insurance, repairs, compliance, empty periods and tax can all reduce what remains. Some costs arrive irregularly, which makes a good month misleading. I’d rather allow for them in advance than discover that several months of apparent profit were really the budget for a future repair.
A repayment mortgage also includes capital repayments, which affect cash flow differently from interest. Paying down principal builds equity, but the payment still has to come out of the money available each month.
This is where my breakdown of the profit left from £1,000 rent is useful. Gross rent, money left after mortgage interest and spendable profit are three different numbers. A leveraged investment needs you to understand all three.
Don’t assume today’s interest cost lasts forever
A mortgage that works at one rate may become uncomfortable at another. I’d want to know when the current product ends, what balance will remain and how much room there is if the next product costs more.
On £75,000 of interest-only borrowing, each additional percentage point of annual interest is £750 a year, or £62.50 a month. A three-percentage-point increase would therefore cost another £187.50 a month, before any change in fees or other costs.
That arithmetic is simple, but it makes the risk tangible. Compare it with the actual monthly surplus after operating costs, rather than the rent alone. If the surplus is small, a rate change can consume it quickly.
I also wouldn’t assume a future lender will offer the borrowing I want. Valuation, rental cover, the property and the borrower’s circumstances all matter. My buy-to-let mortgage guide explains why a deposit percentage alone doesn’t establish whether a deal can be financed.
Inflation changes the real value of debt
Another part of my argument is that inflation can reduce the purchasing-power value of a fixed amount of debt over time. The number owed may stay the same while prices and incomes change around it.
For a clean illustration, suppose the general price level rises by 20%. A £100,000 debt then represents about £83,333 in the starting year’s purchasing power, because £100,000 divided by 1.2 is approximately £83,333. The lender is still owed £100,000. Nothing has been written off.
The Bank of England’s explanation of inflation and interest rates provides useful background on how those forces interact. Inflation isn’t an uncomplicated gift to a borrower: it can also increase repairs, living costs and borrowing costs.
Nor can I assume my rents or income will rise exactly with inflation. The potential long-term benefit only helps if the investment remains affordable along the way. A balance-sheet argument isn’t a substitute for money in the bank when a payment falls due.
My use of leverage changes with my aims
When I recorded the video, I talked about moving from building the portfolio towards reducing the proportion of debt over time. I described a possible progression from around 75% loan to value towards 50% and eventually 40%.
Those were part of my thinking at the time, not a universal set of targets. The right amount of debt depends on what you want the portfolio to do, how stable the income is, the finance available and how much uncertainty you can tolerate.
Higher leverage can help someone acquire more assets with a given pot of cash. Lower leverage can make the portfolio less sensitive to interest costs and leave more rental income after finance. There is a real choice between pursuing further growth and making the existing position more comfortable.
I don’t think a strategy has to stay frozen because it suited you when you started. As your commitments and objectives change, it makes sense to review whether your borrowing still serves them.
Equity isn’t the same thing as accessible cash
A rising valuation can make your net worth look healthier without adding anything to your bank account. To access that equity, you normally need a transaction, such as a sale or further borrowing, and both have consequences.
A refinance replaces or increases debt; it doesn’t create profit merely because money arrives in your account. The new loan needs servicing and will eventually need repaying. Fees and lending limits can also mean the amount available is much smaller than a headline equity figure suggests.
That’s why I’d separate property value, mortgage balance, equity and available cash in any portfolio review. They answer different questions. Confusing them makes it easier to feel richer than your day-to-day finances actually allow.
I also want a reserve that doesn’t depend on another refinance completing on time. A delayed valuation or lender decision shouldn’t leave the whole plan unable to pay its bills.
Our mortgage and rate stress calculator lets me compare interest-only or repayment mortgage payments at different rates. With rental cash flow enabled, I can test what remains after the mortgage and entered operating costs. It is a pre-tax illustration, not a lender’s affordability assessment, and fees need separate consideration.
Use borrowing to support a sound investment
For me, leverage is one reason property can be powerful. It lets me combine my own capital with finance and take part in the performance of a larger asset. But the quality of that asset and the way it operates still come first.
I’d check the purchase price, achievable rent, full costs and downside scenarios before deciding how much debt to use. I’d also consider what happens if growth is slower than expected. An investment that needs a generous future valuation simply to escape today’s problems isn’t the sort of foundation I want.
If you’d like to discuss how borrowing fits your property plans, book a free 30-minute call. You can also explore the Starter Club or find out about Done For You for support with your next step.