Property is an incredibly powerful asset to build wealth thanks in large part to the ability to borrow money. Most banks are happy to lend 80% of the property’s value or even 90% if you pay Lenders Mortgage Insurance.
However, it is possible to borrow 105% of the property’s value if you have other assets and can release some equity.
Taking on 105% debt to buy a property might seem daunting at first, but when you break down the numbers, it can actually be a sound strategy, especially with the right setup and financial planning.
Here’s how it works and why it can lead to substantial long-term gains.
Imagine you’re buying a dual-occupancy rental unit with 105% financing. With current market conditions, let’s say you’re expecting a rental return of 5.5% on the property. However, your debt costs come to 6.5%, plus an additional 1% for property management fees, maintenance, and other expenses, totalling 7.5% in costs.
So, while the property brings in 5.5% in income, your total costs reach 7.5%, leaving you with a 2% shortfall. On a million-dollar property, that 2% amounts to a $20,000 annual loss.
At first glance, a $20,000 annual loss might sound concerning, but that’s where tax benefits come into play. This scenario qualifies you for deductions through depreciation and negative gearing, which can substantially reduce your taxable income.
If your income is around $190,000, your accountant can apply deductions to lower your tax liability. Essentially, every dollar you spend on losses can translate to a deduction that reduces your tax by about 50% at a high tax rate.
Let’s break this down further. If the property has a $7,000 loss, you could potentially recover $3,000 to $3,500 of that loss through your tax return. On a $20,000 loss, your tax return might cover $8,000 to $10,000, depending on your income bracket. This means that out of pocket, the property might cost you closer to $10,000 net after tax.
Now, consider the growth side. Assuming the property appreciates at a long-term average rate of 7% per year, that’s $70,000 in capital growth on a million-dollar property. With only $10,000 in net annual costs after tax deductions, you’re effectively paying just 1% of the property’s value to generate that $70,000 in growth. In other words, you’re netting $60,000 annually.
This strategy works because you’re leveraging the property’s growth while minimising your annual out-of-pocket costs. By holding onto the property and allowing it to appreciate over time, the benefits of capital growth far outweigh the initial expense. Over a decade, for example, a consistent 7% growth rate would mean your property’s value could nearly double, providing you with huge wealth-building potential.
While this approach requires careful planning, especially with interest rates always changing, it’s a model that has worked well for investors willing to hold long-term. By using 105% financing and maximising tax benefits, you’re creating a scenario where short-term losses are offset by long-term gains.
While this might not be a situation that every investor wants (or should) take on. It’s important to see that property is a lot about finance as much as it is about the property you buy. Get your numbers right and have a good team around you, like a trusted buyers agent and an accountant, and you will really be able to the most out of your income, borrowing capacity and equity. If you’re considering commercial property purchase, reach out to a commercial buyers agent instead.
