A great way to create wealth is through leveraging your assets.
Leveraging involves borrowing money and can be a much faster way to increase the size of your assets than saving and paying down your debt. But leveraging could also increase the size of your losses, unless you build in precautions and safeguards.
Often people compare shares with property as the best means for wealth creation.
Wealth is created faster by increasing your asset base so that you have a larger asset base working for you, which in effect creates greater and faster wealth.
Now let’s look at the leverage ability of both asset classes.
With shares you can borrow up to 50% loan value ratio (LVR) of the asset itself. This means that if you had $100,000 cash to invest you can borrow a further $100,000 against the share portfolio of $200,000. This effectively means you now have $200,000 working for you instead of $100,000 working for you.
Property on the other hand gives you the ability to borrow up to an LVR of 80% of the property itself; meaning if you had $100,000 cash you can borrow $400,000 to purchase a property worth $500,000. So now we have $500,000 working for you instead of $200,000, as in the above example with shares.
It’s fair to say that some Banks will lend more than 50% LVR against a share portfolio but this is rare and most banks will only lend up to 50% LVR.
Some people may say that Shares gives you a better return on your investment, even though the base is smaller.
In this example the share portfolio of $200,000 would need to return an average of 25% pa for you to end up with the same amount of money as a property of $500,000 at around 14%pa. (Capital growth of 10%pa and rental yield of 4%pa). Remember we started off with the same deposit of $100,000.
If you were able to achieve a 25%pa return over the longer term, then obviously it’s better to leave your money where the debt and risk level is lower.
Recently the government have made changes to the way Self Managed Superannuation Funds (SMSF) can invest their money. In the past SMSF’s were not permitted to borrow money and this meant they were unable to leverage, except in certain circumstances where they were able to leverage into shares through Warrants.
Recently the laws were changed so that SMSF’s are now able to borrow and invest into property.
This is a very exciting area and it now allows a person to roll over their Superannuation from a Master Fund that they may have with their Employer into their own SMSF, and through a similar Warrant product borrow the balance from a Bank and buy property, thus instantly increasing ones asset base.
You can now rollover your Employer Superfund into your own SMSF and use the funds as a 20% deposit on your next property investment.
The Super guarantee that your employer contributes for them can be directed to your own SMSF and can be used to fund the negative gearing. You can also salary sacrifice up to $25,000pa to help with the payment of the loan.
The exciting thing about this strategy is that once you reach 60, the SMSF can be turned into a Pension Fund and all income such as rental and any Capital Gain on the sale of the property is tax free.
In addition, if you wanted to pay down the principle on the loan then you can, in most circumstances, use between 85% and 100% of the money to do this, as compared with paying the loan off outside of the SMSF where you would need to pay income tax at 46%, leaving you with 54% to pay off the principle.
In the SMSF you only need to pay 15% tax on the Super Contribution, leaving you with 85% to pay off your principle. In some circumstances if the property was negatively geared the depreciation on the property creates a paper tax deduction which can be used to offset the 15% tax so that you end up with no tax and the full 100% of your money can be used to pay off the principle.
If you compare that with holding the same property outside of Super you would need to pay full Capital Gains tax at 46% (23% tax with a 50% exemption if held for more than 12 months) and the rental income attracts tax at ones normal marginal tax rate.
For many clients, they see their Super funds as not working very hard because they were unable in the past to leverage this.
One word of caution; Many Warrants will only allow the one property and do not permit the borrowing of the increased equity in that one product. So for many people if you are in accumulation mode and not retirement mode where you want to purchase further properties, the current Warrant structures do not allow you to do this. You would need to see someone like Chan & Naylor who may recommend other solutions for you.
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