The power of financial leverage, part two

Part one compared cash against an ordinary mortgage. This one goes further, into how a property can be bought without a conventional deposit at all. Drawing on my own experience and Wendy’s, here is the difference between a standard retail purchase and the methods experienced investors use: vendor finance, investor funding, and commercial lending such as bridging, construction finance and crowdfunding.

Retail against sophisticated

Take two investors, Sharon and me, both with experience behind us.

Sharon buys the standard way

Sharon buys using her own money for the deposit and the bank’s for the rest. She finds a property at £200,000, puts in £50,000 of her own as a 25% deposit, and mortgages the other £150,000.

The other route

My aim on the same £200,000 property is to buy it without putting in my own money, using a combination of the methods below instead.

Side by side

Assume the property rents at 5% of its value a year, and values rise 5% in the year.

• Money in. Sharon puts in £50,000. The other route puts in nothing, and controls the same £200,000 of property.
• Rent. £10,000 a year either way. The property doesn’t care how it was bought.
• Capital growth. £10,000 either way, for the same reason.
• Cost of the money. Sharon pays mortgage interest on £150,000. The other route pays interest or a share of profit to whoever funded it.

The property performs identically. What differs is whose money is at risk in it, and what that money costs.

The methods

Vendor finance

The seller lends the buyer part or all of the purchase price. It suits a seller who wants the deal done and a buyer who doesn’t have a conventional deposit sitting there. Terms, interest and the repayment schedule are negotiated between the two of them.

Investor funding

Capital comes from private investors who want exposure to property without running it. They fund the deposit or the purchase, and in return take a share of the rent or the profit, or an agreed rate of interest. The buyer uses somebody else’s money; the investor gets into property without managing anything.

[SOLICITOR] The paragraph above describes taking money from private investors. With the call to action removed it reads as an explanation of how the market works rather than an invitation, which is the right side of the line, and the page carries no offer, no rate, no return figure and no route to a conversation. It’s still the one passage here touching the s.21 question the solicitor already has, so it’s worth their eye while they’re reading. Nothing to change before that comes back.

Commercial lending

• Bridging. Short-term lending that covers the gap between buying and arranging something permanent. Used where speed is what wins the property.
• Construction finance. Lending built for development, covering build costs and repaid when the project sells or refinances.
• Crowdfunding. Capital pooled from a number of investors through a platform, which reaches a wider pool than any one relationship would.

Risk, and why it’s higher here

These methods can do more than a conventional purchase. They also carry more risk, and the complexity is part of the risk rather than separate from it. They ask for proper planning, real due diligence and a clear head about what happens if it goes wrong: rates move, markets turn, and the party funding you has their own circumstances. Joint venturing with someone experienced, or being mentored through the first one, is how most people manage that.

The point

Leverage is what lets an investor build something bigger than their own cash would allow. Sharon’s route is simpler and slower. The other is faster and asks a great deal more of your judgement. Neither is the right answer on its own, and anyone telling you otherwise is selling something.

First published by Sara Cromie on LinkedIn. Brought across here so it outlives the feed. Nothing in it is financial advice, and capital is always at risk.