That €75,000 Sicilian Property: Adding Leverage

Welcome to Financial Fluency - your weekly guide to mastering financial English, learning how money works, and making confident financial choices.

In this issue:

• A Look at the Markets: S&P 500

• That €75,000 Sicilian Property: Adding Leverage

• Quote of the Day: Grant Cardone

• We value your feedback

• Word of the Day: Leverage

• Word of the Day: Mortgage

• Test Your Knowledge: Interactive quiz

• Whenever you are ready, here is how I can help you

A Look at the Markets: S&P 500

This chart shows the S&P 500 has remained remarkably strong despite ongoing geopolitical tensions and the Israel-Iran conflict. What does this tell us? The markets believe there won't be further escalation, even after the US became involved by launching strikes against Iran's nuclear facilities. This steady performance suggests investors are confident that a broader regional war can be avoided.

However, I would still urge caution. Geopolitical situations can change quickly, and markets might not be fully considering these risks. Whilst current investor confidence reflects optimism, the unpredictable nature of international conflicts means we should remain careful with our investment decisions.

That €75,000 Sicilian Property: Adding Leverage

How borrowing money can multiply your returns from 9.4% to 93.1%

In the last two newsletters, we analysed buying a €75,000 apartment as an investment using Warren Buffett's discounted cash flow calculations.

We looked at a long-term rental in mainland Italy, then examined a short-term holiday let in Sicily which appeared undervalued by 9.4%.

This week, I want to examine how the numbers change for our successful Sicilian property when using leverage - that is, buying the property by placing a deposit and getting a loan.

What is a Buy-to-Let Mortgage?

This is different from either a commercial mortgage (for commercial properties such as offices, shops, or factories) or a residential mortgage (when you buy an apartment or house to live in).

A buy-to-let mortgage is specifically for purchasing property as an investment to rent out to long-term tenants or holiday guests.

For our Sicilian apartment, let's assume a €25,000 deposit plus a €50,000 interest-only buy-to-let mortgage at 5% annual interest.

The Sicilian Airbnb with Leverage

Remember our successful Sicilian property from last week? Here's how leverage changes the calculation:

Annual costs increase by: Mortgage interest: €50,000 × 5% = €2,500

Revised cash flow:

• Rental income per night: €80

• Occupancy rate: 50% annually

• Annual rental income: €14,640

Annual costs:

• Property tax: €400

• Insurance: €250

• Utilities, Wi-Fi, maintenance: €1,500

• Airbnb host fee (15%): €2,196

• Cleaning, linen, management: €2,500

• Mortgage interest: €2,500

• Total costs: €9,346

Net income before tax: €5,294 Less 21% property tax: €1,112 Annual net income: €4,182

What Might the Property be Worth in 10 Years?

We assumed a 3% annual increase in property values for this tourist area: €75,000 × (1.03)^10 = €100,794

With an interest-only mortgage, you still owe €50,000 after 10 years. Your net equity: €100,794 - €50,000 = €50,794

The DCF Calculation (10-Year Analysis)

Using the same 9% discount rate:

Present value of rental income: €26,837

Present value of net equity sale: €50,794 ÷ (1.09)^10 = €21,442

Total intrinsic value: €26,837 + €21,442 = €48,279

The Verdict

Without leverage (from last week):

• Your investment: €75,000

• Total returns over 10 years: €82,062

• Return on investment: 9.4%

With leverage:

• Your investment: €25,000 (deposit)

• Total returns over 10 years: €48,279

• Return on investment: 93.1%

Leverage has amplified your return on investment dramatically - from 9.4% to 93.1% over the 10-year period.

The Multiplication Effect

If you had €75,000 to invest, you could potentially buy three similar properties using leverage instead of one property with cash.

This could multiply your returns - but also your risks - by three.

Important Risk Considerations

Here's the crucial point: you have to pay the mortgage whether or not you have tenants or customers.

If your Sicilian property sits empty for several months, you're still paying €208 per month in mortgage interest plus all other costs.

Additionally, leverage amplifies losses as well as gains. If property values fall or rental income disappoints, your losses are magnified.

The Verdict

Leverage can significantly enhance good property investments, but it requires careful analysis and adds considerable risk.

The key is ensuring your numbers work even in challenging scenarios - vacant properties, major repairs, or economic downturns.

Conclusion

The purpose of these newsletters has not been for you to decide whether or not to invest in individual properties - rather to give you an idea of how the calculations work so that you can use your own numbers and assumptions.

Additionally, discounted cash flow analysis doesn't work for buying a property to live in because there is usually no incoming cash flow to discount. Next week, we will look at a comparison of buying or renting for your primary residence.

As always, none of this is financial advice. Everyone should invest according to their personal circumstances, risk tolerance and financial goals.

Quote of the Day: Grant Cardone

This quote shows the potential benefits and pitfalls of using leverage. I tend not to use leverage myself, apart from my residential property. As Grant Cardone warns, I do not use it to buy depreciating assets like cars, but I understand why some people do (or have to).

We Value Your Feedback!

Your opinion helps us improve and lets you suggest topics or ask Business English questions for future issues.

Word of the Day: Leverage

Leverage - noun/verb - using borrowed money to increase the potential return on an investment; the use of debt to acquire additional assets.

Context and Usage: In finance, leverage refers to using debt to increase your purchasing power and potential returns. It's commonly used in property investment, stock trading, and business acquisitions. The term can be both a noun (the amount of debt used) and a verb (to use debt strategically). Higher leverage means higher risk but also higher potential rewards.

Common Collocations:

High leverage - using significant amounts of borrowed money

The hedge fund used high leverage to amplify their returns.

Leverage ratio - the proportion of debt to equity in an investment

Banks monitor the leverage ratio carefully when approving mortgages.

Leverage up - to increase the amount of borrowed money used

The company decided to leverage up to fund the acquisition.

Leverage effect - the amplification of gains or losses due to borrowing

The leverage effect turned a 10% property gain into a 50% return on investment.

Business Example: The private equity firm used leverage to acquire the company, borrowing €80 million against €20 million of their own capital.

Investment Context: Property investors often use leverage through buy-to-let mortgages, allowing them to control assets worth much more than their initial deposit.

Word of the Day: Mortgage

Mortgage - noun - a loan secured by real estate property, where the property serves as collateral for the debt.

Context and Usage: A mortgage is specifically a loan for purchasing property (unlike a general loan). The property itself serves as security - if you can't repay, the lender can take possession.

Note: Many Italian English students use "mortgage" and "loan" interchangeably, but a mortgage is only for property purchases.

Common Collocations:

Buy-to-let mortgage - a mortgage for purchasing investment property

Buy-to-let mortgages typically require higher deposits than residential mortgages.

Residential mortgage - a mortgage for buying a home to live in

First-time buyers often struggle to get approved for a residential mortgage.

Interest-only mortgage - where you only pay interest, not capital

Many buy-to-let mortgages are interest-only to maximize cash flow.

Mortgage rate - the interest rate charged on the mortgage

Rising mortgage rates have cooled the property market.

Business Example: The company secured a commercial mortgage to purchase its new headquarters, with the building serving as collateral.

Property Context: Unlike personal loans, mortgages are secured against the property, which is why they typically offer lower interest rates than unsecured borrowing.Text

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Disclaimer:

This newsletter is for informational and educational purposes only and should not be construed as financial advice. The information contained herein is generic and does not take into account your individual financial circumstances. You should always consult with a qualified financial professional before making any investment or financial decisions.

Additionally, the authors and/or publishers of this newsletter may hold investments in securities or other financial instruments mentioned herein. These are included for illustrative purposes only and should not be taken as a recommendation to buy or sell such securities or financial instruments.