Quick Bite: Leverage AKA the mortgage magnifier

In this quick bite, Ed McKnight from Opes Partners challenges the perception that property investment is low-risk, explaining how leverage amplifies both gains and losses. How exactly does the "mortgage magnifier" work? Ed shares how even a 5% property value change can result in far bigger equity shift for investors. Plus, we look at historical returns between property and shares in New Zealand over the past 25 years. 

This quick bite is from our previous episode 'What does property investment look like in 2025?'

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Investing involves risk. This episode is brought to you by Sharesies Limited (NZ) in New Zealand.

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Episode Transcript

Speaker 1 (00:00):
You're listening to a share these podcast.

Speaker 2 (00:03):
When you're thinking about investing. A lot of people say
property investing is a way to go, but it's based
on leverage and on taking quite a big risk. If
the value drops, you've effectively lost your entire investment, Whereas
whether shareholding, obviously the gains might be lower, but the
losses tend to be a little bit lower. So I
guess there's probably a bit of a chance here for

(00:25):
people to get both sides of the story if they
look into it in some death. But on that idea
of leverage, talk to me a little bit about that
in property investment at the moment and whether it's a
good time to be leveraged.

Speaker 1 (00:38):
Yeah. I think the thing in New Zealand is was
always considered property to be quite safe, and I think
that's really mischaracterized property because property is actually a pretty
high risk, higher return. But when we typically think about
property over the last kind of twenty five a year,
so since nineteen ninety six, the average property increase in

(00:59):
New Zealand has been about six point three percent, and
for shares it's been eight point six percent. So shares
have been higher return, and that's where a lot of
people start by saying cool shares, higher return, But then
we've also got to think about risk. Now, when we
think about risk and investment circles, often we're talking about
like the ups and the downs, and so we see
that with shares that you do have some pretty high ups,

(01:20):
you also have some pretty high downs. So if we
think about the best year and the s and P
five hundred, since Google Finance started reporting the S and
P five hundred and nineteen ninety six, the best year
has been about fifty four percent up. Great year if
you timed that. The worst year has been down forty
five percent. So shares higher return, but bigger ups and downs.

(01:41):
The worst year and property has been quite recent it
was about fifteen percent down and best has been thirty
percent up. So typically this is the way we think
about property versus shares in New Zealand that cool shares
higher return, but also about higher risk. But what that
conversation misses is the leverage part. So let's run through

(02:02):
those numbers, because we always think that when you add
debt to an investment, whether it's property or a business,
whatever your asset happens to be, that is going to
make the returns larger, but it's going to make the
down side much larger as well. I call it the
mortgage magnifier, just because I love my alliterations. Mate, who doesn't.
So let's say you're buying a five hundred thousand dollar property.

(02:24):
You put one hundred thousand dollars worth of cash in
and we've got four hundred K worth of debt. Now,
if that property goes up by five percent, that property
is no longer worth five hundred thousand. It's worth five
hundred and twenty five thousand. Now most people be like, oh, okay, yeah,
that sounds about right. But what that means is that
your equity within that property has gone from one hundred
grand to one hundred and twenty five grand. So yep,

(02:48):
the market went up by five percent, your house went
up by five percent, but your equity within that property
went up by twenty five percent. Now that sounds pretty good,
but we've got to talk about the downside as well.
What happens if it goes the other way. That house
goes from five hundred k drops by five percent to
full seventy five. You've now lost twenty five thousand dollars
and you're down twenty five percent, and we are.

Speaker 2 (03:09):
Seeing that at the moment in some markets, aren't we
We are seeing values in some respects kind of dropping
backwards in places, or valuations not kind of coming in
where they were originally put out. So that's a real risk.

Speaker 1 (03:20):
Yeah, the market's starting to smooth out quite a lot,
but it's actually even worse than than what you've made
it out to be. You know, in Lower Hut at
the largest peak to trough drop, property prices were down
like thirty percent. And so the reason that those property
drops hurt isn't just the fact that you know you've
lost thirty percent on your investment. It's that if you
put in a twenty percent deposit and your property value

(03:43):
dropped by thirty percent, you're now in negative equity. Your
return on the money you put in is negative one
hundred and fifty percent, because you're getting five times if
you put in a twenty percent deposit, you put in
a fifth of the money, you're getting five times the
market return. And so typically we think of New Zealand
property a little bit lower risk, a little bit lower return,

(04:05):
but an actual fact, if you're using debt, it's much
higher risk and much higher return than shares, and that's
the thing that I think people miss And I'm not
really trying to emphasize the higher returns here. I'm trying
to emphasize the higher risk when we take on debt,
because that's the thing a lot of people forget about.
Investing involves a risk you might lose the money you
start with. We recommend talking to a licensed financial advisor.

(04:27):
We also recommend reading product disclosure documents before deciding to invest.