The gearing effect describes the 'amplification' of your capital returns, positive or negative, from having a mortgage (debt) on the property. In other words, if the property grows in value, the gearing effect is added to that percentage growth, and if the property declines in value, gearing effect is subtracted from the percentage decline. See our article on the benefits and risks of investing in a geared property.
How is the 'gearing effect' calculated?
The formula for gearing effect is:
Gearing effect = (Historical suburb growth rate) ÷ (1- Loan to value ratio*) - (Historical suburb growth rate)
*Loan to value ratio, or the debt percentage is calculated by Outstanding Debt ÷ Latest Valuation
If we look at BAN01 (as at September 2019), we can work with the figures given to calculate the gearing effect of 2.80%:
Historical Suburb growth over 20 years = 7.87%
Loan to value ratio = 121,200 ÷ 461,574
So, gearing effect = 7.87% ÷ (1 - 0.262579...) - 7.87%
= 2.80% (rounded to 2 decimal places)
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