Why low gearing is not always the low-risk strategy landlords think it is

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Why low gearing is not always the low-risk strategy landlords think it is

There is a recurring assumption within the landlord community that reducing debt is the safest course of action, and that is an understandable position. Many landlords have spent years paying down mortgages, often with the intention of reaching a point where their properties are owned outright or close to it, but like many widely held assumptions, it is worth asking whether it tells the full story, because in practice, low gearing can introduce a different set of risks that are often less visible, but no less significant.

Equity does not generate cashflow

A portfolio with low or no borrowing can look exceptionally strong on paper. High equity, low loan-to-value ratios, and significant unrealised gains all point towards financial stability, but those numbers do not pay the bills.

Equity is not income, nor is it liquidity, and equity does not fund unexpected costs or create flexibility when circumstances change.

Unless that equity is accessed, it remains largely dormant.

This creates a position many landlords recognise, even if they do not always describe it in these terms, asset rich, but cash constrained.

Liquidity is what creates optionality

The practical difference between equity and liquidity becomes most apparent when decisions need to be made.

Liquidity allows you to act.

It allows you to: 1) reduce borrowing if interest rates move against you, 2) take advantage of investment opportunities, 3) support family members or respond to changing personal circumstances and 4) manage periods of reduced rental income without stress.

Without liquidity, those same decisions become constrained, delayed, forced, or in some cases avoided altogether.

From a commercial perspective, the question is not whether borrowing exists, but whether it is being used efficiently.

Borrowing at a cost of 5% to deploy capital into opportunities returning 8% or more is not an abstract concept. It is a widely understood financial principle, provided it is approached with care and discipline.

What happens when the market turns?

Property values do not move in a straight line. That is not controversial, but it is often overlooked when thinking about risk.

If property values fall by 10% or 20%, equity reduces quickly, and in some cases significantly, yet two things remain unchanged: 1) the nominal balance of interest-only borrowing, and 2) any liquidity already held.

This creates a position where equity is variable, but liquidity is stable, and in that context, the landlord with no borrowing but no liquidity may find themselves with fewer options than expected.

By contrast, the landlord who has already rebalanced part of their equity into accessible capital may be better placed to respond, meaning the perception of safety and the reality of control are not always aligned.

The inheritance tax exposure attached to equity

There is another dimension to this that is often overlooked. Equity in rental property is not just idle, it is exposed.

Residential investment property forms part of your estate for inheritance tax purposes and does not benefit from Business Relief in the way that qualifying trading businesses can.

The consequence is straightforward. Significant levels of equity can give rise to significant inheritance tax exposure.

A portfolio with £millions of equity could, in broad terms, face a 40% inheritance tax liability on that value above available allowances. That is not a theoretical risk, it is a known outcome if no planning takes place.

Importantly, that exposure is attached to an asset which is: a) relatively illiquid, b) concentrated in a single sector, and c) not necessarily producing income in proportion to its value.

Why this matters in practice

Taken together, these factors point to a broader issue.

Low gearing can create a position where:

1. cashflow flexibility is limited
2. decision-making becomes constrained
3. equity remains exposed to market movements
4. a growing inheritance tax liability sits in the background

None of these points suggest that debt is inherently good, or that reducing it is inherently bad either. They simply highlight that the absence of debt does not automatically remove risk, and in some cases, it changes the nature of that risk.

Rebalancing, not maximising

The purpose of raising these points is not to promote borrowing for its own sake, it is to encourage a more balanced view.

Many established landlords have built substantial equity over time, often without a deliberate strategy to manage how that equity is used. The more relevant question is not how much equity exists, but whether it is working effectively.

If equity is not contributing to cashflow, flexibility, or long-term planning, it may be worth considering whether part of it should be repositioned.

That could involve refinancing, diversification, or simply creating a liquidity buffer.

A conversation worth having?

If you are weighing up your own strategy, whether that involves holding, restructuring, or reducing your portfolio, it is worth stepping back and reviewing how everything fits together.

Our consultancy does not start with a recommendation. It starts with understanding what you are trying to achieve, and whether your current structure supports that.

These conversations are typically most useful for landlords with established portfolios and relatively modest borrowing who are beginning to think about how their assets will serve them over the next phase.

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