Low-interest rates and robust rental demand mean many property portfolios have been in the black rather than the red over recent years.
Historically rock bottom rates resulted in reduced mortgage repayments and a growing pool of very happy landlords.
But times can and do change.
And when they do, how well do you think your property portfolio will fare?
Will it survive the stress test challenge?
Here’s the thing: the Reserve Bank may not have increased the cash rate, but lenders have certainly been upping the ante for investors.
Interest rates for investors as well as the rate payable for interest-only loans have been ramped up by about 0.5 to 0.7 percentage points over the past 12 months.
Now the majority of investors have been able to wear these increases without too much trouble.
But what about if rates went up by another percentage point or even more?
How would your cash flow cope with that scenario?
Let’s consider a $500,0000 interest-only loan that previously was costing you interest of four per cent per annum over a 30-year loan term.
12 months ago the monthly repayments on that were about $1,666 but today – today at 4.7 per cent – it’s about $1,958.
Say investment rates keep going up (and that will happen one day) and hit six per cent, what will your monthly repayment be then?
It will be about $2,500 or about $834 more per month than it was not that very long ago.
How would your portfolio survive that additional repayment stress?
Let’s face it: capital city rental markets have been in good shape for the past few years.
Today, however, we’re starting to see some softness in some parts of the market – namely inner cities area with an oversupply of new units.
There’s more supply on the market than there is demand from tenants, which means some landlords are having to drop rents to secure new tenants.
And even if they do that, they could be faced with a period of vacancy when there is no rent coming in whatsoever.
So, again, if your repayment is about $2,000 a month, how would you survive that rental vacancy stress test with no rent?
(Of course, if you own investment grade properties in the right location, this is unlikely to be a problem for you.)
I’ve said it before: one of the keys to investment success is to maintain your properties to a high standard.
Not only will that mean that you’ll have access to a wider selection of good tenants, you’ll be able to achieve a stronger rent and it also means that your repair costs can be kept to a minimum.
The fact is: no matter how much preventative maintenance you do, there will always be unexpected repairs.
Your hot water system may break down or the roof may start leaking.
As is right and proper, there are a variety of repairs that are classed as emergencies under residential tenancies legislation. And that means they need to be remedied as soon as possible.
How would you survive that cash flow stress test if you had a repair bill in the thousands of dollars without any notice?
It should be fairly obvious by now that in such a circumstance you need to have access to excess funds – perhaps in your “rainy day buffer” in a line of credit – to pay for all emergency repairs.
Of course, adequate insurance will ensure you are covered for most emergency repairs.
But the devil is in the detail.
In Queensland, for example, insurance policies that didn’t include flood damage were not covered during the devastating 2011 flood event.
So it’s imperative to understand what your policy covers and any potential exclusions.
Otherwise, the costs for repairs will need to be borne by you, which can hit your pocket twice!
Once for the initial repair costs and secondly for any income loss, you may experience while repairs are taking place on your property.
Another insurance stress test is personal insurance such as income protection, which can assist when you are unable to work due to unexpected illness or injury.
If you’re unable to work and have no income coming in, how will your portfolio last the distance?
Probably not overly well in my opinion.
The lesson from all of this…
Unless you live under a rock, you’re probably aware that life is full of ups and downs.
So to sustain an investment grade property portfolio over the many years it takes to create wealth, you must learn how to ride these peaks and troughs.
A good place to start is to recognise some of the stresses that can come and go during our lifetimes.
And be prepared to overcome them when they do.
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