As the owner of investment property, it is always a good idea to regularly monitor the performance of your portfolio taking into account a range of different situations that could occur. Stress testing is more often used in the banking sector - for example to examine how secure a financial instrument or model can be in range of scenarios (and using specific algorithms to deduce what the return would be within such circumstances).
In the buy to let sector, similar principles can be applied using the accounts that you would already be maintaining as well as tools available on the web. This is something that even the healthiest of portfolios needs to go through every now and then.
5 Stages of Stress Testing Your Property Portfolio:
1) Data Collection: mortgage payments; rental receipts; voids; maintenance / repair costs; tradesmen / labour costs; insurance; bank charges; gas inspection costs; transport / fuel costs; EPC charges; interest payments on other loans related to your property business; legal costs; book-keeping and other auxiliary charges (you may want to also add your property buying costs, if any). You should ensure that the information you use is accurate and up-to-date so that you are getting a clear picture.
2) Net Operating Income: this is essentially what is left after rent and all associated costs are paid.
3) Future Cash Flow Testing: whilst Bank of England interest rates stood at historically low levels at the end of the first decade of the 2000s, most people are aware that they can change at a very quick pace - particularly if inflationary pressures mount. For this reason, it is important to examine the cash flow from your properties through various rate increase increments remembering that long term averages are between 5-6% (look at historic interest rate figures using the link we have provided below). It is through this analysis that you can often weed out any issues with your properties that may be getting overlooked (and potentially save some money).
For example, are you spending too much on maintenance, repairs, insurance etc.? Could you keep some of the cash-flow by managing the properties yourself? Could you potentially turn any of your properties into a HMO (and benefit from an improved yield)? Would acquiring more property make sense (to balance out the negative cash flow you may be achieving)?
4) Releasing Money from Your Portfolio: for those who had bought property before (and during) the onset of the credit crunch, keep an eye on the various house price indices and reports (such as 'Hometrack') to see how the value of your property is moving. Look at a number of different growth scenarios to determine when and how the equity level in your property will increase in order to see, approximately, when you will able to release cash (either by selling or re-mortgaging). Note that some areas (such as London) are often less affected than others and can go up in value quicker - often due to a short supply.
Start with a hypothetically pessimistic view of negative growth to see how you will be able to handle every situation (good and bad). You should also bear in mind the fact that lenders, particularly during a downturn, tend to take a particularly stringent view with regards to valuations - it is therefore better to take a conservative approach (for example using sales and not asking prices).
5) Major Costs: lastly, and often forgotten about, is to test worse case 'real life' situations against the performance of your portfolio (refurbishments / larger repairs, boiler replacements, bad tenants etc and the ongoing costs of eviction). These costs do mount, particularly after you have owned your portfolio for some time.
With points 3-5 above, the best form of undertaking a stress test is to ensure that you will be able to sustain the portfolio if both interest rates increased; the value of your properties continued to decrease and refurbishment costs are accounted for (whilst always looking at your net operating income).
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