4 Ways Property Investors Can Manage Interest Rate Risk

03/07/2021 by David M Slater

4 Ways Property Investors Can Manage Interest Rate Risk

Finance costs are the most significant expense for most property inventors. With the threat of rising inflation, the Bank of England may look to move interest rates from their historic lows of 0.1% which could have a significant impact on property investors. This article will discuss how property investors can manage interest rate risk. It will assume that the reader does not intend on paying down debt in the medium term, which would clearly eliminate interest rate risk.

Stress Test Deals. The first way that property investors can manage interest rate risk is by stress testing each deal. When you assess prospective property deals ensure that you factor in higher rates than we have currently. Rather than inputting current rates for mortgage products, increase this amount to 5, 5.5 % to get an idea as to whether the deal would still stack up should rates hit this level. Portfolio and limited company landlords may find that their prospective lenders apply stress tests against their deals anyway and therefore won't lend against higher risk deals. These checks may not be so stringent for investors with a smaller number of properties, therefore ensure you factor in your own stress tests when analysing a deal. It is important that you calculate the breakeven point, this is the maximum amount that rates can rise to before the property stops being profitable. You then are able to understand how high rates can climb to before each property starts to become loss making. Applying an average breakeven point across your portfolio could make tracking rate rises and interest rate risk easier to manage.

Fix it. The next way to manage interest rate risk is to consider choosing longer term fixed rate products. This will ensure that you are able to lock in lower interest rates for a longer period of time and will give you certainty of your cashflow for the period that the rate is locked in for. If you have any products that are currently on the Standard Variable Rate because the initial term has expired, now is a good time to speak to your broker about longer term fixed rate products. For properties that you have extracted your initial investment from after refinancing, you may wish to consider even longer products such as those above 5 years as you may be content not to refinance again in the short/medium term to raise capital.

Watch debt maturity. Property investors who build up portfolios may find it difficult to track the various different mortgage products that they have. It is important that you are able to monitor when each of your different mortgage products ends, this will ensure that you avoid a situation where you have multiple mortgage terms maturing in the same quarter. Should this happen then you are vulnerable to any interest rate rises that take place as you will be hit by increasing rates on multiple products, damaging your cashflow. The greater the amount of debt and products the higher the risk should they mature at similar times so take care here to ensure that where possible you arrange your mortgages so they don’t mature at the same time. This is a robust method that property investors can use to manage interest rate risk.

Don’t overleverage. The final way that property investors can manage interest rate risk is by not borrowing too much. It can be tempting to borrow up to the maximum, particularly when you are starting out to ensure that your limited capital can be used most efficiently to buy as much property as possible. Clearly the more highly geared you are the more exposed you are to rises in interest rates. If you have already built your portfolio to a good size them you should consider whether you need to keep refinancing your properties to release further capital for deposits. Importantly avoid a situation where you have refinanced properties to such an extent that you would pay more tax on sale of the property than there is equity in the deal, this will make you a mortgage prisoner waiting for values to rise further before you can take any profit on sale. You will be highly vulnerable to rate rises if you are in this position as you will be unable to sell without taking a loss.

Conclusion. Servicing debt is likely to be your biggest expense as a property investor and therefore it is key that property investors manage interest rate effectively. Ensure you prepare for interest rate rises even when conditions seem benign as it is likely that rates can only move upwards from their present historic lows. This is particularly important if inflation starts to bite as the Bank of England may consider rate rises to bring this under control.

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