How To Take The Headache Out Of Any Interest Rate Hikes That Might Be Coming
As our properties reach new heights and we take on more debt, the fear of an interest rate rise can throw us into a world of pain. Josh Master shares how you can best prepare for this.
So you’ve finally made it.
You’ve finally managed to secure a few properties over the years and your income is getting better and better. You’re carrying quite a bit of debt but hey, your portfolio doubled in the last 10 years so you couldn’t be happier.
Only problem is, you’re not.
Now that you’re sitting on a reasonable sized portfolio, you suddenly realize that despite being millions of dollars richer, you’re also carrying millions in debt.
Doesn’t this go against everything your parents told you? You’re starting to feel like a walking GFC that’s about to topple over at the unexpected news that interest rates have moved a quarter of a per cent and have wiped you out.
Suddenly this whole “property mogul” thing doesn’t sound as flash as it used to.
Believe it or not, this is the scenario that plays out in the heads of most investors and it can happen whether you’re holding property worth $500,000 or $5 million.
As our properties reach new heights and we take on more debt, the fear of an interest rate rise or our investment sitting vacant for a few weeks can throw us into a world of pain. All of a sudden, our balanced view of income and expenses starts to tip in favour of the latter and our brain starts telling us that we need to batten down the hatches, often for good reason.
Let’s face it. Property is a highly leveraged investment that holds enormous financial responsibility. Couple that with the unfortunate phenomenon called “reality” and if we haven’t made allowances for things to go a bit sideways once in a while we can face the sudden realization that we may have some major issues on our hands.
So how do we fix this?
The answer is a lot easier than you might think. Like anything though, when you’re gripped by fear it can be difficult to see the forest for the trees.
I like to make the analogy from the perspective of a running a business (because I do), but also because there are a lot of parallels between running a business and managing a property portfolio.
Successful businesses study the marketplace, do their research and come up with a financial plan that will successfully target a particular market to generate profits and build the wealth of that business.
Same goes for property investing.
Having launched a number of businesses in the past, one of the most important strategies to ensure the business survives throughout this process is to have what I call a “buffer” - enough cash to cover expenses for six months or more should your (generous) sales projections not go as planned.
This often means having to delay a launch or put more conservative plans in place for expansion, but it also means that you have a more resilient business when times are tough. You also don’t find yourself staring at the ceiling at 2 am in the morning as often.
How many restaurants have you seen spend months on a beautiful fit-out (which aren’t cheap by the way), only to find that they’ve only been open three months before they’ve had to shut their doors or the owners have had to sell and move on? In an industry that has accepted profit margins of 2% to 3%, buffers are supremely important.
The same philosophy works in property investing.
Setting aside part of your savings, or better still, some of the equity that you have available in your current portfolio, can mean that any shortfalls can easily be covered should your situation change or life takes an unexpected turn.
If you’re worried about the shortfall between your rental income and your mortgage repayments, simply work out the difference and make sure you have enough set aside to take care of things for as long as you feel comfortable. You may even want to do your own stress-test by raising the interest rate you currently pay to see what the shortfall could potentially be if rates were to rise suddenly.
Here is a comment that came through from one of my clients around a discussion on how they handled their finances:
“When I bought my first investment property I had $0.00 buffer. In the first year of holding, I had some unexpected expenses, and it was vacant for six months. For six months I spent every Saturday night at home. As a single girl at the time that was very depressing.
I (now) work out my holding costs at 7.5% interest rate and then keep two years of holding costs. It might be a bit much, but it helps me sleep well at night.”
Putting aside a buffer doesn’t necessarily mean having to take that money out of circulation either. I recommend putting the funds into an offset account or similar facility so that at least it’s working to reduce your interest repayments while it sits there idle.
Creating a buffer does take some discipline though. It really needs to be looked upon as a concrete set of funds that is for emergency only. If you think of it as a pool that you can occasionally dip into when you need this or that, you will soon start to draw on it for other things as well. Before long, you will be promising yourself that you will top it up the next chance you get. We’ve heard it all before and this is often when things begin to unravel.
So, while creating a buffer on the side may mean that it slows down the speed of your investing, it can also create the safety net that you may need should things not go to plan. After all, property investing is a long-term game, and you want to make sure you’re still there at the end.