14:33 PM, 27th October 2010, About 13 years ago
Mark Alexander explains why, even though rates at these levels are extremely unlikely, high interest rates due to high inflation over a sustained period could actually be extremely good news for landlords who follow The Money Centre strategy of combining liquidity and high gearing.
Do you think the people predicting 8% interest rates and 10% inflation are scaremongers?
I read all of the Bank of England reports, the minutes of the MPC and regularly attend local BoE events and nothing from them suggests this is a likely scenario. Are the people who forecast these results naïve or do they just want to get their names in the papers, some might ask.
Nevertheless, I thought it would be a good idea to put these sorts of figures into our Property Portfolio Review forecasting model to see how devastating the impact of 10% interest rates, 10% property growth and 10% interest rates might actually be to landlords.
The outcomes showed that the critical period would come in the first few years, particularly for highly geared borrowers due to negative cashflow. However, for landlords with high liquidity, regardless of whether they are highly geared or not, the longer term prognosis would actually be incredibly positive. These findings fully support the property investment strategy that The Money Centre has been promoting now for over 20 years.
I used the following assumptions; a £1 million property portfolio with a current gross yield of 6% and 80% borrowing. The figures used to calculate insurance premiums, voids, maintenance, lettings costs and management are based on national averages. Costs are increased in line with inflation. I’ve assumed that for the purposes of this case study that the landlord owns 8 investment properties and tenants change every 12 months.
Property will double in value every 7.2 years which equates to 10% average growth rate per annum.
Interest only will be paid throughout the term of all mortgages.
Properties will be owned indefinitely.
Rental income, property insurance, maintenance costs and Find a Tenant costs will rise annually in line with an inflation rate of 10%.
The cost of Management will remain constant at 10% of rent.
Interest rates will remain constant at 10% per annum after the first three years.
Required minimum monthly cashflow will remain constant at £0 per month.
The buy-to-let property portfolio will be refinanced every 36 months to release the maximum amount of cash assuming an interest rate of 10%, interest cover of 125% and gearing at 0%.
Lenders fees are assumed to be paid up front and are not included in these calculations. The lender may allow you to add these fees to the mortgage advance. Your broker will be able to discuss these with you and to provide you with an alternative illustration of mortgage costs including all fees on request.
As the table shows, the landlord would have a tough time for a few years in terms of negative cashflow. However, with cash in the bank the landlord would be in a position to fund the losses for a few years and look at what happens after that!
The Money Centre’s Property Portfolio Review service includes forecasts prepared on a variety of scenario’s specific to their client’s property portfolio. A Consultant visits the landlord at their own home and subsequently delivers up to three 28 page reports, each outlining the strengths, weaknesses, opportunities and threats associated with the landlords own best and worst case scenarios. The service costs just £495 including VAT and comes with a total satisfaction money back guarantee.
Landlords who are worried about high interest rates should think long and hard before switching to new fixed rates as interest rate margins have typically doubled in the last 2 years. However, raising money against properties with little or no mortgage secured against them, in order to build a liquidity fund, is strongly recommended.
To arrange a Portfolio Review meeting with a Consultant recommended by The Money Centre please telephone Neil Patterson on 01603 428560. Payment for this service is by debit or credit card only. Alternatively, if you simply require advice on remortgaging one or more of your buy-to-let properties to increase your liquidity reserves, please call our Customer Care Team on 01603 558111.
To some of our readers, the thought of borrowing money at 4-5% interest rates now, simply to create a liquidity fund, might seem like a crazy notion. However, if inflation and interest rates do ever get back to 10% or higher, as they did in the early 1990’s, try borrowing money then! The banks and building societies will be running for the hills like we’ve never seen before. This will force more and more people into renting.
Having a liquidity fund isn’t just important for use as a rainy day fund in the event of high interest rates though. It’s also useful for estate planning purposes and investment diversification. The other thing to bear in mind is that the differential between interest paid and investment returns are relatively low and constant when combined with effective tax and financial planning. The Money Centre also have partner arrangements to provide both Tax and Financial Planning advice, details of which are accessible by contacting the Customer Care Team on 01603 894525.