Property Portfolio Leverage – what is the right amount?

by Readers Question

21:56 PM, 8th October 2014
About 4 years ago

Property Portfolio Leverage – what is the right amount?

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Property Portfolio Leverage – what is the right amount?

Leverage is a topic that I spend a great deal of time thinking about. In my humble opinion a lot of writers/’gurus’ that are incredibly well respected pay little attention to how much leverage one should take on. Of course the real answer to this question is very specific depending on ones individual circumstances but do any of the forum members use any basic heuristics? Property portfolio leverage - what is the right amount

A lot of literature talks about the power of leverage (we have all read the instead of buying a £100k house outright we buy x4 with a 25% deposit etc) primarily because a number of the gurus have done incredibly well from being turbo-leveraged at one point in time. Clearly this is down to personal preference and although I have what I would call a healthy risk appetite I like to be able to sleep at night performing a variety of ‘stress tests’ surrounding my property portfolio (voids, interest rates, boilers, losing my day job etc. etc). I have read Mark Alexander’s strategy a number of times where he talks about holding quite chunky amounts of cash in the bank which I think is very prudent and I run a similar strategy by utilizing my full ISA balance each year. I would hazard a guess that other landlords are not as prudent as Mark though.

In my head, I tend to consider my primary residence and my property portfolio and other assets consolidated under one balance sheet and I am very focused on total assets / equity (my personal leverage ratio) and my cashflow coverage ratio based on interest rates stress tested at 5-7%.

The hardest thing for me is considering adding properties to my portfolio, particularly at lower implied yields than the average of my portfolio given that my leverage ratio will naturally increase and my average gross yield on the portfolio will fall.

What are your thoughts?

Regards

Jerry Maguire



Comments

Mark Alexander

22:11 PM, 8th October 2014
About 4 years ago

Hi Jerry

Increasing leverage is a bit like fitting a bigger engine to a car, it may well go faster but you could ruin the handling and if you don't upgrade everything else you might not be able to stop as fast as you need to, in which case it dangerous.

Therefore, leverage is only one of a number of considerations and needs to be balanced against serviceability and liquidity.

Some people think they are "playing safe" with no leverage at all but there is a massive "lost opportunity" cost to this strategy too. If they don't make any money from investing and they are expecting asset values to depreciate then why are they investing in the first place?

Equally crazy though are the people who stick to a set formula based on LTV. I've read forums where people are arguing about whether 60% LTV is better than 85% LTV and vice versa but both could be equally right or wrong. You've mentioned my 20% liquidity ratio (thanks for that) and in summary the theory is that cash reserves equal to 20% of long term debt should be held for the sake of prudence. However, that's not the entire story either, everything also needs to be tied into what you refer to as a "stress test". One person might be comfortable with zero profits if mortgage rates hit 4%, others (like you and I) will be happier at 6% or 7% whilst some would never sleep at night unless their break-even figure was anything less than double digit interest rates.

I would advise all landlords to "stress test" their own properties. It's free and we have built a very simple template so that anybody can run the figures for themselves without being a spreadsheet wizard or having a degree in maths - see >>> http://www.property118.com/calculating-rental-yields-and-returns/

My suggestion to anybody who is uncomfortable with the results from the Landlords Calculator (breakeven interest rates for example) is to consider adding Equity Finance to their portfolio in order to reduce interest bearing mortgage debt - see >>> http://www.property118.com/equity-finance-for-buy-to-let-landlords/44713/
.

Mark Alexander

22:27 PM, 8th October 2014
About 4 years ago

Sorry for double posting Jerry but I missed a crucial section of your article which you were seeking comments on.

With any form of leveraging there is a certain element of speculation. I agree that adding another property to your portfolio, which is at a lower yield than the average, will reduce your overall yield and increase your risks. However, I would add - only in the short term! If you think values are unlikely to increase and that rents will not go up then why are you not selling your portfolio right now and investing into an alternative asset class?

Unless you have significant surplus income to invest (thankfully I did in years gone by) then the only way to grow a portfolio is to speculate when a realistic opportunity to raise cash via refinancing presents itself.

One thing I know for sure is that constant change is here to stay!

Just 6 years ago it was possible to get a lifetime base rate tracker mortgage at 90% LTV at a rate of less than 1% over bank base rate for life with free legal fees, no arrangement fees and no valuation fees. When I tell that to newbie landlords they think I'm telling fairy tales! However, six years ago equity finance for the average landlord was unheard of too, the newbies are aware of it now but many more established landlords have their blinkers on and still moan about high rates and fees yet ignore the new innovations. The deals of 2003 to 2008 are a period for the history books to be cherished by all who built their fortunes during that period.

I wonder what landlords will say when they look back and and discuss where we are now in 6 years time?

Will they be kicking themselves for missed opportunities?
.

Mick Roberts

7:35 AM, 9th October 2014
About 4 years ago

What I don’t see a lot on these sites, is IF someone has 4 x 25% deposits, why not buy one cash (if at bargain discount), spend your few k doing it up, get tenant in, make the deal look attractive, then re-mortgage & quite often you can get ALL your money back, sometimes more.
I know nowadays, you may have to wait 6 months to re-mortgage, but if you can, you should never run out of deposits & can keep buying forever, if you want to.

Mark’s formula is very good, you’d be hard to go wrong playing his safe maths, but Mark u gonna’ tell me off. I’ve spent all me money this year buying houses, never been so skint for years. But there is a reason & I am sending a message out here, bargains are hard to find, & if you are confident the deal stacks up & you gonna’ get the rent in shortly after u get the key,s, then I say go for it, don’t waste time thinking too much, ‘cause u can be rest assured, in normal circumstances, u gonna’ be paying more for that property in a few years time-IF you get it at the right price today.

Mark Alexander

9:29 AM, 9th October 2014
About 4 years ago

Reply to the comment left by "Mick Roberts" at "09/10/2014 - 07:35":

Hi Mick

Why would I tell you off?

You may make a lot of money very quickly if these properties shoot up in price.

Likewise, I wouldn't say "told you so" either if they don't and you can't afford to go on holiday or pay your mortgages etc.

Your money, your future, your choice!

I thought you had taken the decision to stop investing and start living though?

Addictive this property buying isn't it?

Six years on from breaking that buying addiction I still cant stop myself from looking though every estate agents window in every town I visit - that's regardless of what country I'm visiting at the time too LOL
.

James London

11:43 AM, 9th October 2014
About 4 years ago

Reply to the comment left by "Mark Alexander" at "09/10/2014 - 09:29":

Hi mark,

I have read your strategy and have acted on some of the advice namely reducing the equity held in my properties, you mention that you should try to hold a large cash reserve but if you do that how can you grow your portfolio if that is all the cash you have? Is the cash reserve more of an ideal situation you would try to attain or I’m I missing something?

Cheers

James

Mick Roberts

12:09 PM, 9th October 2014
About 4 years ago

You’d tell me off ‘cause I know & agree, we should always leave some money spare, but I broke the rule this year ha ha.

Yes, would need discussing verbally, but I know you like to share things, so vaguely, seems daft to the outside about living more & then buying more ruddy houses, but I’ve been buying better quality houses, so more work now buying ‘em, setting ‘em up. Although my tenants have been finding ‘em for me & them, so no time cost to me there.

And with these being better area houses, in the long run, should be less time to run ‘em, as better quality tenants, value them more, want to stop forever, as normally can’t get any better than these better area houses, & no rush in making them look secure if tenant leaves on a Fri night, as these areas less prone to the crooks.

So hassle now, easier later.

Yes it is ruddy addictive, my drug had worn off about 5 years ago, but this year, it has got ruddy addictive

Mark Alexander

12:28 PM, 9th October 2014
About 4 years ago

Reply to the comment left by "James London" at "09/10/2014 - 11:43":

Hi James

Yes the cash balances are the perfect scenario and not a precise science. If you read Mick Robert's posts above you will see that some landlords take bigger risks. Sometimes it pays off, sometimes they end up bankrupt. That's what risk taking is all about.

I don't like to think of myself as a big risk taker and I would certainly advise caution to anybody building a rental portfolio. If it's a case of more properties and no liquidity or safe levels of liquidity and no more property I would always choose the latter - but that's just me.

Work on building up your liquidity so that you can have a bit of both, i.e. liquidity and investment.

If you want to roll a dice at the risk of losing everything then follow Mick's strategy - you might just get lucky 😉

You might also win the lottery ......... if you buy a ticket of course! ........ but I don't ........ so I will never win it.
.

John Daley

12:39 PM, 9th October 2014
About 4 years ago

I think this debate is too personal for anyone to say there is anything as firm as a recieved wisdom or a set of rules for this.

Leverage is balanced against personal circumstances, financial resilience, personal risk appetite, your own financial position, future financial stresses from careers and family.

That just the personal stuff, then you have the political and economic factors, legal developments, regional property markets.

So it's not simple but it is possible to navigate it with a little thought and planning. I think a lot of landlords buy into the story without really building a business plan and then when things go wrong they are stuffed because their circumstances can't cope with adverse events.

It's really important to know what will be left of the rent after the costs of letting have taken their share. I have done some work in social housing that indicates it costs about £2 k a year to own & manage a social home in the long term.

That is based on maintaining the decent homes standard in perpetuity. In the PRS you have to plan for tenancy churn and voids which are not really a factor in the social area

What happens if interest rates go up to 3% in the next two years. It is a possible scenario, how many landlords would have to sell ? How many would have to stop doing maintenance or safety work or face going into a loss on their properties.

We saw a few months ago a report on a landlord with four or five properties who would have been substantially better off by never going into letting.

At the end of the day high gearing is always a substantial risk factor in all types of business, loads of companies and individuals have gone down as a result of over borrowing.

On the other hand there are those who have made a bundle by riding out the risks, though I think that might be a bit too adventurous for the average investor. Is anybody really sensible to commit their assets to what amounts to 'luck'

Mick Roberts

12:46 PM, 9th October 2014
About 4 years ago

Ha ha roll a dice.
I wouldn’t recommend my LATEST way for a lot of people, but in my case, there are other factors where I’m reasonably safe.

I’d have been better off not going into letting on my detached properties 10 years ago, but finally last 5 years, they’ve redeemed theirselves.

James London

13:21 PM, 9th October 2014
About 4 years ago

Reply to the comment left by "Mark Alexander" at "09/10/2014 - 12:28":

Thanks Mark that has clarified things for me, assess how comfortable you are with risk and invest accordingly, the funds that I released through refinancing was pretty much my initial investment, I have some saving which will act as my raining day fund, I was going to invest that as well, but I think I’ll just invest what I released via the remortgage, which would be the same position in terms of seed money as I was before I first bought the properties.

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