Let’s have a more detailed look at how we can do some risk analysis.
Often the different scenarios are not as black and white as our rudimentary analysis suggests and we might want to assess the risks of, and look at the consequences of, events within a range of possibilities.
What do I mean by that? Think of this example. We might be worried that if interest rates go up, we won’t be able to afford our finance and the property may go from being cash flow positive to cash flow negative.
So we can ask ourselves “How likely it is that interest rates may go up?” and come to the conclusion that there is an equal chance. But we will need a more detailed analysis before we can decide whether this is something we can live with, or plan for, or whether we should continue with the deal.
Or perhaps you are worried about void periods and want to know how much void you can cope with before the property becomes financially unviable.
What we are trying to establish is “What if?” as in “What if interest rates go up?” or “What if I can’t find a tenant?”
Let’s think about a £200,000 apartment which we can let at £14,400. We have taken out an 85% mortgage of £170,000 meaning we have put in £30,000 of our own money and we are paying an interest rate of 6%.
We can calculate the net rent after costs as follows:
Rent Received £14,400
Less
Mortgage @ 6% £10,200
Management fees £ 1,440
VAT on management £ 252
Insurance £ 100
Service charge £ 600
Rent net of costs £ 1,808
At a weekly rent of £277 this means that we can cope with total void periods of six and a half weeks before the property is cash flow negative.
Now we have some actual figures to work with we can start to make more informed opinions. We may think it is highly unlikely that the property will be vacant for six weeks in any given twelve month period. Or we may think it is likely to be vacant more than six weeks, in which case why buy?
What about our worry about interest rates? Well, we can work out at what point it becomes critical.
By using trial and error and a range of rates we can work out that cash flow will be breakeven at just over 7%.
Rent Received £14,400
Less
Mortgage @ 7% £11,900
Management fees £ 1,440
VAT on management £ 252
Insurance £ 100
Service charge £ 600
Rent net of costs £ 108
So we can now assess the likelihood of interest rates going from 6% to 7% and decide whether that is a risk we are prepared to take, and we can consider what we might do to mitigate the situation if itdoes happen.
Here’s to successful property investing.
Peter Jones B.Sc FRICS
Chartered Surveyor, Author & Property Investor