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I am thinking about the next stage of growth for my small portfolio of properties and would welcome any views on stress-testing. Is it sensible?
What do you stress-test for?
What numbers would you use in a stress- test?
If you're getting mortgage finance, they'll stress-test the rental cover for individual properties and your whole portfolio. They'll also look at the LTV across your whole portfolio.
I've written some explanations and Excel formulas for rental cover here.
The interest rate and rental cover rate used for stress testing varies between lenders but I think they're currently around 5% and 150% respectively. I'm sure a mortgage broker will provide more accurate figures for these though. :-)
From a management point of view, I'd suggest that you also apply a stress test to your cash reserves. The more properties you have, the more often something will need repairing. Could you cover an unexpected new boiler or roof repair? What about a couple at the same time (if your portfolio is large enough)?
Landlord | PaTMa Founder | http://www.patma.co.uk | Property and Tenant Manager
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Thanks Simon - i’ll certainly look at the spreadsheets appreciate the links.
Any thoughts on why a certain LTV would be an issue?
Some lenders wont allow high portfolio wide LTVs but the criteria and levels vary.
If your portfolio is owned personally, a high LTV can be a big warning sign for issues with the Section 24 tax changes.
It depends a lot on your personal situation and strategy, etc; but I'd suggest 75% LTV or higher is getting risky. I think many landlords are trying to stay well below that now, perhaps more like 50% - 60%.
Thanks for your reply. Sorry but I don’t understand. How is LTV by itself relevant to a stress test?
Loan to value (including across a portfolio) is just another factor that lenders will look at as part of their decision.
I don't think it would be part of the official rental cover stress test. That's calculated from the rent, mortgage amount, a higher "stress" interest rate and the required rental cover percentage.
You may want to consider it in your own stress testing though - what would happen if property prices go down (or even crashed), is it important for your plans that you stay in positive equity? If so, LTV feeds into how much of a market shift you could sustain.
For Section 24 it's not LTV directly but it's an indicator of risk - is your portfolio still profitable after tax in 2020? If your LTV is high, you definitely need to check!
OK so I get that it’s an issue for further lending at the same rate, but, I think the real risk is in high gearing isn’t it? There’s little risk of financial collapse if I have one property worth £100k with an LTV of 75%? If I have £100k in the bank is there?
And even for getting a new deal - I could just pop down an additional £5k and jobs a good-un?
So do you think an FA will look at the historic changes in house prices, and calculate a probability of a major drop? Otherwise I guess there is no context for comparison is there?
If you've got cash in the bank then it mitigates most risks! :-)
You'd need to check with a mortgage broker or financial advisor about how/if lenders consider such things.
Purely speculation but I doubt a lender (or most FAs) would look for specific histories and probabilities. Hence the very sweeping rules of max LTV and the rental cover tests - simple tests that are easily calculated.
You may want to dig deeper for your own stress tests though and I'm sure you could find an FA who would help with that.
Without the comfort of cash in the bank, this calculation shows what might happen to a 75% LTV buy-to-let costing £100k if the interest rates go up to 6% (pretty unlikely, but we are talking about stress testing). In the current market of cheap mortgages it could be making 12% ROI. But at a 6% interest rate it's making a loss after tax for higher rate payers. If the mortgage was only 60% LTV though, it would stay profitable even at 6% interest and after tax.
That’s really useful. Exactly the type of thing I am looking to work out! Cheers
But a large and heavily leveraged portfolio in the North - where in many locations prices are static/falling (Manchester excepted) is implicitly at risk if there is a major rise in loan costs - which could be an issue with a no deal Brexit if Sterling fell and Govt needed to attract inward capital via higher interest rates.
In turn that begs question as to whether you are unilaterally stress testing your BTL investment - or more widely stress testing your personal finances.
I think it has to be a stress-test go overall financial risk. I would bail-out my property investments if needed - in fact, I think this is a key part of my risk management.
As per above posts I think LTV by itself is irrelevant. I like to hold capital to deleverage as I think it would help me negotiate with the banks if I had problems. If they have my money I’m pretty sure they would just bankrupt me by calling in the loans in times of trouble.
Do you stress-test across both, or just your property portfolio?