When interest rates start going up, bond payments follow swiftly and, just like that, a surplus can become a shortfall. Or a small (manageable) shortfall can suddenly become a big (unmanageable) shortfall.
If you have a R1 200 000 bond and interest rates go up by 1%, there will be an additional R12 000 a year or R1 000 a month that you need to pay. Now imagine you have 10 properties. Suddenly, you’ll need an extra R10 000 monthly on your shortfall just for interest. And what if interest rates increase by not 1% but 3%? That means you’ll need R30 000 monthly on your shortfall just for interest. How do you hedge yourself against this risk?
The two most common ways to do this are to fix your interest rate and ensure you have a sufficient reserve fund (accessible cash in your access bond/flexi bond). Unfortunately, fixing your interest rate can be expensive in itself (you might get a higher fixed interest rate), and you don’t always know when interest rates will increase.
Reserves can at least help you subsidise your property portfolio shortfalls. You can either build these reserves up over time or, even easier, access them through refinancing. It is recommended to always have at least 15% of the value of your properties in cash as a reserve fund. If you are older, you can increase this percentage. But what if you don’t have a fixed interest rate or you have insufficient cash reserves in place? Here are the top 5 things you can do to improve your property portfolio’s cash flow and hedge against the risk of interest rate hikes.
1) INCREASE RENTAL INCOME
Stay updated and aware of when rental escalations should take place and ensure you escalate your rent by enough. Remember, even if a tenant can find a slightly more affordable property nearby, moving is a tedious process with a lot of costs involved, so they might decide rather to stay on.
Also, look at which services you are paying for. For example, you could charge fees such as electricity, water, and sewerage to the tenant. With estate properties, even the levies are sometimes charged to the tenant.
You could also consider changing the purpose of the property, for example, turning the property into a multi-let or short-term rental property (e.g., Airbnb).
If you manage the property portfolio yourself, another option is to charge additional fees, such as contract fees, monthly admin fees, late payment fees, etc.
2) CUT BACK ON EXPENSES
If you can’t increase your income, look at decreasing your expenses. List the expenses for your property portfolio and decrease or cut them out if possible. You’ll likely be able to find something to cut back on.
Some examples of how you can do this are pushing back when body corporates want to impose special levies or challenging the municipality’s valuations that affect rates and taxes. You can also look at reducing or eliminating rental commissions.
When you manage your property portfolio well, it goes a long way to increasing cash flow.
3) RESTRUCTURE YOUR DEBT
Restructuring your debt is a great way to improve your cash flow. The goal with restructuring is to increase your term (reducing monthly payments), decrease interest rates (also reducing monthly payments), or make additional cash reserves available (thus having cash available to subsidise shortfalls). By restructuring your debt, you are either doing a bond switch to another bank, restructuring with the existing bank, or simply refinancing.
4) GET A PARTNER IN
You may not be able to afford to own this property portfolio by yourself. If this is the case, have you considered bringing in a partner who can assist with cash reserves in the form of a loan or equity?
It is certainly preferable to rather own 50% of a property portfolio than lose 100% of a property portfolio because you could not manage the shortfalls.
5) SELL SOME PROPERTIES
Lastly, you could sell some of your properties. This option is a last resort, but one would rather have a smaller portfolio than no portfolio at all. And sometimes selling is the best or only option you have.
But beware, you do not want to become a desperate seller who will sell at any cost to survive. It is therefore important to plan and act early on if you have to sell. Make sure the property is in a good condition and that you have enough time to sell to get a decent price.
Ultimately, you can build a successful property investment portfolio that will provide long-term growth and stability through proactive planning, smart decision-making, and ongoing evaluation. Shortfalls are a challenge for property investors, but when you follow these steps, you can mitigate the risks and improve your cash flow.