Stress Testing Your Buy-to-Let Portfolio More Important than Ever

Private rented sector landlords certainly haven’t had an easy ride over the last 4 years or so. Section 24’s effect of majorly restricting mortgage interest rate relief combined with the Stamp Duty surcharge, buy-to-let borrowing restrictions and the looming risks of interest rate rises have resulted in a more unstable landscape to operate in. Whilst controlling the rampant speculation of previous cycles isn’t a bad thing, this new environment evidently disfavours those who are unwilling to adopt a professional approach.

Stress Testing Your Buy-to-Let Portfolio…

Stress or scenario testing your portfolio is an excellent way to avoid (or at least anticipate) any surprises, particularly as the chances of any legislative changes remain slim.

Below, regardless of the size of your portfolio, Ruban Selvanayagam, of sell house fast company Property Solvers has outlined some of the ongoing checks and balances worth undertaking on a regular basis. 

Section 24 the Finance (No. 2) Act 2015

At the time of writing, 75% of mortgage interest on buy-to-let property borrowing is non tax deductible.  Although there is an applicable 20% credit, a further 25% of mortgage interest relief will be restricted from the 2020/21 tax year.

Although there are landlords who have been receiving alarmingly high tax bills, it would be fair to say that most have been proactive in dealing with the inevitable effects of this legislation.  

Much depends on the individual’s own financial circumstances – particularly the level of gearing.  As a result, some have decided to deleverage by selling parts of their portfolio. 

Others have been transferring properties into Limited company structures or simply exiting the sector completely.  According to Savills, 120,000 buy-to-let mortgages have been redeemed since the introduction of the Stamp Duty surcharge in 2016.

The time lag between the official tax year end and when tax is owed highlights the importance of closely monitoring your portfolio’s financial performance. Even amongst proposals to increase the basic rate of tax threshold, which would result in a certain proportion of landlords becoming less exposed, it’s still worth undertaking the following:

• Use bookkeeping tools like Xero and QuickBooks to stay on top of monthly cashflow (typically using the profit and loss calculators).  These figures can then be transferred to an Excel or Google spreadsheet. A simple excel formula can calculate ongoing tax liabilities to avoid surprises and mitigate the impact of the legislation to the best of your ability;
• Use the same tools to get an average level of monthly cash flow and deduct a further 25% to get a broad understanding of what your tax liability will be post April 2020.

It’s worth referring your calculations over to an accountant to ensure that your forecasts are aligned with the legislative guidelines.

Prudential Regulation Authority (PRA) Buy-to-Let Borrowing Requirements

Accept that the days of high loan to value lending are over and lenders will be heavily scrutinising any mortgage or remortgage application you make.

You will need to ensure that the rent on the property covers 145% of the mortgage payment when the interest pay-rate is at 5.5%.  Although there is a degree of flexibility on this calculation, lenders are required to investigate your existing portfolio (and the associated debt load) alongside ongoing tax liabilities. Control the risks by:

• Keeping up to date with your accounts and ensuring you’re in a sound financial position;
• Regularly checking your credit rating;
• If you own multiple properties, checking whether there are any that will need extensive refurbishment works in the future.  These costs should be factored into your forecasts and overall liquidity profile – especially if you are considering taking on more secured debt;
• Checking what the standard variable (reversion) rates are on the mortgage.  In a situation where you were unable to remortgage, would the property’s financials still stack up?
• Checking that you have enough reserves to be able to afford any potential cash injections into the portfolio. 

It’s also worth noting that more landlords are tapping into Limited company borrowing.  Although payrates are generally higher, with the landscape is becoming more competitive, many expect more cost-efficient products to appear as this segment of the market matures.

Interest Rate Rises and Wider Macro Economic Risks

For over a decade now, commentators and economists have attempted to predict when and how the Bank of England’s Monetary Policy Committee will push up interest rates. 

It’s never been an easy call to make – particularly after the Brexit referendum.

Yet, with most mortgage holders paying less than 4% as an interest rate, future rises are likely to be gradual.  It is, nonetheless, worth preparing for such an eventuality:

• Apply different rates of interest and scenarios to your portfolio.  For example, what would happen if the market was to crash and you struggle to refinance?  Would your rent roll comfortably cover your mortgage payments and all the associated costs?
• Consider that in a market downturn falling rents and growing incidences of arrears may become a reality;
• Look at the target demographic of your tenants.  For example, if you let to those in receipt of Local Housing Allowance (LHA) be mindful of potential cuts and how that will impact your portfolio’s performance;
• Particularly in a no-deal or disruptive Brexit scenario, with an increased likelihood of an inflation surge, the Bank of England may have no other choice but to forcefully raise interest rates.  Although many mortgaged property owners will be in the same boat, the financial levers that lenders had after the last crisis (namely quantitative easing) may not be available.