Property rental during a recession… top tips!
First Published: September 2022 | Available in: Property Articles Your Property NetworkThe economic pointers are signalling a continued rise in the Bank Rate during 2022, perhaps towards the Bank of England’s ‘neutral rate’ of 2.5%, and a recession is also predicted to last until at least 2024.
A key risk facing property investors is the impact of higher interest rates on their business – since finance interest is usually, by far, an investor’s largest expense. Plus, the ability of tenants to pay their rent given the cost of energy currently.
This article considers how property investors can survive these turbulent times…
Bank of England warning – the UK will fall into recession in late 2022, for at least 1 year
The Bank of England (‘BOE’) has formally predicted in its latest report that the UK will enter a recession from Quarter 4 2022, which is expected to last until at least 2024, with inflation set to rise to 13% or more, as a result mainly of the Russia-Ukraine war and the impact on energy prices.
The BOE’s main weapon against inflation is to increase the Bank Rate, with the intention of increasing borrowing costs to encourage consumers and businesses to spend less. Bank Rate has increased 6 times since December 2021, from a low of 0.1% to the current (mid-September 2022) 1.75%.
As most landlords use mortgages to grow their property business, this will mean higher mortgage interest costs, either now for variable-rate mortgages, or in the future once fixed-rate mortgages expire… on top of the increased risk resulting from tenants having themselves less money if they have borrowings, plus the increase in energy costs.
So, how can property investors can survive these turbulent times…
1. Ensure adequate cash reserves
Cash reserves are essential to ensure survival in a high-interest rate world. Many investors think this means a having £2-3k in their current account. Realistically, this may not last long! Consider aiming for 3-6 months of mortgage payments, or an amount per property. That’s a ‘running balance’, to be restored as and when dipped into. The key requirement is access to liquid cash to fund any rent arrears, unexpected repairs, and rising interest costs.
Remortgaging existing property, using low-rate credit cards, cheap personal loans, & using an offset mortgage, are all ways to maximise cash in the bank.
This may seem counter-intuitive – most people would prefer to reduce debt, not increase it – the purpose is to build a financial fortress, and the elephant in the room is that mortgage interest payments can’t be added to the mortgage, or capitalised (as they were during the Covid crisis), no matter the amount of equity in a property.
High inflation will erode the true value of debt, but surviving higher interest rates and rent arrears will separate those that survive, from those that don’t.
Top Tip: Interest on ANY borrowings to finance a working capital fund is tax deductible (albeit subject to the ‘Section 24’ mortgage interest restriction). The borrowings are treated as business debt, regardless of where the funds are secured.
2. Sell property to shore up funds + eliminate poor / average properties
Perform a financial analysis of your portfolio – do all your properties generate a good (as opposed to “OK”) yield. If not, either accept that you will need to lower the debt, or consider selling any properties that don’t have a good rental yield.
Remember, achieving capital growth means always having cash resources to ‘stay in the game’ and if in tough times that may mean 1 or 2 properties need to be sold, then so be it. While there is a case for carrying property with “OK” yields in periods of low interest rates, it’s risky to drain cash reserves by funding poor-yielding investment property as rates rise.
Assuming a decent price can be achieved, consider selling off enough property to build up the cash reserve buffer. This is pure survival – most investors don’t want to sell, but sometimes you may have to move one step back (during the recession) to move two steps forward (after the recession).
Top tip: Complete a CGT / mortgage review of your portfolio, to see which properties could be sold to release the most cash from the sale i.e. a combination of the least amount in CGT plus releasing the maximum equity after settling the mortgage.
3. Pay down (some) debt
Many landlords are sat on old tracker mortgages (what Robert Kiyosaki would refer to as ‘good debt’). There seems little point in repaying such business debt, given the interest is tax-deductible, & re-mortgage rates and prices in the future are likely to be higher.
But, personal loans, credit cards, car finance, mortgages on the lender’s own Standard Variable Rate, may be worth paying down, or off. Look critically at the way the portfolio is financed … is each mortgage the best rate that could be achieved given the Loan To Value? This is where a good mortgage broker can be valuable – by ensuring that the optimum financing structure is in place.
Top tip: Don’t pay interest rate on debt just to get a tax deduction – analyse your various debts & use spare cash to repay ‘bad debt’ – AFTER you have built that all-important cash reserve, of course. Interest is a cost, just like any other.
4. Can rents be raised?
Consider if rents can be raised, on both existing and new tenancies. Many landlords don’t raise rents for years on end, and then find themselves receiving way below market value rent … that’s very kind, but remember you are running a business!
For each property, review the current market rent and compare that to the current rent … across a portfolio the difference can really add up. Rents can be increased via a Section 13 notice to the tenant, which doesn’t require a new tenancy agreement to be signed. Obviously, presenting this to the tenant needs to be done diplomatically, to ensure a good future relationship.
Also, consider converting properties from single to multi-let if suitable, to increase net rental income. Or, develop the property cost-effectively (e.g. alter the layout) to generate a higher rent. Think about all options!
Top Tip: Higher rents offset higher costs, and while there is certainly a benefit in having a low tenant turnover, more money may be ‘left on the table’ if rents are allowed to lag behind market rates significantly, and for years at a time.
5. Provide a superior property
Well-maintained properties means higher demand from potential tenants, better-satisfied tenants, justification for higher rents, and lower voids.
Talk to your tenants – would they appreciate some additional storage, fresh carpets, some redecoration? Would they mind paying extra per month if you were to do the works they would like? Just £50 per month extra rent across a 10-property portfolio means an extra £6,000 per year – the equivalent of carrying £120,000 less debt at 5% interest! Think about that!
Top Tip: Repairs and maintenance is fully-tax-deductible from rental profits – for many landlords who are now Higher Rate taxpayers due to Section 24 this means the taxman contributes 40% towards the cost of repairs.
6. Increase income from non-property rental sources
That means maximising your income from your job, or business (or side-hustle!). Ask for a pay rise, ask for extra cash instead of non-cash benefits, hack at every business expense possible, raise prices any way you can – be bold!
Top tip: Fortune favours the brave! People don’t usually buy goods and services based solely on price … are you aware of the value you bring to your employer, or to your customers, if you are employed or self-employed? Could you increase your income by fully-leveraging your skills and experience if you have non-property income source, by making sure you are not underpaid?
7. Commission a tax review
Examine your tax strategy (if you have one!) & check with your accountant that all possible options to increase income & reduce costs, including tax, have been considered. It’s a rare client that has nothing at all that can be improved! Property investors have umpteen options to save on what can be a massive expense – taking 40-50% of net profits for Higher Rate taxpayers.
Top tip: Professional fees are fully tax-deductible against rental profits. DIY tax-planning is not advisable for portfolio investors! But treat tax like just another expense – to be accepted as a fact of life, but minimised proactively.
8. Run your business professionally
Some landlords talk a good game about being ‘serious investors’, but the reality is that many don’t give their property business the time and effort it deserves. Time spent ‘minding your own business’ is time well spent. Big companies often have outside consultants look over their operations and finances – could you ask your fellow landlords for help, or discuss how to improve your business using forums, Facebook etc.
And, time spent on maintaining that all-important ‘tenant rapport’, checking if any works are needed on properties, improving financial management processes, and generally taking a proactive & hands-on approach, will be well worth it. Property investing is not ‘passive income’, as some would have you believe (if only!).
Top tip: Any costs incurred ‘wholly and exclusively’ for business purposes can be claimed as an allowable expense – provided you have good records & the costs isn’t specifically excluded as a tax deduction (e.g. ‘tenant entertaining’!).
9. Buy more property
Higher interest rates will cause many homeowners & investors pain – & they may well need to offload property quickly, which may mean some bargains are available. If you are able to fund deposits, remain credit-worthy, there may be opportunities to buy property more cheaply. It’s a sad fact that not every property owner will be able to survive a recession – for those that do, the extra reward will be the opportunity to source property at significant discounts.
Top tip: Remember – landlords are taxed on the profits of the whole portfolio – so upfront costs associated with new purchases can be used to offset profits from existing properties.
10. Cut your cloth!
Desperate times call for desperate measures … sometimes we all need to watch the pennies, and landlords are themselves also consumers, who may be paying more for their home mortgages and +energy costs.
In the real world it’s probably unlikely that all of the increase in mortgage costs can be passed onto tenants, so keeping a careful eye on your own expenses is also needed … many landlords have enjoyed bumper (and unexpected) rental profits since the Bank Rate was dramatically reduced to 0.5% in March 2009 … but now is the time to ensure that money is not wasted in times where more financial restraint may be required.
Top tip: Charles Dickins said in his book ‘David Copperfield’: “Annual income 20 pounds, annual expenditure 19 pounds 19 shillings and six pence, result happiness. Annual income 20 pounds, annual expenditure 20 pounds ought and six, result misery” … still true in 2022!