Even in “more traditional” economic environments there can be significant swings in interest rates and property price performance. The fact that since 2008, and the onset of the worldwide economic downturn, we have seen swings in currencies, economies and property prices the like of which we have never seen before says everything. It may seem a little bizarre, it may seem a little extreme but do you ever stress test your property portfolio to see how you might perform under different environments?
What is stress testing?
Stress testing is simply a means by which you use an array of different variables to try and forecast how your finances would perform under various circumstances. The variables would include things such as base rates, property price movement, rental income, increased costs and other similar variables. Only a few years ago it may have seemed extreme but as we have seen over the last eight years you just never know what is round the corner.
Stress test your finances
The best way to stress test your finances is to vary the cost of finance, cash flow and forecast property price movement. It is relatively easy to calculate the change in finance costs as interest rates move higher and lower and you can also do this over a period of time using different rates in the future. If you are familiar with spreadsheets it is fairly simple to set up a form which will calculate cash flow, forecast property price movements, etc and immediately give you an indication of how your finances would look in specific economic environments.
There is no point in stress testing your finances on very small variances, instead use the best and the worst case scenarios and other levels in between. You will very quickly be able to see whether you have sufficient “financial headroom” in the event of unforeseen circumstances or perhaps costs which you have not planned for.
After stress testing your finances and your portfolio you will very quickly see whether you have any potential issues going forward. There may be a slight shortfall in cash flow under certain circumstances, you may need to re-adjust your portfolio to provide stronger long-term cash flow as opposed to short-term speculative investment returns or you may find you have the perfect investment set up. If you do find any issues you do not necessarily need to act immediately but perhaps consider some kind of backup plan which you can fall back upon.
It is amazing to think of the number of people who have never even heard of stress testing let alone carried out this action on their own finances. Stress testing also works for general finances allowing you to predict, with some degree of certainty, future cash flow. While some may become concerned if they find issues and shortfalls in the future, the whole point of the exercise is to flag any potential problems going forward and give you time to address them.