Well, only a week ago I didn’t expect to be writing this article! We are currently in the middle of a global pandemic, with unprecedented government intervention, which changes on a daily basis.
Obviously, the priority is to remain safe and well. But, it would be remiss of us not to think about the coronavirus impact on our property investments, especially if this turns into a protracted time of shutdowns and financial impacts.
During this crisis, it is already clear that cash flow is king. An old saying, but the truth of that statement is becoming obvious, as you can’t spend the equity in your property investments.
So what does the risk from coronavirus look like across your portfolio? You may be finding yourself asking the following questions:
- Under what scenarios could your cash flow be impacted and what would that look like?
- How robust is your portfolio?
- What can you do to mitigate the impact?
- This article will give you the tools to answer this question.
The ultimate aim is to build a model based on working assumptions that forecasts the impact to your cash flow in instances where tenants can no longer pay their rent.
Please note: Although it is important you understand the process of building a risk model so that you can tailor it to your needs, I have provided a FREE Coronavirus Cash Flow Analysis Calculator that will work this all out for you (note that after completing the pop-up form, an email will be sent to you with the download details).
But it is important you understand how I have built this example coronavirus risk model, so please read on to get the most out of the calculator.
To begin, let’s break down how you build such a model step by step.
Step 1: Modelling Assumptions
For the purposes of this article, I am going to assume the following remains true following recent government announcements:
Across All Property Types:
- No evictions possible for the next 3 months. This basically means we have to accept any non-payment of rent, for whatever reason.
- BTL lenders to allow a 3 month mortgage payment holiday (although details are sketchy. Do you have to prove your tenant is impacted by COVID-19, for example).
- Workers in the retail and particularly the hospitality industry are at high risk of financial difficulty. This group will be on low wages and may lack savings to cope.
- The self-employed, freelance and zero-hour contract workers are also at high-risk of financial difficulty, given that many such workers will be on relatively low incomes with little in the way of savings.
- Employed professionals with high incomes, but paying high rents are at medium risk of financial difficulty, given that the proposed support for employees is 80% of their income, but up to a maximum of £2,500 per month. However, such tenants will probably have considerable savings and other investments they could liquidate, lowering the risk profile somewhat.
Specifically For HMO’s:
- You will still be liable for all fixed costs such as utilities, broadband and so on.
Specifically For R2R:
- You will still be liable to pay the guaranteed rent to the landlord, along with any fixed costs (if HMO or Serviced Accommodation, which are the usual R2R models).
Note this situation may have changed by the time you have read this. It is a good idea to bookmark https://www.gov.uk/coronavirus for the latest updates and check regularly.
Feel free to make your own judgements and add categories depending on your tenant profile and property portfolio and the latest government interventions.
Step 2: Define Job Sector Types
Different sectors of the economy are going to be impacted in different ways. Clearly, key works will continue to work and get paid. At the other end of the scale, zero hour contract workers are likely to get laid off with no pay.
I would suggest the following job sector types, as a minimum, which I see in terms of decreasing order of rent payment risk:
- Non-essential retail (e.g. pubs and restaurants).
- Self-employed (e.g. plumbers and electricians. No employment contract).
- Essential retail (e.g. supermarkets).
- Other (anything else, including key workers).
Step 3: Define Salary Bands
It helps to define some salary bands. Why? Because those on lower salaries are likely to be at higher risk of not being able to make rent payments, due to being in at-risk job sectors (e.g. bar work) and/or lack of personal savings to see them through an extended period of no work.
I would use the following, as an example:
- Low Wage: Up to £15k.
- Medium Wage: Up to £30k.
- High Wage: More than £30k.
Again, use salary bands which you think are appropriate to you and your property business.
Step 4: Define Risk Factors Matrix
The next step is to define for each Job Sector and Salary Band the associated level of risk.
As an example, a tenant working in a bar (non-essential retail job sector) on £12k per annum (low wage salary band) would be at a high risk of rent default.
Equally, an NHS Doctor (key worker covered by the “other” job sector category) on £80k (high wage salary band) would be at a low risk of rent default.
Use the categories of Low, Medium and High risk to define your matrix.
I would suggest a Risk Factors matrix something like the below:
|Non-Essential Retail||Self-Employed||Essential Retail||Other|
Again, feel free to amend with your own interpretations and definitions.
Step 5: Define Financial Impact on Rent
Now you need to make some educated assumptions on what the outcomes from the Risk Factors Matrix means on the ability of the tenant to pay rent. I would suggest being conservative, but you can also change these to assess the impact on your cash flow at different levels of payment.
For the purposes of this exercise, I am going to assume:
- Risk Factor HIGH: Rent is unpaid.
- Risk Factor MEDIUM: 50% of the current rent is able to be paid.
- Risk Factor LOW: Rent remains paid, in full.
Step 6: Cash Flow Scenario Analysis
To make use of the above, you need to understand the tenant profile of your portfolio. Gather your mortgage information and tenant referencing information. Then make a list of each property and note down:
- Mortgage payment.
- Any fixed costs (e.g. management, utilities if an HMO or rent payment to landlord if a R2R).
- Rental payment.
- Job sector (with reference to your definitions in Step 2).
- Tenant salary.
From this data you can calculate the following:
- The tenants Salary Band defined in Step 3, based on the tenants income.
- Your Current Cash Flow. Defined as the current rent minus mortgage payment minus any fixed costs. I am ignoring voids and maintenance for this exercise. This is sensible, as no-one can view another property to move to and all non-essential maintenance should be deferred. The main risk of voids are non-UK nationals disappearing back home.
- Your Forecast Rent, based on the Risk Factors Matrix built in Step 4. For example, a tenant with a Medium risk factor would assume that future rent payments would be at 50% of the current levels (from Step 5). Therefore, your forecast rent would be 50% of the current rent received.
- The big one: You can now calculate the Forecast Cash Flow, defined as the forecast rent minus mortgage payment minus any fixed costs.
- The Impact on Cash Flow, which is the difference between what you are getting now (current cash flow) and what you might expect to receive during the coronavirus pandemic (forecast cash flow).
By summing up all your Impact on Cash Flow values, you can see the overall impact on your property portfolio.
So, by undertaking this exercise, you can answer questions such as:
- How are individual tenancies impacted?
- What is the impact on your portfolio as a whole?
You can also experiment with the inputs to the Risk Factors Matrix (Step 4) and the Financial Impact on Rent values (Step 5) to see what the outcomes will be and assess the financial impact per tenancy and across the portfolio.
For example, you could model a worse case scenario and assume all tenants are at a Risk Factor of HIGH and hence all rents become unpaid – what impact would that have?
Coronavirus Risk Mitigation
So, armed with the output from your Cash Flow Scenario Analysis, what can you do to mitigate the risk? Here are some ideas which you can adapt for your own property portfolio:
- Prioritise tenants in the order of the impact to your cash flow. This doesn’t necessarily mean the tenants with a risk factor of High, as you may have properties with small mortgages and relatively high rents. Since cash is king, you want to understand which properties and tenancies will have the largest cash flow impact in absolute terms.
- Be proactive. Contact them. Explain that you understand the financial strain they may be under and you are willing to work with them. You need open communication lines and a chance to show you are an understanding landlord in the current climate. Better to come up with a payment plan of some kind than wait for a rental payment not to show up one day. But use your knowledge of your tenant base. You do not want to open up the invite of a payment holiday if they are capable of paying the rent, especially if you are a full-time landlord depending on the rental profits for your own financial well-being! Remember, plenty of people are still working from home on full pay.
- Make sure they are aware of the current government interventions and what they made be entitled to, in the way of financial help.
- Keep records of when you contacted them and what you discussed. You may need this to show your BTL mortgage provider your tenant has been impacted by COVID-19 and you are seeking a payment holiday.
- Consider your own circumstances: You can apply for a 3-month payment holiday from your BTL mortgage lender, although details are not clear on exactly how this would work. I personally would not apply until I had to, in case the 3-month period is not extended right at the point you might need it most!
- Preserve cash flow. Explain to tenants that any non-essential maintenance will be postponed until further notice. This is sensible from a social distancing perspective in any case.
- What financial reserves have you got? Under each Scenario Analysis, how long would your savings last, if you had to use them to finance your portfolio?
- Note: If you are a homeowner, then you can also apply for a 3-month mortgage holiday on your own home, to ease your cash flow somewhat.
- For those with R2R properties: Be proactive with the landlord. Perhaps they will accept a reduced rent for a period, with a payment plan to make up the difference when this is over. Remember, they should also be able to get a 3-month mortgage payment holiday on the property, to assist. This is where I hope you have ensured the landlord had a compliant mortgage product as it is likely he will need to provide proof you have been impacted by the virus!
I realise the above is a lot to take in and understand. As ever, these things are easier with a spreadsheet in front of you to see how it all fits together. So, I have built a free Cash Flow Risk Analysis Calculator which includes everything I mention above. Click on the button below to download:
Please note that after completing your details, an email will be sent containing the details to download.
The calculator allows you to:
- Define your own Job Sector list (up to four).
- Define your own Salary Bands (up to three).
- Design your own Financial Impact on the Rent values.
- Build your own Risk Factors Matrix.
- Perform your own Cash Flow Scenario Analysis on your current and forecast cash flow per tenancy and on the portfolio overall.
- It will work whether you have a single BTL or many.
- It can include any currently empty properties.
- It can be used for single lets, HMO and R2R rental properties.
- Allows you to plan the positive impact of taking BTL mortgage holidays, if you need to go down that route.
The spreadsheet can be adapted to include more than four Job Sectors and more than three Salary Bands, if your Excel skills are up to it!
I have tried to make it as flexible as possible within the short time I have had to pull this together for the magazine.
So, in addition, I am happy to provide help to anyone who needs to understand the impact on their finances. Simply contact me to set up a call. This is completely free and I won’t try and sell you anything!
At this time we need to all work together. Stay safe!