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As a buy-to-let investor, stress testing your investments regularly is crucial. It means you have options should something not go as planned, allowing you to diversify your risk, minimise any future impact, and adapt to market changes. Stress testing is essential during any market but particularly so during challenging times.
When considering a new investment, there are specific metrics you must consider when stress-testing the viability of a deal. And as a portfolio investor, understanding the exact position of your portfolio and how it is performing is crucial to continue generating a healthy return on investment.
But stress testing is for more than just your interest. When securing finance, lenders will analyse and scrutinise your deal and factor this in when deciding which rates to offer you - so tracking key metrics is a necessity rather than a choice.
The best way to make the correct decisions in property comes down to good data. So, with that in mind, here are the important metrics you should be tracking for new deals and existing buy-to-let investments.
Return on Investment (ROI)
Every investor or developer takes on a deal with the intention of making money, either from rental income, capital appreciation or both.
ROI is the annual profit (income minus costs) generated by your property, divided by the cash you have put into the deal. It's important to measure ROI to determine a property's short or long-term profitability, and this is arguably the most critical metric to consider.
Gross and Net Rental Yield
Rental yield provides a valuable overview of whether a property is profitable. While property values change and rents go up and down, understanding the yield can help you analyse whether your investment is performing well.
The gross yield of your property is the annual rental income divided by the total property value, then multiplied by 100.
The net rental yield is the figure you arrive at after deducting all your costs, for example, letting agent fees, maintenance, accounting fees, insurance, etc.
Although there are many factors to consider, between 5-8% can be considered a healthy rental yield to aim for in the current market. It is also well-known that HMOs and/or short-term let properties currently generate some of the highest rental yields in the UK.
Cash Flow
The ‘cash flow' is a term used to define how much income a property generates after expenses when holding and managing an asset. It really is better defined as ‘monthly profit’. The higher the cash flow, the better the profit and returns you will make on an investment.
Simply put, the ‘cash flow’ is calculated by taking the rental income and deducting the monthly expenses, fixed costs and finance costs.
Investors typically measure cash flow on a monthly and annual basis to monitor the inflows and outflows of money over a fixed period of time. It is essential that you stress your numbers to see how high costs could go and you can remain cash flow positive.
LTV (Loan to Value)
Many lenders have limits on the overall LTV of a portfolio, and criteria can change quickly, especially in a chaotic market. With up-to-date information on the LTV of each of your properties and your portfolio as a whole, you will have a better idea of your current position and your options when it comes to refinancing. Ensure your calculator (ideally in a spreadsheet) can stress test what your numbers look like if the LTV of your investment/portfolio goes up or down.
Total Portfolio Equity
Knowing how much equity is in your portfolio will provide a clearer idea of your choices, especially if you need to refinance to capitalise on a buyers property market and purchase more property to grow your portfolio.
Your total equity can be calculated by establishing the current estimated value of your property minus the current balance of mortgages and any other loans.
Rental Coverage Ratio
Understanding your rental cover ratio establishes your overall risk if you have unexpected void periods, your rental income is reduced, or your tenants stop paying you altogether - which is particularly important during a cost of living crisis.
Should this happen, your mortgage payments will still need to be made, so knowing your rental cover ratio is crucial. It is also an important metric used by mortgage lenders to assess your affordability and is the percentage of the mortgage that the rent must be. Some lenders, for example, carry out stress tests that require rental income to cover at least 125% of the mortgage payments.
Interest Coverage Ratio
The Interest Coverage Ratio (ICR) of your property is based on your outgoing interest payments and incoming rental income. It is another type of affordability test used by lenders to determine how resilient your property/portfolio is to increases in interest rates.
Final Thoughts
Tracking all of these metrics, whether approaching new deals or analysing your portfolio on an ongoing basis, is vital to make well-informed decisions and can be the difference between success and failure.
At Merryoaks, as well as securing funding for our clients, we also help them analyse investment opportunities, run the numbers on a project, build a pipeline of deals and work out what their equity requirements will be should they need to secure funding.
If you have any questions about your next investment or would like assistance analysing the current performance of your portfolio, speak to our Funding Specialists today!
