It’s now more important than ever for landlords to think about maximising cash flow to get through this downturn, especially if they’re due to refinance in the coming months.
The most important task for any business in a recession is paying its debts as they fall due, otherwise it risks going out of business. It can have the best looking profit on paper, but if it has no cash and can’t keep up with the mortgage, the bank might call in the loan on the property.
Focusing on metrics like net profit, return on profit or yield can give investors a false sense of security.
What counts, particularly in a recession, which the Reserve Bank has admitted it would like to engineer this year, is cash flow.
This is the actual cash that flows in and out of the bank account. A positive cash flow means simply that there’s cash left over in the bank account after paying the expenses.
Why is cash flow so important for landlords in this cost of living crisis?
When an economic downturn hits, there’s more chance that others will have financial difficulties, and struggle to make ends meet. For instance, they lose their jobs or run up debts because their income has not kept up with inflation.
Landlords are particularly vulnerable in a recession as rent is usually a renter’s biggest outgoing. This can be a problem if your renters fall into financial difficulty and are unable to pay the rent.
Alternatively, your renters might move out and you’ll need to find replacement tenants. Although this isn’t a problem when there’s a rental property shortage and rents are high, this can change quickly. And even at the best of times, there are usually voids between tenancies where no rent is coming in.
With increasing interest rates, and any unexpected expenses like a new boiler or the tax bills for mortgaged investors of existing houses because they can no longer claim interest payments as a tax deduction, landlords can quickly find themselves in financial difficulties.
This is referred to as negative cash flow, when the money going out of the bank account is more than the money coming in.
Building up a buffer
The best thing landlords can do in this cost of living crisis is to build up a financial buffer to tide them through should their cash flow turn negative.
Reduce drawings from the business to the absolute minimum, and concentrate on building a buffer of three to six months’ expenses, plus the usual sinking fund of 10% of rent for repairs and maintenance.
If rental income is a landlord’s only source of income, the buffer should also include their personal expenses for three to six months. This will enable a landlord to survive a while without drawing money from their property business.
In terms of logistics, it’s easy to set up a standing order to pay a regular amount into a separate savings account. A landlord will then be more likely to leave it alone and not dip into it, keeping it for a rainy day. This will give a landlord the peace of mind that they will be able to ride out any temporary cash flow problems.
During a downturn, it’s important for landlords to maximise the amount of cash coming into their bank accounts. This means having renters that pay their rent on time.
Here are some tips to help you maximise the amount of cash landlords have coming in each month:
When your rental property is empty, you’ll not be receiving any income, but you’ll be paying bills. For instance gas and electricity standing charges and council rates.
To reduce voids, you can either keep the renters you already have, or be organised if a renter gives notice so you can get the property to market promptly.
If someone serves notice, either get a letting agent primed straight away, or get your property listing ready if you’re letting it yourself.
Do think hard about letting and managing it yourself, as self-managing saves an average of about 12% in management fees a year.
Tenant selection isn’t easy at the best of times. Just like interviewing people for jobs, they might seem perfect on the day. However, you realise later that they were telling you what you wanted to hear.
That said, at least with rental demand so high, you’re likely to be able to choose from a short list of renters.
In order to have a stable rental income, you need renters that won’t fall into arrears. With unemployment forecast to increase, the chances of renters becoming unemployed has increased.
You can reduce the likelihood of arrears by focusing on affordability and reliability of income (steady job). It’s easier said than done, but something to look out for when selecting renters.
Increasing the rent is never popular. However, expenses have been going up for landlords as well as renters, at the same time as rents have been fairly stagnant.
Most landlords change the rent at the start of a tenancy to bring it in line with the market. However, if you’ve not put the rent up since before Covid, it’s likely that it will have fallen behind the market rate.
On the other hand, good reliable renters are key to a successful and sustainable rental portfolio. You want to avoid putting your renters in financial difficulty by suddenly increasing the rent by a large amount.
However, during periods of high inflation, if you don’t increase your rent, you’ll be receiving less rent in real terms.
Data from economist Tony Alexander shows 74% of landlords will be raising rents within the next six months.
Trade Me data shows the national median rents being asked on the site was up 7.5% over the year to the end of October, just ahead of the 7.2% rate of inflation.
For landlords planning on raising rents, it is important to keep the lines of communication open with your tenants, so they feel they can talk to you if they have financial problems. Problems can often be averted if they receive help and sound advice early on.
Serving notice for rent arrears
If tenants get behind in their rent serving notice should be a last resort, after you’ve tried to reach a plan for your renters to repay the arrears.
If, despite all your support, they aren’t paying you can apply to the Tenancy Tribunal for payment of rent arrears and eviction. There is a specific process you must follow to the letter.
More than 80% of the Tenancy Tribunal cases deal with rent arrears.
Minimise cash going out
The other part of the equation is managing the level of cash you are spending in your property business.
Here are four tips to help you decide where and how to make cuts in your spending:
How much are you spending?
First of all, you need to keep track of how much you’re spending, and on what. Make a habit of going through your bank statements and updating your accounts at least once a month. Even if it’s just on a spreadsheet or a bit of paper, it’s good to keep track.
You’ll be surprised how much little expenses (boiler servicing, new alarms, house keys, etc) add up. And this is before the interest on your borrowing, and any payments to letting agents to manage your property.
If you don’t have one already, you need a separate bank account that is just for your property business. Keep your personal finances separate. You can set up alerts on your banking app to notify you if your balance falls below a set amount. This will stop you from incurring overdraft fees.
Once you know what is going out, step back, and take a look at what you could do without. What are your priorities? Rank your discretionary spend in order of how much value it adds to your business. Then go through each one and ask how it contributes towards your strategy. Alternatively, is it just a ‘nice to have’?
Defer optional building work
Unless you’re secure financially, a recession might not be the time for to start expensive ‘optional’ building work.
For instance, upgrading kitchens and bathrooms that are a little dated, but in full working order, can be delayed. Replacing chrome taps with black taps isn’t a priority in a recession, unless they’re not in good order.
The payback time of any investment in terms of increased rent needs to be short for it to be worthwhile. You do, however, need to keep up with repairs and maintenance.
What not to do
Don’t be tempted to skip repairs and maintenance.
When money’s tight during a downturn, it can be tempting for landlords to cut back on repairs and maintenance. However, this would be the wrong decision.
Your property is a valuable asset, and like a car, it needs regular servicing. If a property is looked after, the renters are likely to be happier. They’ll be more likely to look after the property and less likely to leave. This preserves your income and reduces voids with no rent coming in.
If your property falls into disrepair, your tenant might take a case to the Tenancy Tribunal. If the tribunal serves a remedial notice, you will have a limited time to do the repairs.
Finally, don’t get behind on your own mortgage payments. If you do get into financial difficulties, get in touch with your lender to discuss a repayment plan.
Although the property market is facing strong head winds, a recession can be a buying opportunity for landlords. At least landlords with financing.