Why experienced property investors aren’t worried by rising interest rates

The failsafe strategy to cope with all interest rate environments

The recent combination of UK economic statistics could mean that UK interest rates could rise this year. The main indicators all put pressure on the Bank of England to raise its base rate:

• Inflation is more than 1% higher than the Bank of England’s target of 2%. In December 2017, the Governor of the Bank of England had to write a letter to the Chancellor of the Exchequer to explain why.
• The expectations for inflation are at their highest for nearly 4 years.
• According to the ONS, house prices in the UK increased by 5.1% between November 2016 and November 2017.
• Meanwhile, the economy is growing a little faster than previously estimated. Given these conditions, it’s reasonable to expect that the pressure on interest rates will go up, not down.

In this article, you’ll learn the strategy that experienced property investors use to make interest rate concerns obsolete.

How far could interest rates rise in the UK?

In November 2017, the Bank of England raised rates for the first time in 10 years. However, even after its 0.25% increase, the Bank of England’s base rate is now just 0.5%. With inflation rising and the economy growing a little more strongly than expected, it could be that the Bank of England increase rates again. Some are forecasting that the base rate could move to around 2% or 3% over the next couple of years.

At some time, the Bank of England could reinstate interest rates between 3% and 5%. Quite when no one knows – not even the Bank of England. It could be within the next couple of years, or further into the distance. The thing is that interest rate movement is part of the economic trend.

If you’ve created an equity buffer, you will be fine. The value of your property portfolio will have risen, while the mortgage on it remains unchanged. This buffer can be used to fund your portfolio during the period of higher interest rates or a period of lower growth. In fact, if you’ve used the strategy I’m going to explain in this article, you might even get excited by higher interest rates, as you’ll uncover some great investment opportunities.

But experienced property investors also use a technique that I call ‘mortgage cost averaging’ to remove interest rate stress.

What is mortgage cost averaging?

Many years ago, when I was establishing myself financially in Australia, interest rates began to rise. I had done all my calculations based on the interest rate I had started with. No one had considered the possibility of interest rates rising, and I had been naïve enough to ignore the possibility. I had been blinkered by rising property values and convinced it wouldn’t be long before I was raking it in.

I was fortunate that my portfolio was small enough and my income big enough that I could absorb the effect of higher interest rates. But I learned a valuable lesson that I have applied to every portfolio I have built since. It’s such an important strategy tool that I stole the concept and renamed it.

‘Dollar cost averaging’ is a strategy associated and used in share trading. The basic strategy is to invest a fixed dollar amount at regular intervals. Instead of waiting for the price to fall, you simply invest at regular intervals when you have the money to do so, and recalculate the average price at which you have bought shares.

Thus, mortgage cost averaging is a simple process where you calculate all mortgages at a pre-defined rate.

How do you use mortgage cost averaging?

The first thing you need to know is the recommended mortgage cost averaging rate for the country in which you have invested in property. I’ve put the main ones in the table below, and also included a conservative rate if you want to remove a lot of the cash flow risk:

Now, I’ll show you how to work out your personal mortgage cost averaging using the rates above, and how to apply it to eliminate that interest rate stress. The best way to do so is an example…

All you need to do is fill in the details in the next table and follow the calculation instructions:

Are you safe if interest rates rise?

Now, fill in the calculation table with your numbers.

If the MCA cash flow rate (K) is positive, then you are fine and do not need to put money aside from current net rental income. This said you might decide to do so anyway (there is never a time when it is not prudent to build a reserve fund).

If the MCA cash flow rate (K) is negative (as it is in the example), then you should put aside the difference into a provision account. Either as a lump sum (allowing for, say, 2 or 3 years (K x 24 or 36)) or, on a monthly basis, put aside K.

* The above will only work where mortgages are interest only. If you have repayment (principal and interest) mortgages, you will need to take account of the interest payment only.

** You can either work out the exact costs of your properties or use the rule of thumb of 30%.

It is as easy as this to eliminate interest rate stress when you invest in property – another reason why I love property investment so much. To discuss your property investment strategy options, get in touch with Gladfish on +44 207 923 6100. We want you to be successful in property investment and enjoy the cash flow and profits that we’ve helped hundreds achieve to date.

Live with passion

Brett Alegre-Wood