Top 5 Ways to Offset Cash Flow Risks in the Property Market
Many people are scared to invest in more property as it might affect their cash flow. But while rising interest rates pose a real risk to cash flow, you can mitigate those risks.
There’s no sugarcoating the fact that higher interest rates do impact cash flow.
And that’s exactly why more and more investors are becoming terrified of investing in more property. As they watch those interest rates go up, they also see their potential repayments going higher and higher – and most of them are not sure they can sustain that.
But here’s the thing…
Many people allow rising interest rates to spook them out of investing without taking the time to understand how their cash flow will be affected. That’s tantamount to hiding from an enemy without first knowing what the enemy looks like, how strong it is, and how it can be defeated.
See, there are several things you can do to mitigate the risks of higher interest rates to your cash flow. But in order to choose the right game plan to offset those risks, you first need to know exactly how an increase in interest rates can affect your cash flow.
In other words, you need a model — or a formula — that can show you how a certain increase in interest rates would affect your cash flow. This way, you’d know exactly how much more money you need to prepare for your repayments.
If interest rates rise by 3%, for instance, you’d know if that translates to an extra $1,000 or $20,000 in your annual repayments. Knowing that number removes a lot of the fear around cash flow risks.
That’s why the first step to offsetting cash flow risks is defining what the enemy is. Because unless you know what you’re up against…
You won’t be able to come up with the right solution for the risks you’re facing.
The 4 Ways to Offset Cash Flow Risks
Once you find out how exactly the rise in interest rates will affect your cash flow, you can explore the following strategies on how to offset your cash flow risks:
Way #1: Buy More Unit Blocks
It might seem counterintuitive to acquire more assets when interest rates are on the rise. In fact, many investors are thinking about selling some assets in order to relieve some of their debt burdens.
But let’s say you’re looking at a $10,000 cash flow deficit in your portfolio now if interest rates do increase in the next 12 months.
One way you can plug in that deficit is by buying another asset to offset that downside risk. Perhaps you could consider taking out equity from your existing properties to invest in a unit block.
This may be a sensible, albeit counterintuitive, move for you.
Not only will you be minimising your cash flow risk but you’d also be expanding your portfolio. And this leaves you further ahead of other investors who are taking the more intuitive road of unloading their assets.
After all, the investors who came out to win big during times of uncertainty like the Great Financial Crisis or the COVID-19 pandemic are those who expanded their portfolios during a period when everybody else contracted theirs.
Way #2: Reassess Your Loan Structure
Another option you can consider is reassessing your loan structure.
If you believe that interest rates are about to go up, for instance, you could take out an interest-only mortgage. Also called adjustable-rate loans, these mortgages offer a low monthly payment during the first years of the loan.
This is because you’d be paying only the interest – at least during the interest-only period.
Way #3: Do a Value Add on Your Property
Let’s say you want to invest in another property to offset your cash flow risks. However, you don’t have the cash or the equity to put a downpayment on a new property. An alternative you can explore is to do a small cosmetic renovation on a property you’re currently renting out.
A cosmetic renovation will only set you back about $10,000 to $15,000.
That’s significantly less money than what you’d need to buy a new house. And yet, it allows you to increase the rents on that asset. And that increased revenue could plug in your deficit from higher repayments due to higher interest rates.
Of course, this might not be a good strategy if you’ve got tenants on your property. Because then, you may need to wait until the end of the lease before doing a value add or otherwise increasing your rents.
Way #4: Consider Debt Replacement Strategies
When the cost of debt is high, you can think about investing in debt as investing in an asset, as well. Think about it this way: You’d be getting the same return as the cost of debt would be!
So, if you’ve got offset accounts on your mortgages or your investment properties you can put all of your savings into those offset accounts.
This will effectively reduce the cost of your repayments. Because then, you’d be making a return on your capital at a level that’s equivalent to the interest rate you’re getting charged.
Indeed, one of the best ways to offset cash flow deficits is taking out your savings – which are just sitting in the bank, getting eaten away by inflation – and pushing it into debt replacement strategies.
Mitigate Cash Flow Risks Through Smart Investing
There’s no way to tell which of the strategies mentioned above will work best in mitigating the risks in your cash flow.
As mentioned earlier, you can only make an informed decision on how to offset those risks once you figure out how exactly higher interest rates would affect your cash flow.
At any rate, now you know there are ways to mitigate your cash flow risks without offloading some of your assets or completely avoiding making more investments. All you have to do is manage your portfolio carefully.
This way, you can expand it while still protecting yourself from downside risks on your cash flow.