Climbing Back Up The Cliff
This article is the second in our series on what to do if you find yourself in financial stress, with a particular focus on property ownership. Part A addressed the psychological and emotional stress of dealing with challenging financial situations.
If you are looking down the barrel of being short on the next mortgage payment, it’s easy to get paralysed like a possum in headlights. But it’s really important to do first things first and work sequentially. Your absolute first priority is to get your head and emotions right. I recommend reading (if you haven’t already) our article ‘Hanging on for Dear Life’ – which has advice on how to deal with your headspace, stress and emotions in these circumstances.
Dealing with your financial ‘emergency’ is not unlike dealing with a medical case:
- First diagnose the problem so that you can treat the cause not just the symptoms – or else the problem could keep recurring.
- Come up with solutions….understand what your options are.
- Pick one. Just pick one. Its sometimes easy to get stuck by ‘analysis by paralysis’
- Choosing a solution is pointless unless you implement it!
- Monitor – is it working?
Step 1: What’s Your Problem?
Sometimes what appears to be the problem is not the real problem. What I mean by that is that the pressing issue in front of you might be a symptom, with a bigger issue beneath, or in fact it could be nothing and you could be blowing the issue up in your head.
- The back ache can be symptomatic of cancer. Taking an aspirin to dull the back ache pain is not going to solve the underlying problem, or
- The sore throat in the middle of the night does not necessarily mean you have a throat infection. A ‘friend’ went to Breckenridge to Ski – high altitude. First night he drunk a few beers, which went to his head – he performed the haka for 3 Texan girls, drank no water and went back to his hostel bunk room to sleep. What was the cause of his sore throat? It wasn’t and infection, it was a lack of knowledge – he didn’t read up about the effects of altitude.
How do you diagnose the problem?
Quantify it. Is this a short term cashflow problem that a capital injection will fix, or is a capital injection just plastering over a bigger problem? You won’t know unless you quantifying it. To quantify the problem, you need to run the numbers…in detail. That means a cashflow projection for at least 12 months to understand the size of the problem… i.e. how much are you going to be short in the next 12 months or so?
- Revenue – are there any imminent rent increases due? Are there rent arrears that the property manager is struggling to collect that are impacting cashflow?
- Are any loans coming off a fixed term, and if so, what is the new rate you are likely to end up on. Work any new interest rates into your forecast.
- Are you paying principle and interest (P&I), or interest only (IO). If interest only, how many months are left on the interest only period…banks these days are not keen to extend much beyond 5 years. Check with the bank – if they say they won’t extend, then forecast P&I and understand how that will impact cashflow. We’ll talk later about possible solutions to this – but its important to quantify ‘worst case’ scenario so you know what you could be up for. Its tempting to jump to a solution…but remember – first up we need to understand what we are dealing with so we can deal with the underlying cause.
- Repairs and maintenance – what have you been spending on average? You might be surprised. Don’t forecast in hope – use real numbers. What maintenance projects are likely to be needed in the next 12 months? Don’t plan to defer maintenance as it will cost you more in the long run. If you own a residential investment, you might have just been through the Healthy Homes upgrade so might not need much maintenance in the near future.
- Council Rates – check your rates – is there a potential increase? Or can you achieve a reduction? (More on that in step 2) Either way – factor rates into your forecast.
- Insurance – do you know what you pay in insurance? Make sure you know what your premiums are and what they get you. Critically, be aware of any premium hikes that are looming.
- Property management – if you are not managing it yourself, what is the impact of paying a property manager? Why would I do that if I am trying to save money? Because it is possible to be penny wise and pound foolish. In the next step – ‘Solutions’ we address why a property manager could be financially beneficial – but for the time being, add this into your forecast.
- Accounting fees – forecast them – you may do it yourself – but forecast them. In the next section we’ll tell you why you should use an accountant if you don’t already.
- Tax – for residential investment property in NZ, the deductibility of interest for tax purposes has either been ruled out or being phased out for existing properties (doesn’t apply to new properties). Is this in your forecast? For commercial properties, a National lead government is looking to rule out depreciation as a deductible tax expense. While not yet law, your forecast should allow for it.
- Capital growth – how much is this property likely to go up by during the next boom? If you’ve held it for 5 years or more, you’ll have an idea of how it has performed. How has it performed compared to other properties? This is important as it can be the deciding factor if looking down the barrel of higher holding costs…for example – if the property is a rock star on the capital growth front that might give you the motivation to push through 18 months of pain from losses.
If you own commercial property, you will have an interest cover ratio that you must meet. Make sure to calculate this so you know how much buffer you have (if any).
You might just have read all this and be thinking – I hate Excel! If that’s you, then talk to us and we can help.
Now you have your numbers you can start to diagnose the problem and understand what is really driving your financial pain. As I write this, interest rates are probably the culprit for much of the pain at the moment…but it’s still important to run full diagnostics so you don’t miss anything:
- Revenue – if not at market rent – what impact would it have on your cashflows if you were to increase rent to market prices?
- Interest – what interest rate would you need to achieve to be cash neutral?
- Principle – what would the impact be on cashflow if you didn’t have to pay it? What if you could reduce the amount of principle you were paying – say by 20%.
- Repairs and Maintenance – has there been any large one-off projects (e.g. healthy homes) that are distorting the numbers?
- Tax – has the exclusion of interest as a tax-deductible expense tipped your cashflow into ‘pain’ territory?
You get the idea – its about going through each line item – look at trends, dig into the numbers and really understand the drivers. I can’t get away from my accounting roots. No matter how well I think we know our business, the monthly discipline of sitting down and analysing the results on a line-by-line basis always throws up insights that makes us stop and say ‘hang on – we should be doing more of that…or that cost is simply not giving us a return’.
Often, we are so close to the front line dealing with all the daily challenges that we lose sight of the slow but steady progress we are making. I liken it to developing a garden. You can be out there every day for weeks on end working around trees not seeing any growth. But you get to the end of the month, and you step back and realise the tress have grown! You can’t stand there and watch trees grow. You must simply water, weed etc. – do the necessary tasks. The joy comes later. Property is no different – there is regular work to be done, the fruits of which won’t be experienced until some date in the future. But just because you can’t see growth, it doesn’t mean it isn’t coming down the track.
What does that practically look like? If you are looking down the barrel of a $20k loss in the next 12 months, you might panic and list your property this afternoon and sell it tomorrow at a loss. But…if you knew you’d experience $150k of capital growth in the next 18 months, would that change your perspective? It doesn’t mean you can ignore the $20k loss…but by doing a proper analysis you get the full picture of where you are at. It doesn’t matter whether you are a one property business or Google Corp – every business has to run the their numbers to inform what next steps should be.
I can almost hear some people reading this saying ‘I’d rather die than have to do all this boring number crunching’. I get that – so then get an expert to do it. People like…well us…who, strange as it may seem, love this stuff! Otherwise let’s keep going to solutions…
Want to get our Solution Options article? It will be the next in this series. Please don’t throw stones at me… waiting really is for your benefit. What is likely to happen is that even if you don’t do a forecast, reading this means your brain has clocked all this stuff and overnight your subconscious will do more thinking about it. At some point in the next 24 hours you will probably get some insight spring up to your conscious mind about your portfolio and you’ll start turning that over in your mind. If we didn’t pause, you’d go straight to solutions and risk rushing into ‘fix it’ mode. This could ‘fix what ain’t broke’. Sure – you might just have another glass of wine and forget about this till the Solutions article comes through – no problem. But no harm done in waiting a little.
OK, so now we are ready for solutions… If you have not subscribed to our newsletter, you can do so here.