It is quite common for portfolio managers to run stress tests to see how their portfolios react under various scenarios. In my software developer life, I might refer to negative testing. Likewise, it seems prudent to stress test in the same way with your real estate portfolio. Putting the portfolio under stress helps to identify and manage risk. Be creative and think of all the things that can go wrong and see what happens to your portfolio. Although government intervention is always a wild card, I think it is best to assume you are on your own to keep your real estate portfolio from imploding in a crunch.
What are some things that I would consider to stress the portfolio? You might consider swings in interest rates directly affecting your financing costs or affecting the market value of your properties. Interest rates obviously impacts financing on new projects and could impact the profitability considerations of any deals in flight. If you have to maintain certain debt to equity ratio (loan to value), the valuation of your properties will be something you are concerned about.
Some questions to consider
What happens if the valuations on your properties drop by 30%? What happens if 30% of your properties are vacant and can’t be filled? What happens if 30% of your properties have tenants that become delinquent and force eviction proceedings (assuming you are allowed to evict)? What happens if property taxes go up 30% across the board? What happens if your maintenance and/or other costs go up 30% for the year? What happens if you lose your property management company? What happens if you face a lawsuit? How about a natural disaster or some bad bout of snow? What happens if a tree falls on the house? An old pipe connecting your house to the street bursts? What happens if your balcony collapses? Your house becomes unlivable and you need to secure replacement housing for your tenants? Although I am lucky to avoid many of these scenarios, I have had large surprise repairs that took out most of the profits for a property for a year. A resilient portfolio should withstand such shocks. You would hate to have your real estate portfolio come crashing down because you did not take the proper risk management measures.