Stress Testing Your Investment Properties
Rob Minton (the original Cashflownaire, who we admire deeply) recently did a podcast. In the podcast with Quentin D’Souza available here, he happened to mention that he “stress tests” his portfolio every year.
You’ve probably heard of bank stress tests, right?
Investopedia defines a bank stress test as…
“An analysis conducted under hypothetical scenarios designed to determine whether a bank has enough capital to withstand a negative economic shock. These scenarios include unfavorable situations, such as a deep recession or a financial market crash.”
These stress tests are designed to uncover vulnerabilities within the banking industry. These vulnerabilities put the bank (and all of the bank’s customers) at risk.
Quentin suggests using this strategy with our investments. In other words, do a stress test on your investments to try and find your vulnerabilities.
To apply a stress test to your investments, you can think through what might happen under the following scenarios:
1. An increase in interest rates.
2. An increase in vacancy rates.
3. A decrease in rental rates.
4. A decrease in market prices.
5. An increase in market times (filling vacancies/selling assets)
6. Unexpected large expenses.
The idea is to find scenarios where you might find potential problems in your investments. Once you identify a possible problem, you can take action to reduce your vulnerability for that particular scenario.
Oddly enough, the pandemic has created multiple stress tests for us. Unfortunately, these stress tests aren’t hypothetical. They’re real life stress tests with serious consequences. 🙁
If you own a business, you can also run stress tests on different scenarios to see where your business is vulnerable.
Here are a few scenarios to consider:
1. What would happen if you lost your top three customers?
2. What would happen if interest rates increase?
3. What would happen if you lost your biggest source of new leads?
4. What would happen if you lost your best employee(s)?
5. What would happen if your business was forced to close temporarily?
6. What would happen if you couldn’t work in your business?
Yes, these scenarios aren’t fun to think about. However, it’s an important strategy you should use to your advantage.
Wouldn’t it make more sense to identify a problem before it arrives? To be proactive instead of reactive?
Our mission as Cashflownaires is to move into the glorious Position of F-You. This is a position of strength where you have control over your life.
You can’t be in a position of strength if you’re vulnerable to unexpected problems.
So make some time this weekend to put your investments and your businesses through various stress tests!
Vince & Mike
P.S. This stress test idea can also be applied to other areas:
1. What would happen if you were forced to evacuate your home?
2. What would happen if your home/business were to burn down?
3. What would happen to your family if you were diagnosed with a serious illness?
P.P.S. Quentin D’Souza, who shared the “stess test” idea with me, has written several books on real estate investing. You can find them on Amazon here.