1. Diversification: the Hong Kong investment properties are all residential apartments on Hong Kong Island. All are either small or medium sized units. Ages range from 4 to 30+ years. This means that there is no meaningful diversification in the portfolio;
2. Location: location is a positive. There is less scope for new developments on Hong Kong Island (especially in the Mid-levels) than in, say, New Territories or West Kowloon. In the longer term, two of the properties have the potential to marginally benefit from the proposed MTR extension.
3. Vacancy risk: lease terms are typically two years with the tenant having the right to terminate on two months' notice after the first year. Our termination dates are well spread out which means that the risk of having multiple vacancies at the same time is quite low. All tenants have paid two months rent as a security deposit which we hold. We have a small number of properties (very small, alas). This means that the impact of a single vacancy on our cash flow could be quite significant (depending on which property was vacant).
4. Debt: using borrowed money is great when things go in your favour and a disaster when they don't. Most of the property investors who have got into financial difficulties have done so because they have been unable to service their debts. So how robust is our debt servicing capacity? In this area we score quite well:
(i) Cash flow: assuming all properties are leased to paying tenants (one is currently vacant), we have positive cash flow on the portfolio as a whole - the rents will meet the mortgage payments and other outgoings. The excess of rent over outgoings is currently sufficient to cover some further interest rate increases (I need to work this out properly, but roughly at least another 1.5%). However, due to the small number of properties, a single vacancy would result in a negative cash flow;
(ii) Maturity profile: all mortgages are on P+I terms. The residual terms range from 6.5 years to 16 years. This means that we are paying more in principal each month than we are in interest. Our position improves with each passing month and, if things got tight, the possibility of rescheduling to interest only could be looked at;
(iii) Gearing: our highest gearing level (loan to value) is about 49%. The weighted average is about 35%. We have generally taken a conservative approach to the use of debt. At times this has held us back (we could own more properties and have a higher net worth had we been willing to gear higher) but it leaves us much less vulnerable to a downturn.
In summary, the risk of vacancy is a greater risk to the private portfolio's ability to service debt than the risk of higher interest rates. (If we had a bigger portfolio this would be different.) This risk can be adressed through either (a) changing some of the mortgages to interest only or (b)making early repayments or (c) meeting the shortfall from salary should the need arise. However, in general the Hong Kong investment properties are well placed to survive a moderate downturn without causing too much anxiety.
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