How Much Diversification Is Sensible?

How Much Diversification Is Sensible?

This is an excerpt from Chapter Two, ‘How Much Diversification Is Sensible?’ of Frazer’s upcoming book, ‘The Alternative Guide To Property Investment‘. You can register your interest in pre-ordering the book by clicking on the button at the bottom of this post.

In the previous chapter, I mentioned that I go against traditional wisdom as I am not particularly convinced about diversification across different asset classes as one cannot possibly be knowledgeable about all of them and therefore must seek to rely on third-party advisers. If you have no time or inclination to look after your own money this is probably sage advice.

I accept that for most people there are good reasons to do so but, for me, I would point to the fact that one of the wealthiest people I have ever met invests all his money in property. But not just in any property, and not just in one particular area, but in one particular street (in central London). He won’t even consider buying properties on adjoining streets. As far as he is concerned, they are outside his area of expertise. Clearly, specialisation can have its advantages.

Therefore, I am not giving advice, just telling you what I personally think. The consensus of opinion about diversification may be generally sensible for most people but may not be right for everyone, especially for those who are experts in their field. That’s a matter for you to decide.

What I do think is sensible for most people is to diversify and spread your risk (within reason) so all your eggs are not in one basket.

And one reason I believe property crowdfunding is such a beneficial concept is that it allows you to spread whatever available capital you have over a number of different properties so, if a disaster befalls one, you don’t have all your money tied up in it and you still have others to fall back on.

Within the asset class ‘property’ itself, you could, if you wish, diversify your portfolio in a number of different ways. It could include traditional buy-to-let properties, new-build apartments, commercial investments, HMOs (houses in multiple occupation) and ‘fixer-uppers’.

Secured lending and development finance are other options that fall within the property investment umbrella, as you lend out sums to property developers and business owners who own property they can use as security.

Diversification also means a selection of risk profiles. Of course, you should take into account your personal circumstances and lifestyle requirements, as well as your own attitude to risk. Typically, higher risk investments come with the prospect of higher rewards, whilst a safer investment may yield lesser gains.

Buy-to-let has been the most popular option for property investment. Private renting has almost doubled in the period from 2003 to 2015, and in Manchester, it has almost quadrupled, from 6% to 20%.

This means, in theory, that the buy-to-let sector should offer great potential for investment over the coming years. However, as we shall learn later, the traditional way of purchasing single buy-to-let properties may no longer be the best way to capitalise upon this growing market. In fact, it may not be feasible at all for most individuals anymore.

The commercial property market, too, can be a good option.

Investing in commercial real estate can mean:

  • positive leverage (potentially increasing ROI (return on investment);
  • tax benefits (proper structuring can offer an array of benefits tied to interest, depreciation and so on);
  • more control (personal ownership equals control);
  • a hedge against inflation (such property tends to benefit long term from inflation);
  • cash flow and current income (rental income from stable commercial real estate means a potentially steady and predictable income stream);
  • historically strong returns (average annual return: 9.5% sustained over a 20-year period).

You can find out more about commercial property and how it compares with residential property investment later in this book.


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How Do I Diversify My Property Portfolio?

How Do I Diversify My Property Portfolio?

A diverse property portfolio is the absolute gold standard when it comes to a successful investment strategy. Cherry picking a healthy mix of investment types across the board, and taking into account your lifestyle requirements and risk profile, is key. You should also put in the time and effort to compare and contrast which investments are likely to generate the highest returns.

That’s just for starters. Let’s go into a bit more depth about what you need to know in order to create a fully diverse portfolio of property investments.

Why Should I Create A Diverse Property Portfolio?

It’s principally about not putting all your eggs in one basket. With diversity across your entire portfolio, you bolster yourself against any problems should anything come up to scupper any one investment in the portfolio.

What Criteria Should I Be Looking For?

Well, this is a subjective thing. In short, it depends what you’re looking for. There’s an array of factors to consider in order to nail down what exactly is going to be the right investment for you.

These include (but are not limited to) questions such as:

  • Are you looking for a short or long term investment?
  • Are you likely to need your money back quickly (i.e. how much liquidity do you need?)
  • Are you looking for income or capital growth?

What Options Are Available?

Again, depending on your criteria, you might consider:

  • The slow and steady traditional buy-to-let model
  • The fixed revenue of student developments (ensure that you’re able to exit easily, though!)
  • HMO (House of Multiple Occupancy) – a lucrative choice, but pretty management intensive

Alternatively, you could consider investing in:

  • Development finance
  • Hotel investments
  • Secured lending
  • Commercial property

Location, Location, Location

Another way to broaden the scope of your property portfolio is to diversify by location.

There is, however, a counterargument to this: whilst investing in property over several locations is a diverse-happy strategy, there’s a lot to be said for specialising in one or two particular areas. This is an option for those aiming to deepen their expertise in one area, and can also be argued to deliver better results.

That being said, when diversifying by location, here are some of the major factors to bear in mind:

  1. Promising Places

Look for towns and cities with projected increases in property prices. This can often be seen as a result of new employment opportunities being created by businesses opening or relocating to the area.

Tip: a term common in property investment circles is the “Waitrose” effect: price increases can sometimes be anticipated by the opening of a new Waitrose food market in the area.

  1. A Place In The Country

As the capacity for home working grows, more people are taking advantage of the chance to relocate to the countryside. Smaller villages in the outskirts of big cities, particularly those on good rail routes for commuters, are likely to grow in demand.

Demand

Both in the residential sales and rental markets, a key part of your research should definitely include knowing what is in high demand.

As the population of renters looks to overtake the number of homeowners, many investors are considering buy-to-let as a good option to add to their portfolio. Consider covering your bases with both buy-to-let and development projects for the sale market.

REITs and Crowdfunding

  • What is a REIT?

REIT stands for Real Estate Investment Trust. It’s a company that owns and operates income-producing real estate.

  • What is Crowdfunding?

Crowdfunded property investment involves coming together with a group of other investors, each putting in a sum towards purchasing a property.

What’s the Difference?

With models like property crowdfunding and peer-to-peer lending, there are fewer potential outgoings and a lot less hassle than when investing with a REIT. Nonetheless, by virtue of the crowdfunding model itself, sharing the investment with many other investors, you lose the control that you have with a REIT investment.

With REITs, however, there are typically lower rates of return to be expected. This is due to higher expenses, such as maintenance costs and fees. These kind of portfolios can be much more complex to manage. REIT investments are generally a better bet for a long term investment, typically spanning 10 to 20 years, whereas with property crowdfunding and P2P secured lending, you’re looking at a much shorter term investment, from as little as 3 months. Returns in crowdfunding and P2P for property are potentially significantly higher than REIT investments – up to 12% p.a. on some platforms.

Even if you don’t have huge sums to invest, both REITs and property crowdfunding are potentially good options, allowing you to create a diverse property portfolio more affordably.

If, however, you are leaning towards leaving your investment with the experts, rather than managing your portfolio yourself, you should still be sure to keep an eye on market conditions. Knowing when it’s time to review the ratio of your portfolio, and spotting signs that an investment could lose its profitability (meaning you should make a hasty exit!), is vital.

Conclusion

Spreading your capital over a variety of investment types is, inarguably, the most sensible course of action. REITs and property crowdfunding are both good options if you wish to add property to your investment portfolio, but don’t want the job of managing a property yourself, or wish to diversify as far as you can within your affordability. Whatever path you choose, don’t forget: diversity is vital.

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