Ever hear people say, “Buy property, you can’t go wrong….it always goes up in value.”
Well, not always. In the recent past, we have seen significant declines in property values in some Perth locations. For an investor who held multiple properties in an area affected by this downturn, the impact would have been far greater than that felt by someone who had minimised their risk by having invested in a diversified property portfolio.
As a property investor there is plenty of potential for long term capital growth if you buy properties with strong fundamentals (i.e. good infrastructure and proximity to services and facilities like public transport, schools, shops and recreation). Naturally there will be peaks and troughs in any property cycle and some factors will be outside your control, so it also pays to implement another simple strategy—diversify your property portfolio.
You can diversify your property portfolio in several different ways:
- Diversify by location
- Purchase properties at different price points
- Buy different styles of property (i.e. houses, villas, units, townhouses)
- Consider a mix of commercial and residential property.
The main issue with buying all of your investment properties in the one area is that you’re not managing the risk of potential changes over which you have no control. For example, if you purchase all of your properties in an area where there may be a major change in zoning downwards or a major infrastructure change that will be a detriment to the area, you could be up for tens of thousands of dollars in capital decrease affecting all of your properties.
The same goes for buying in a location that later loses popularity (perhaps we won’t talk about mining towns here, the pain is too great for some). Reduced demand from buyers could affect the resale value of all your assets. What’s more, as the rental values fall away, this will impact on your serviceability of the debt.
Buying two good quality properties (say one for $550,000 and the other for $350,000) rather than one good quality property at $900,000 gives you greater flexibility should you need to free up cash at some point (i.e. as you are nearing retirement) and it can help to spread your tax burden.
For example, having the two assets means you can sell one and retain one of the properties which will keep generating income and also continue building equity. And if you purchased two properties and sold them in separate financial years, you could spread your Capital Gains Tax liability over two years rather than having to pay CGT on the whole profit for the sale of the higher value property in the one year.
Style of Property
Diversifying your portfolio across different property styles is also worth considering and this will often be a direct outcome of buying across different price ranges. This strategy can also help to spread your risk by having properties which appeal to different segments of the market (i.e. families, single person households, young couples without children etc.) both in terms of re-sale value and rental demand.
Commercial and Residential Mix
The fourth alternative we suggest is to look at purchasing commercial property as an alternative to residential to truly diversify your portfolio.
When investing in commercial property it is more about the rental return of the asset and the security of tenure which is directly linked to the covenant on the property. Generally, net returns are higher for commercial than for residential meaning that in most cases outgoings are paid for by the tenant. Capital gains can also be significant if the asset is well located and displays significant functional and economic utility.
At Hegney Property Advisers, we have been securing quality commercial property for clients who are seeking rental returns at around 5.5% to 8.0% net per annum depending on their size and what sector of the commercial market they invest in. Whilst the choices are typically less varied and will generally require a greater capital outlay than a residential asset, investment in the commercial property market is a worthwhile consideration to achieve complete diversity.
Investment in the property market should be a long term proposition, however there are times when the market stagnates or even declines in value, which can limit your ability to free up equity at any given time and potentially limit your ability to service the debt associated with your investment. You can't always control the external factors which cause these market downturns to occur so it makes good sense to work towards minimising the risks through a diversified property portfolio strategy. A new financial year is often a good time to review your property portfolio and this is something that the team at Hegney Property Advisers manage every day.