By Guest Blogger: John Lindeman, Researcher and Educator
7steps2success.com.au
If we were completely confident about the performance of our investments, there would be no point in diversifying at all. We would simply put all our eggs in one basket, and invest where the results were going to be the best.
The only reason we don’t do this is because we can’t be sure about the outcomes, and so we diversify, or balance our investments. The logic is that if one of our property investments falters, good continued performance in the others will still give us an acceptable overall result.
Some investors spread their housing investments across several states, others own a mix of houses, townhouses and apartments, while still others balance their portfolio across capital cities, regional towns and rural centers.
The issue is that simply spreading your investments in this way may not give you a balanced property portfolio at all. Let’s look at some of the most common strategies investors use to minimise their exposure to risk and see which of them makes the most sense.
Capital city versus regional housing markets
Australia’s big regional centers such as the Gold Coast, Sunshine Coast, Townsville and Cairns in Queensland, Newcastle and Wollongong in New South Wales and Geelong in Victoria have much larger populations than some of our capital cities and some of their population growth rates are amongst our highest.
Yet, even though these regional housing markets occasionally boom, their overall long-term price growth rate is lower than that of our capital cities. This is because housing prices respond to both demand and supply, and housing shortages are generally more acute in our largest capital cities than in regional markets.
This means that buy and hold investors seeking a balanced portfolio should only invest in capital cities, unless there is strong evidence that a particular regional or rural market is about to boom, in which case correctly “timing” the local market’s boom potential is critical.
One State versus another
Some investors believe that a balance is achieved by spreading their property investment portfolio across several different States. This can lead a huge mistake being made, if the properties are all located in the same type of market.
For example, you might spread your properties across several States, but if they are all located in mining owns, or potential retiree locations, or first home buyer markets, then they are all still located in the same type of market, which means that you haven’t really spread and minimised your risk at all.
Different types of housing markets
Irrespective of where we decide to invest, we need to look at the single most important fact about housing investment. The best investments will always be where the demand for housing is so great that it leads to housing shortages. Seventy percent of dwellings are owner-occupied and thirty per cent are rented, so the two most basic types of housing markets are those where renters are in the majority, and those where owner/occupiers predominate.
High cash flow investments rely on constant rental demand
Rental markets are far more volatile than owner-occupier markets, because the people who live in the dwellings don’t own them, while the people who own them don’t live in them.
This volatility provides opportunity as well as risk. Rental markets can offer high positive cash flow, but also high risk if the rental demand lows down or the market is over developed with new dwellings sold to investors.
If your strategy is high permanent cash flow, then you should invest in areas where the rental demand is high and further development is not possible, such as permanent rental markets in lower social economic suburbs, or older well-established localities where new overseas arrivals rent, precincts with students renting near tertiary institutions.
Continued price growth is caused by growing owner occupier demand
On the other hand, if you are seeking sustained capital growth without speculative risk, you can choose from first home buyer markets located in urban growth corridors and outer suburbs, upsizing upgrader markets situated in well-established upper socio-economic areas and downsizing retiree markets located in coastal and harbourside suburbs.
If you are certain that one type of market is about to boom, it makes sense not to diversify and concentrate all your properties in that one type of market. But because so many of the macro dynamics such as interest rates, economic conditions, population growth, lending rules and finance availability can change, it becomes very difficult to accurately pick the type of market where price growth is most probable.
This is why it is best to limit the diversification of your portfolio to a combination of those types of markets which have the best potential to provide the outcomes from property investment that you are looking for. Achieving such a balance means that while all of your investments may prosper, it is highly unlikely that none of them will.
John Lindeman is the In-Depth columnist for Your Investment Property Magazine and a popular contributor to property related media. John also authored the landmark best-selling books for property investors, Mastering the Australian Housing Market and Unlocking the Property Market, both published by Wileys. Visit www.lindemanreports.com.au
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