Diversification is spreading your money between different kinds of investments and products to reduce the risk of your overall investment portfolio.
Wanting to preserve wealth by ‘not losing money’, grow wealth safely, and create an income you can be confident in throughout market changes are the most pressing priorities for the kinds of investors we work with in property.
If this sounds like your client, it makes sense to consider how they can diversify their property portfolio.
Firstly, it is worth considering sector diversification. For example, the long-term rise in online retail, which is reducing demand for High Street shops, does not necessarily impact demand for housing nearby.
Commercial property values are driven by commercial activity in an area, and its impact on rents. Residential property values are driven differently, for example by living standards, demographics, and economic activity. Ultimately, this sector is relatively stable since supply is constrained, and yet demand is strong and growing, since we all need a roof over our heads.
Within the residential sector, there is then a wide range of sub-sectors including private rental housing (that is, property rented by a landlord to a tenant), social housing, student accommodation and later living.
Perhaps the easiest way to diversify a property portfolio from a sector perspective is to invest in a diversified fund or real estate investment trust.
REITs own or finance income-producing real estate across a range of property sectors, and are mostly traded on major stock exchanges. For example, British Land has £13.7bn assets under management at the time of writing, diversified across assets including offices and retail buildings.
However, such investments do not offer the tangibility, low volatility and control that attract so many investors to property in the first place. So what if the client prefers to focus on direct investments – owning ‘bricks and mortar’ that they can control?
In an environment of rising regulations, it is increasingly preferable to focus on just one sector or sub-sector, or to work with someone who specialises in their sector. This is because a lack of specific sector knowledge creates additional risk, which can easily outweigh the benefits of diversification. A saying from Warren Buffett is relevant here: “Wide diversification is only required when investors do not understand what they are doing”; or “keep all your eggs in one basket, but watch that basket closely”.
Let’s say you have decided to focus on residential property investment. Within this, there are significant benefits to diversification, including:
- Geographical diversification
- Number and type of properties
- Number and type of tenancies.
Where should you invest?
Geographical diversification is about avoiding concentrating risk in a particular area. For example, news that a major employer is leaving Croydon, south London might influence demand for property in that area, but it will not affect investments in Manchester.