Diversify your property portfolio to minimise risks: Mark Armstrong

Interest rates appear to have bottomed out for the time being and debate continues with regard to the outlook for the property market.

Ultimately, however, there comes a time when the talking stops and it is time to act. But how do you manage your risk once you decide to take the plunge?

When you’re investing in any asset class, there’s no such thing as a sure bet — and residential property is no different. Whilst there’s potential for capital growth, there’s a flipside of a potential stagnation or decline in market value.

You can reduce these risks by implementing a simple strategy — diversifying your property portfolio. You can do this in two ways. First, buy properties in a range of locations; that is, different suburbs within a city, and/or different states.

Buying all your investment properties in the same suburb or neighbourhood means you’re intensifying your exposure to potential changes outside your control.

For example, if you buy all your properties in an area where shifting ground increase the prevalence of major cracking, you could be up for tens of thousands in repair bills, more than once.

Further, if you buy all the properties in a location that later loses popularity (such as a ‘boom’ town based on a single industry which later goes bust) reduced demand from buyers could affect the resale value of all your assets.

If you buy all your properties in an area which later plays host to a freeway that creates considerable nearby traffic noise, you’ll bear an increased risk that not one, but all your properties will stagnate or fall in value.

By diversifying across areas within a city, you can minimise the risk of substantial cash outlays and capital stagnation or loss. If one property takes a hammering, the pain won’t be as bad when your other properties are holding their own.

The second diversification strategy involves buying across different price ranges. This will provide more flexibility when the time comes to sell and free up equity; for example, when you’re nearing retirement and want to top up your super fund.

Let’s say you have $1 million to spend. You can purchase a single asset with the whole amount, or two assets worth, say, $650,000 and $350,000 each.

If you buy two assets, you need only sell one to free up cash, enabling you to keep the other and continue to amass a source of equity and income outside super.

This strategy can also spread your tax burden. If you bought one property worth $1 million and sold it for a profit, you’d be liable for capital gains tax (CGT) on the whole profit at once.

If you bought two properties and sold them in separate financial years, you could spread your CGT liability over two years.

Because houses are generally more expensive than units or townhouses, diversifying your portfolio across different prices ranges means buying across all three property styles.

Having said this, diversifying doesn’t mean compromising on the quality of your investment assets. When it comes to residential property, quality is definitely more important than quantity.

You can’t control changes in the local environment, infrastructure or demographics. But by diversifying your portfolio and choosing good quality properties, you can minimise the risks associated with these factors and come through the worst of storms relatively unscathed.

Mark Armstrong is a director of iProperty Plan, which provides independent analysis and tailored advice to investors and home buyers.