Diversification 101 – How and why to plan for diversification within your property portfolio (Ep.53)

The Property Planner, Buyer and Professor discuss all things diversification, from the reasons why you should diversify your portfolio to the many ways you can implement diversification in your investment strategy.  

In this episode David Johnston, Cate Bakos and Peter Koulizos take you through:  

  1. Beware of one size fits all strategies! The suggestion that you should have a 50/50 balance of shares and property (or any other type of investment) is vastly oversimplifying the concept of diversification and neglecting the most important element of the equation, YOU!  
  2. Discussing the different asset classes for diversification, there’s more to consider than just property v shares.  
  3. How you can diversify with property – state, city, regional centres, different suburbs, city segments, property types, growth focused V cash flow and more.  
  4. Tax comes second! Tax benefits should never be a primary reason to invest in a particular asset, it is the icing on the cake. Don’t sacrifice the cake for the icing.   
  5. Considering the macro and micro of diversifying your property portfolio. The macro is the state or the city and the micro is the suburb. Start with a big picture view and work down to suit your property plan, not the location you live or a buyer’s agent. Or worse, where a buyer’s agent is buying, but not based in. Your next purchase could be anywhere in Australia.  
  6. Capital gains v cash flow, how your investment strategy needs to be tailored to you. 
  7. Land tax, an often neglected area of property investment. How and when should land tax factor in to your property decisions? More than two reasonably priced properties in any state will generally start to eat into your returns via land tax. 
  8. Blue chip v gentrification, higher rewards come with higher risks.   
  9. Fractional investing, is it worth getting a fraction of your foot in the property door?  
  10. And of course, our “gold nuggets”! 

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Show notes

  • Diversification: not as simple as 50% property and 50% shares! Residential property is the nation’s most valuable asset class, with a total estimated value approaching $7 trillion. To put this figure into context, it is about four times greater than the value of listed equities on the stock exchange, which is around $2 trillion. 
  • I use these numbers to simply illustrate the point that the suggestion that you should have a 50/50 balance of shares and property (or any other type of investment) is vastly oversimplifying the concept of diversification. Ultimately, people who make ‘one size fits all’ investment statements are neglecting the most important element of the equation, YOU!  
  • We are all unique and at different stages of life, with differing goals, risk profiles, preferred asset classes, family circumstances, financial situations and the list goes on. The appropriate investment balance is not simple for many reasons. 
  • Asset classes for diversification: offering different risks and rewards 
    • Property 
    • Shares 
    • Bonds 
    • Mortgage-backed securities 
    • Real estate investment trusts and more 
  • What are mortgage-backed securities – investors provide funding rather than funding provided by deposits, if you don’t have banking licence, they are relying on investor money. The quality of the loans within that package – they can be good quality or they can be really poor quality. That is something that’s harder for average investor to understand. There has been an increase in these types of loans, the small and second and third tier lenders have increased market share. 
  • Diversification professionals – getting advice about diversification is something you need to get right, be sure to get someone independent and get someone who knows what they are talking about across all of it, not biased towards one particular asset. If you are income earner, a lot of your super is in share market as well.  
  • Tax comes second! Accountants – they were focussing on tax benefits and depreciation, saying to buy a brand new property because of tax benefits, they’re accountant was talking about tax. Don’t focus on the icing on the cake and sacrifice the cake, Invest in a good quality investment, tax comes second. Kickbacks from developers. If you’re strategy relies heavily on tax deductions, you are either investing at the wrong time or in the wrong asset. 
  • Residential property – people who have a number of properties, may not factor in diversification enough. For example, the location of the properties is highly concentrated in the city or state that they reside in.  
  • How to diversify within property:  
    • Property purpose – zoned properties determine their use: industrial, commercial, residential.  
    • Location within the state: regional, capital city, inner city, activity zones, apartments, urban and suburban.  
    • Genre of dwelling types – houses, townhouses, apartments, villa units, strata v freehold. All with varying rental potential. You could buy an apartment for stronger yield or for the same money, a quality house in a nearby region – diversification for capital growth v rental yield. Keep in mind vacancy rates and what sort of tenants you are going to get with the dwelling type and location. Be aware that a ‘villa unit’ in Melbourne is different to a ‘villa unit’ in SA – see the resources for an explanation of dwelling type nomenclature. 
    • Suburbs within the city – north, south, west – look for a different property type and also different suburb. Suburbs within a city can have different cycles – this goes to managing risk. If one part is going through a different stage of the cycle, hopefully the other side is going through an upward cycle.  
    • State – market cycle risk and also a big reason for diversifying according to state is land tax. When you are purchasing with capital gains in mind, land tax should not sway you to look at a different state, but if cash flow is your goal, then potentially you should be looking at interstate locations to avoid a hefty land tax bill. This also depends on the number of properties you would ultimately like to own, if you are only purchasing one or two properties, this won’t be as much of an issue.  
  • Cash flow – diversify to be in a position where you can hold multiple properties. If your strategy is to go for capital gains all the time, you’ll hit the limit of what you can borrow and the bank will say no. Typically, properties with strong capital growth potential, have a correspondingly lower rental yield and you will have heightened out of pockets. Keep a balanced portfolio with some cash flow neutral properties and some that are positive. 
  • Blue chip v gentrifying areas – there is more speculation in investing in gentrifying areas. If you do your research well, you can get a property that performs well in the long-term and outperforms blue chip suburbs in the short-term.  
  • The reasons to diversify: 
    • Location concentration 
    • Land tax 
    • Cities in property cycles 
    • Price range – dictates where is the appropriate place in Australia to be investing 
    • Cash flow drivers 
  • Fractional investing – you can buy a fraction of a property, like shares – so you can slowly build your wealth. Ensure you consider whether this is the right approach for you as there are some risks as well.  

David Johnston – The Property Planner’s Golden nugget: As you can see, when developing your Property Plan and strategy for your next purchase, there are many factors to consider before even getting to the stage of property selection. Diversification highlights why the property purchase could be anywhere in Australia and one of the reasons we ensure we don’t have location bias in our business, why we refer our clients to buyer’s agents and also our property select service to support clients who want to buy and select property like an A-grade buyers agent.  

Cate Bakos – The Property Buyer’s Golden nugget: if when you get advice from someone about diversification, if it is based on tax, or if it is coming from someone who has a particular strength in only one asset class, you need to get a second opinion.  

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