Buying residential property in Australia is an expensive decision. According to the Real Estate Institute of Victoria, the median property price for a house in metropolitan Melbourne has jumped to $1,004,500 in 2021.
Conventional wisdom says we should spread our eggs to reduce our risk, but when buying residential property, this is very difficult.
For most of us, we do not have this sum of money just lying around. We require the assistance of banks to buy property, through a loan. What this means is that not only are we not spreading our eggs, but we are gearing even more heavily towards the potential success of this asset.
Obviously it follows that to buy a residential property in Australia, most of us are taking a significant punt on the success of this asset class. Fortunately for most of us, the residential property market has delivered. The fact that Sydney and Melbourne are amongst the most expensive cities in the world, reflects this.
But even considering Australia’s residential property success, some properties have under-performed. The very definition of a median is the middle of the best and worst. For those who have already selected an under-performing asset, the impact of a concentrated approach is already being felt.
To illustrate this, consider the performance of the Melbourne suburb of Officer, which was down 10% over a three year period, to August in 2015. Another example is mining town Karratha, which fell 32% in the 2014-15 financial year. This second example is an extreme one, as we all know about the fall out of the mining boom and most of us would not have invested there in the first place, due to its highly speculative nature. However, it does illustrate the point that not all property is created equally and there are several more examples to draw on.
It also highlights how vitally important it is to get the investment selection right. Unlike other growth investments, like shares for example, where it's likely your portfolio will be diversified to a range of companies, if you are only buying one property, your total portfolio success is riding on it.
Consider how this could look if multiple investment properties are purchased. It’s not uncommon for property investors to try and compound their success, by consistently leveraging to further property purchases. Investing this way could deliver the best long term portfolio performance and for many people in Australia over the past 30 years it has. However, the point here is how it impacts concentration of risk.
Looking at the positives of multiple investment properties in a portfolio, it provides the opportunity to spread some of the ‘concentration risk’, by diversifying and purchasing in a different suburb or even more broadly a different state. It is, however, amazing how often I meet people who have invested a second, or even a third and fourth time, in the same area they hold their original investment. The logic being they have achieved some initial success and they feel they understand that particular market. On the point of concentration of risk, the implications are obvious.
Concentration of risk is something that all investors should be mindful of, regardless of how bullish they are on the specific asset class prospects. Simply put, high concentration of assets lends itself to periods of out-performance and periods of under-performance, compared to the alternatives. With the impact of debt leverage overlaid into the equation, this can result in being forced to realise negative outcomes by virtue of having fewer other options to draw on.
Property is a great part of a well-rounded portfolio of assets and several of our clients own investment property. However, the point of concentration risk goes to the heart of good portfolio management. Regardless of how you choose to invest, the starting position should be to consider the five asset classes of Cash, Fixed Interest, Property, Australian Shares and International Shares against your personal objectives and risk tolerance. The better diversified you are, the lower the volatility generally speaking and being diversified provides more flexibility in trading in and out of investments, for personal or investment reasons, throughout the asset cycle.
Yield Financial Planning Is Here To Help
As a uniquely experienced property investment planner, we have helped thousands of Australian’s make more informed property planning decisions than they potentially would have and many of our clients are successful property investors. If you’re looking at buying residential property, contact us.