By Brad Nightingale

“Should we diversify our residential property portfolio?” It is a question that regularly comes up and like many areas of property investment, there is no right or wrong answer. Much of the decision will come down to individual preferences and circumstances. But it is important to have considered the advantages and disadvantages of diversification before the decision is made. Diversification means “not placing all your eggs in one basket”. The theory is that if one of your eggs (properties) and the area in which it is located performs poorly, then ideally, your other eggs (properties in different markets at different points in a property cycle) will still be performing for you in any given year. To examine the effect of a diversified versus a non-diversified portfolio, let us look at a case study. Our investor has done some research and come up with Areas A and B as potentially good for long term capital growth. The investor has the capacity to purchase two properties and is trying to decide on whether to buy two properties in area A, two in area B, or one in each area. The theoretical results are given below. Please keep in mind that there are many assumptions, but the below example will show the effect of each decision. Over a 10 year period, areas A and B grow at the following rates: In Scenario 1, our property portfolio gains complete exposure to the growth rates of area A, which in the first two years is zero. This would have been very frustrating and stressful to the investor from a cash flow point of view. In the first two years of Scenario 2, we have two properties growing at 20%, a fantastic result indeed, but we are then exposed to four straight years of zero growth in our portfolio. Therefore the question our investor needs to ask is: “Am I willing to expose my entire property portfolio to the natural fluctuations of only one property market?” Looking at Scenario 3 where our investor has exposure in markets A and B simultaneously, we can see that the year by year fluctuations of each of the two different markets are balanced by each other. So across the ten year period, although Scenario 3 does not have years of large growth rates like 20%, the slow growth years are balanced, resulting in less fluctuation on the path to capital growth. Diversification decisions are more critical in the early part of your portfolio accumulation, say when you are looking at your second purchase for example. At this stage, the second property will represent 50% of your property portfolio, exposing this large percentage to the effect of the market in which this property lies. Whereas the purchase of the 10th property will mean that only 10% of your portfolio is being committed to the purchase. The fluctuations associated with this 10th purchase will have far less of an impact on the overall performance of the portfolio in comparison to the second purchase. There are many factors to consider in the diversification decision. Indeed many property investors have been successful by diversifying and many have been successful by concentrating their investments. At the end of the day, it is an individual decision that depends on your own investment psychology and the confidence you have in your market analysis.

At Power Tynan through our relationship with NPA we have the ability to source the best Rental Properties in the regions of Australia with the best long term growth prospects. If you are interested in Property Investing call us today to discuss.