How to build a balanced property portfolio
Diversification is a cornerstone of successful investing. Here's how it can bring balance to a property portfolio.
Most investors are familiar with the merits of diversifying across different asset classes. We are often told that a 'balanced' portfolio will have exposure to property, shares, cash and perhaps fixed income investments such as bonds.
The underlying logic is that not all investment markets move in the same way at the same time. When one investment market is experiencing a slowdown, the other assets in your portfolio may be rising in value. In this way, diversification helps to smooth out returns and lower risk.
Exactly how you diversify depends on your age, income, appetite for risk and so on. But what if property is the mainstay of your investment portfolio - as it is for many Australians?
The good news is that it is possible to take diversification into a narrower context by investing in different sectors within the property market.
One asset class - two key markets
Within a property portfolio, diversification can be achieved by investing in different locations, and also by diversifying your wealth creation strategies.
As a general rule, residential property has historically been a great source of capital growth with lower income returns, while commercial property has been a valuable source of passive income with less capital growth.
By spreading your money across both the residential and commercial property markets, your portfolio can offer the best of both worlds - long term capital growth plus regular income. As with any diversification strategy, this lets investors spread risk while maximising growth opportunities.
Commercial property can be the stumbling block
All this can sound easy on paper. Within the residential property market, for instance, you may choose to invest interstate to achieve geographic diversity.
The stumbling block can arise with commercial property, and that's largely because investors are unsure about how it works.
Investing in commercial property is not hard. But it is an asset class that comes with a different playbook from residential property.
Know the similarities, understand the differences
As with all real estate, a good location is critical to the success of a commercial property.
Unlike residential properties, a commercial property will be tenanted by businesses. So location features such as nearby beaches or great views carry less weighting.
Instead, proximity to transport links and a local workforce are desirable. It also makes sense to look for a location with a healthy local economy. This way, if one tenant moves on, there will be plenty of other businesses keen to take out a lease.
Just like residential property, commercial property also offers opportunities to add value. This can involve recognising how vacant land can be utilised, or if the floorspace can be reconfigured to better suit the needs of current tenants, or attract additional tenants.
There are also more notable differences from the residential market.
For one, commercial leases are much longer than residential tenancies - generally running for at least 3-5 years. That makes sense because businesses dislike the disruption of having to relocate. Long leases are a plus for investors as they drive the steady, longer term rent returns that commercial property is renowned for.
However, they do also carry the risk of longer-term vacancies should a tenant leave - which is why strong tenant and property management is crucial.
A simple way to achieve balance
Even if you can tick all the boxes for location, the right lease terms and opportunities to add value, it can be the sheer cost of a quality commercial property that sees direct investors limited to one, or maybe two, properties at most.
Rather than diversifying and bringing balance, this can actually concentrate risk within your property portfolio.
There can be a simple way to spread this risk.
The solution is to invest in a professionally managed commercial property fund.
This is a low-stress, cost-effective strategy to bring diversity to your property portfolio. Investors can, for example, purchase units in some of our funds at Westbridge Funds Management from as little as $50,000.
Our suite of options also includes multi-property funds that offer even more diversity, with underlying assets that span different types of properties, such as retail and industrial, spread across a variety of locations.
Without the need to tie up significant capital in a single commercial property, a managed property fund is an affordable way for investors to build a balanced property portfolio - one that generates robust value growth while also being a source of regular income.
Disclaimer: Always read the PDS and TMD before deciding to invest.
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