Diversification is being dubbed as one of the most important considerations to have as a property investor. Here’s how to ensure you’re not falling behind on this front.
Speaking on a recent episode of The Smart Property Investment Show, Propertyology's Simon Pressley outlined nine steps to a sustainable investment strategy.
“Diversification is one of the most important of the nine steps, yet one of the least respected ones,” Mr Pressley told host Phil Tarrant.
“It’s Investment 101. If you think of what a share investor would do, for example, with say, a $200,000 share portfolio, they would spread that across multiple stocks and in multiple companies on the stock exchange. But unfortunately, a lot of property investors, they will buy their investment property in the same town or city that they live in.
“That’s not diversification at all; it’s the complete opposite. I live in Brisbane, so if I buy my first investment property in Brisbane as well, I’ve got all my eggs in the one basket.”
There are key points to consider in order to ensure diversification in property, according to Mr Pressley.
“[It starts with] certainly having an appreciation for where you live and where you invest are completely different decisions,” he said.
“So, understanding that local economies arguably have the biggest influence on how a property market will perform and no one has the crystal ball. So if anything, where you live, you should be considering investing in, I think. And this is what I do personally. You should be considering investing in locations other than where you live. Again, it’s like the person who might work for Commonwealth Bank. It doesn’t mean all their shares are with Commonwealth Bank. But it’s also breaking up your capital into smaller chunks.
“Again, I’m deliberately using the example of what a share investor would do. If they had $10,000 or $100,000, they will put it in multiple companies. And just because a property investor might be able to afford an $800,000 asset or a million-dollar asset, I would argue it’s not the best that you could do with that money, to put it into one property.”
Mr Pressley said a big component of diversification is cash flow versus investment capital, noting that they’re very different things.
“I think some people get confused, especially with the capital part of it. I think cash flow is self-explanatory, but the capital part of it [isn’t],” Mr Pressley explained.
“One of the most common ways that people invest in property is in an earlier stage of their life, they probably bought the family home. And then over the years, they acquire equity in that family home. And at a later date, they borrow against that equity in the family home to invest. Very common strategy, nothing wrong with that strategy at all. But there is a difference between what type of capital is it? Is it capital we’re raising against the equity in an existing asset, or is it capital that’s in the form of cash savings, accumulated savings? And how we use that capital, whether our capital is coming from borrowed money or whether it’s coming from saved cash, will have an effect on our annual cash flow.
“We do a lot of financial modeling for our clients. So, let’s say for example, someone does have $200,000 we’re interested in, is that $200,000 cash or is it $200,000 equity that you’re releasing in an existing asset? And then how can we break that up? Not putting that 200 grand in the one asset, as I said, and using different combinations of loan-to-value ratios will have a different impact on the cash flow. But it’s also a very clever way of using numbers and often it could mean that you could buy two or sometimes three properties instead of the one property.”