7 thoughts on diversifying your property portfolio

Spinning Plates

Diversification of investments is of course, instinctively a good idea. The basis for this is to spread your capital into a range of asset classes so as to “hedge” against one particularly type of investment rather than the sense of putting all one’s eggs in one (or very few) baskets.

But as with most aspects of investing, the story isn’t quite that simple…

Imagine you are a traditional, experienced private property investor with a high proportion of your total assets in property and wanting to away from purely property related opportunities.

In general terms this is a sound strategy. I would say that some additional factors should always be borne in mind. Here are 7:

1. While never the only game in town, real estate is still known to be the most resilient and secure of assets in developed countries. The right balance of different property sectors in a portfolio can give a powerful hedge without unnecessarily introducing unknown variables into the equation.

2. One key objective of diversification is to reduce risk of loss. But there are caveats to think about: 

  • Unless this is done with an investment that has a similar or better risk-profile and the market sector is equally well-understood by the end buyer, diversification could actually increase the riskiness of the investment portfolio, outweighing the hedging against the rest of the portfolio. 
  • Your years of experience in property is a strong advantage not to be taken for granted.

3. Another reason for moving away from further property sector investments would be, that once with a solid property base, take on some more “riskier” speculative investments whether in real estate or outside, with a hope of higher returns. With “safer” investments under one’s belt the capacity for loss on others is greater, having those solid real estate based investments to fall back on. depending on the property portfolio you already have, it may actually be worth adding or trading into more solid property investments. For example adding residential to your commercial property portfolio or vice versa. Check out our article on Taking Control of Risk.

4. With a solid bedrock in the portfolio, you are then in a good position to look at buying share equity into a property development company, or perhaps acting as a secured lender via a fixed-term mini-bond. This changes your landscape as you need to be adept at researching property businesses and carefully analysing the legal structure around the agreement you enter into. An upside is that entry is straightforward and exit is after a fixed term, usually without transaction cost. The danger of being too easy, is that there is no obligation for you to carry out full due diligence. But in my experience it is absolutely vital you do so.

5. So how do you safety-check a successful, growing, ambitious property developer before investing? Analyse their business plan, their accountability and their track record. Are they serious about growth and highly capable of achieving it? That’s down to careful recruitment of key personal in all areas including finance, a sound growth strategy combined with the core property development expertise, a board of repulatble directors and equal skills at bringing the right key people on board.

6. A prudent developer balances its portfolio with a mixture of lower and higher yielding investments and a mixture of short, medium and longer-term maturities from investors like you to maintain the appropriate balance between risk and return. 

7. This balance for a small/medium sized property developer can be realised by simultaneous involvement in two or more of Commercial Retail and Industrial developments, Hotel & Hospitality sectors and build-to-rent residential. It’s pretty easy to investment in multiple such companies especially wise when there is a healthy diversity between the different company’s operations, all within the world of property we know and (deep down!) love.

Passive Income – Naughty or Nice?

Naughty or Nice?

As we start this series of posts on the classic (and sometimes controversial) topic of Passive Income, it’s worth taking a bit of time to agree on what we’re talking about when we use the phrase.

It seems there’s a massive misunderstanding around whether passive income is to be aspired to or or something to be suspicious of. It’s an innocent enough phrase but why does it evoke such strong opinions both for and against?

What’s the reality behind passive income? As with most things in life, taking the time to understand something is usually well worth the effort.

I suspect there are two key reasons for this lack of understanding:

  1. There is no simple definition of what passive actually is and how it can be attained, and therefore a lot of confusion around the whole subject.
  2. The phrase has, like several others, been used and associated with “get rich quick” schemes. The idea put out to the unwary is that passive income is a way of getting money for nothing and often for no financial commitment, which is highly appealing but ultimately doomed.

To try to address both of these reasons let’s get down to some proper definitions.

The most succinct definition of passive income I have found, from trading website ADVFN is: “Income (such as investment income) that does not come from active participation in a business.”

Often the best place to look for definition of income types ought to be from the tax man. In the UK passive income isn’t a category for tax purposes, but you can get a feel here for what HMRC considers passive income.

But according to the US tax service there are three types of income:

  • Active income
  • Passive income
  • Portfolio income

Active income is when you trade time for money. A regular Job.

Dictionaries can’t quite decide in some case the difference between passive and portfolio income.

According to Investopedia, US passive income is “Earnings an individual derives from a rental property, limited partnership or other enterprise in which he or she is not materially involved.”

And portfolio income is “income from investments, dividends, interest, royalties and capital gains. Portfolio income does not come from passive investments and is not earned through normal business activity. Typically, income from interest on money that has been loaned does not count as portfolio income.” – Investopedia, again.

(It’s somehow reassuring to know that the simple phrase passive income seems equally misunderstood on both sides of the Atlantic!).

Nevertheless, all agree that the difference between active and passive (or portfolio) income is whether one is materially involved in generating the income.

Some income is more passive than others.

In reality there is seldom black-and-white active or passive income – most income is somewhere on a scale between the two…

What about property income ?

Since we’re on a property blog, this is an excellent question. If you’re a landlord and working directly in your business are you getting passive income? I would say not quite – its somewhere on the scale : semi-passive. If you’ve delegated out all the work to managing agents, what then? Still not 100% passive but getting closer.

If you’ve invested in a fully-managed purpose-built student property ?

Or invested in property bonds or crowdfunding?

Again these sit on the scale of semi-passive, especially when you include the due diligence and research needed before making the investment. It’s hands-on, “do-once” work, but work it certainly is.

And in the end

In conclusion, I would suggest that a stronger investment goal than the Holy Grail of pure passive income is to create income streams through investments that are leveraged by other peoples time (lettings agents, good brokers, investment researchers) and perhaps also other peoples’ money (for example secured loans and mortgages).

I’ll leave you with an example of semi-passive property income: Purpose-built student property is a proven “done-for-you” model. Once you’ve carried out your due diligence and own the student suite, there is literally nothing to do for years –  except receive your net rental income (which compares very favourably with labour-intensive buy-to-let).

Don’t take my word for it – see for yourself some passive income in action…

Why are high-quality Property Bonds still so popular with investors and developers?

Join Venture

With us living longer, pension funds are not giving many of us the financial future we planned for, and other ways are often sought to grow financial nest-eggs to top up that future income. Bank savings accounts aren’t delivering on that either…

So is there a place in a portfolio for Property Bonds – for those of us that would rather be the lender than the property developer?

With good Property Bonds, you team up with an established property developer in a Joint Venture. But there are none of the set-up costs for the bond holder that you would normally associate with a direct property development project, or the advisor fees that come with buying traditional regulated investments: all of your capital goes to work for you.

Here are a few other key reasons to consider profiting from Property Bonds:

  • Property is seen as a secure asset class and with not enough homes being built in the UK demand continually outstrips the supply.
  • There are more and more obstacles in directly owning investment property. Heavier taxation for residential investment property and reduction of tax reliefs for expenses; difficulty in raising mortgage finance for buy- to-let; dealing with tenants; licensing; regulation, the possibility of rent controls; the list goes on). Many property investors are looking for less hassle and more profit: being the lender, not the landlord.
  • As part of this movement, investors who are cash-rich and time-poor are looking to partner with developers by lending rather than getting directly involved in the day-to-day running of projects.
  • In uncertain economic times a predictable fixed income for a known period of time has much appeal.
  • Whilst no investment is risk-free and they’re not for everyone, a well-chosen Property Bond can offer credible security and a practical exit strategy should things go wrong with the developer.

Learn how to spot a good property bond, and those to avoid. All this and more is covered in our Property Bonds guide – grab your copy today: