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.