Today I’m going to cover how you can manage your risk when investing in property. When you’re investing in any asset there’s no such thing as a sure thing, and investment property is no different. While there’s potential for capital growth which you don’t necessarily get in other asset types, there are still market peaks and troughs which you need to manage. The simplest way to manage the risks is by diversifying your property portfolio.
STEP 1. Buy in different locations. That is, different suburbs within a city, and/or different states and areas.
If you choose to buy all of your property in the same suburb or area you’re intensifying your exposure to potential market changes beyond your control, as well as potential environmental factors that are beyond control.
- If you buy all your investment property in an area where there is a lot of wind/salt damage to the paint, you may be up for repainting bills all at once, which can run into tens of thousands.
- If you buy a large amount of your investment property in an area that loses popularity (like a boom town, for example) the subsequent reduced demand from buyers can affect the resale value.
- If you buy all of your properties in an area and five years later the council builds a major freeway right next door, you risk losing value due to traffic noise
By diversifying across different suburbs and areas both within a city and across states, you can minimise the risk of repairs, outlays, damages and costs. If one of your properties needs repairs or drops in value the financial pain won’t be as hard when your other properties are holding up fine.
STEP 2. Buy across different asset types and price ranges.
Doing this gives your much more flexibility when you do need to sell and free up your equity. If you have assets that are easy to move it makes the whole portfolio more liquid.
Here’s an example:
You have $1 million to spend. With this cash you can either buy one house worth the whole $1 million or you can buy two assets worth $600,000 and $400,000.
If you buy one instead of two assets you have nothing to sell if you need to free up cash, while still maintaining an asset. If you buy two investment properties, you can sell one to free up cash, which allows you to keep the other and continue to amass a source of equity and income outside super.
This method also helps you with your capital gains tax (CGT). If you buy one property worth $1 million and sell it for a profit, you’re liable for CGT on the whole amount at once. Compared to that if you buy two properties and sell them in separate financial years, you can spread your CGT liability over two years.
How To Manage Risk
Basically, diversification covers a range of strategies but the bottom line is to buy across a range of asset types and locations, because not only does this ensure you can weather the storms of the ups and downs with property investment, but you also open yourself up to getting different rental yields, depreciation benefits and other tax benefits.
You can’t control changes in the local environment, infrastructure or demographics. But by diversifying your portfolio and choosing good quality properties, you can minimise the risks associated with these factors and come through the worst of storms relatively unscathed financially. The key to investing well is that whenever you can afford to buy any good quality asset you should.
Need some help with diversifying your investment property portfolio? Come and see us for your no obligation consultation today!