Building a Diverse Minimal Risk Property Investment Portfolio

Building a Diverse Minimal Risk Property Investment Portfolio

Minimal Risk Property Investment

All investments involve some element of risk. An investment is the purchase of an asset with the hope that it will generate an income, or its value will appreciate over time. An asset can be something tangible, such as property, or intangible, such as stocks and shares. In either case, there is no guarantee that the value of the asset will increase, and it is always possible for things to go wrong, resulting in the investor losing any money they have put towards the investment. In general, the higher the risk involved, the greater the return if the investment is successful. Investments can be split into three general risk classes.

High Risk Investment

High risk investments are investments with the largest returns, but the most chance of going wrong. The volatility of stocks and shares makes them prime examples of high-risk investments. This kind of investment should only be made by investors with a lot of experience and knowledge of the market they are investing in. Typically, high risk investments are only made by investors with a very large budget, who can stand to lose considerable amounts.

Moderate Risk Investment

Moderate risk investments involve a considerably lower chance of things going wrong than high risk investments. The potential returns are generally lower in line with the reduced element of risk, but they can still be considerable. Property investment tends to fit into this category.

Low Risk Investment

Low risk investments stand to make the lowest returns. This kind of investment includes fixed deposits and savings accounts. There is very little chance of an investment failing to generate a return, but the return that can be expected is substantially less than that which could be earned through investments with higher levels of associated risk.

Why diversify?

Having a diverse investment portfolio is commonly cited as the best way to minimise risk. Diversification allows an investor to spread risk across several assets, so that if one asset class hits a slump or starts to perform badly, the negative effects of this will be balanced by the other investments that are performing well. Creating a diverse portfolio can mean investing in several different types of assets, such as property, stocks, shares and bonds. However, it is possible to develop a diverse portfolio containing only property investments, if this is where your skills and interests lie. The effect is the same: the risk will be spread across a diverse range of property assets and therefore be reduced.

Types of Diversification in Property Investment

Location

When investing in property, location is everything. Location sells houses. It has long been said that it is better to have the worst property in the best location that vice versa. However, finding a great location and buying up a lot of property in this area is typically a high-risk strategy. There are lots of great locations across South Africa, giving rise to hundreds of property investment opportunities. A wise investor will by several properties in different locations, to diversify their portfolio and spread the risk.

There are many reasons that an investment portfolio consisting only of properties in a specific area could fail, no matter how fruitful and popular that area seems. Consider, for instance, the effects of a major new bypass being built, land contamination being discovered or a local industry on which mush of the local population is dependent for employment closing. In each case, house prices in an area and the popularity of that area would decease significantly. If an investor’s entire portfolio is built around this location, they could stand to lose a large amount.

Cost

One of the best pieces of advice that an investor can choose to heed is to split their budget over several differently priced properties. So, for example, if you have  R5 000 000 to invest, it would be better to buy several properties costing between R800 000 and R1 200 000, than to buy one property with a purchase price that requires your whole budget. Likewise, if you have a smaller amount, for instance R2 000 000 to invest, it would be better to split this amount up and use it as a 25% deposit on four properties bought with a 75% mortgage. Here’s why:

The first advantage is diversification. Spreading the risk over several properties means that if one fails to generate a return, you will still have returns from the others to fall back on. Secondly, the returns generated are likely to be higher, both in terms of rental income and capital growth. You can earn a rental income from each separate property, which not only means you are likely to receive a higher total rental income, but also means that if one property stands empty for a while, it is not a problem as you will still receive a rental income from the other properties. Further to this, the increase on value of several properties over time is likely to exceed the appreciation of a single property. The final reason diversifying in terms of cost is a good idea is that it allows you to release equity from part of your portfolio if you require a lump sum, for example when coming up to retirement. You will retain your other asset and still be able to acquire the money you need from the sale of just one property.

Property Type

The final form of diversification that can be used to reduce risk is property type. Investing in residential and commercial properties will allow you to fall back on one market if there is upheaval in another. It is also worth considering holiday lets, properties abroad, off plan developments, hotel rooms and student lets. Each type of minimal risk property investment has its own advantages and keeping a diverse portfolio will allow you to benefit from the best of all worlds.

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