By diversifying their assets, investors can ensure that interim performance across their portfolio is balanced to an acceptable average. Stronger assets can support those experiencing weaker conditions.
Directly owned real estate assets involve a long-term commitment and a disciplined investment strategy and so are not as vulnerable to daily fluctuating sentiment.
It is commonsense to state that real estate assets are a good balance to shorter-term investments. However, there are relative risks.
Point 1: Place residential investment at the core of any sensible property portfolio.
Residential real estate is the lowest-risk real estate because it has the lowest price point and is very liquid. It is required by everybody, not just investors.
It is the easiest real estate category in which to invest, borrow, and have some flexibility.
Several million dollars can be committed to this asset class over the medium and longer term before there need be any thought about moving to other property classes.
Point 2 : The first step to diversify a property portfolio from purely residential is to buy retail properties.
Each category relies on the vibrancy of the preceding markets and the risk increases progressively.
Retail carries the least risk after residential because usually the buildings are simply designed and are unlikely to become obsolete.
Like residential, retail tends to consolidate in the longer term to become better quality.
Point 3: Commercial office and particularly industrial real estate carries a higher risk than residentials and retails.
Such property can also become victim to location trends, such as the relocation of prime industrial precincts to the urban fringe as the city expands or because of major new infrastructure such as ring roads.
For this reason, shrewd investors realise that industrial and commercial property requires faster returns on investment capital. That means property yields in these classes will always be higher than retail yields, which does not require as fast a return because of its lower risk.
Point 4: Residential investments are more oriented towards capital growth than net return while industrial properties rely more on income return rather than capital growth.
Real estate – like equities – offers both income and capital growth. Investments in cash offer interest only and no capital growth.
When analysed on an annual basis, these twin factors of income and capital growth are referred to as the ”internal rate of return (IRR)”. This concept of ”IRR” is a common measure of analysis.
The IRR for real estate varies, but there is a simple guide to the differences between the four main property classes.
A range of 9-12 per cent IRR is only for passive investment properties. Property investments that are to be actively developed, such as subdivisions or construction developments, carry a higher risk. The IRR needs to be higher to justify such investment, somewhere in the range of between 18 to 22 per cent.
A final look completes the comparison. Although it is again very simplistic, it indicates the relative overall return for a variety of investment options.
Point 5: The medium to longer-term property investment prospects in Australia – particularly in its capitals – are very good.
That is because strong population growth is likely to continue, especially in Melbourne.
Such growth not only creates demand for housing, but drives retail, industrial and commercial office markets.
Research suggests that a new dwelling is needed for every two extra Australians.
In the non-residential sector, every new person generates a need for an extra 1.5 square metres of retail space, 2.1 sq m of office space, and up to 20 sq m of various other kinds of space such as industrial, warehouse, factory and logistical.
There are very low levels of vacancy for all these types of space in Australia at the moment, mostly because of a lack of speculative construction since the onset of the financial crisis.
That means there are excellent prospects for strong rental growth and capital performance during the next decade.
However, investors still need to choose carefully.
Point 6: Good investment properties should be located in a growth area where population is likely to boom.
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