Property represents one of the best investment opportunities out there. With dual sources of income available in the form of capital and rental value, investing in both commercial and residential property doubles the odds of securing positive returns.
However, in order to generate significant wealth or achieve financial independence, you usually have to invest in several properties. Building up a portfolio can take time, and even then it is not simply a case of acquiring one after the other and waiting for the cash to start rolling in.
There are important decisions to be made every step of the way. First of all, for each individual acquisition, forecasts need to be made about the prevailing market conditions – what are the price trends in that area? What kind of returns can you expect in both capital and rental income, and which should you prioritise?
These are not decisions that can be made once and then forgotten about, either. Property portfolio management is an on-going process – do you cash in on the capital value of a property when prices rise, or do you go through the process of a review to increase rent? And how do the potential income strands across your entire portfolio interact so you are maximising your total possible returns?
This is why taking a strategic approach to portfolio management is important. And that all starts with having a master plan.
Modern Portfolio Theory
In the mid-20th Century, a school of thought emerged in asset management that came to be known as Modern Portfolio Theory (MPT). In a nutshell, MPT is all about balancing risk and reward across a range of investments. It proposes that by carefully choosing the right range of low-risk investments, which individually might not promise huge rewards, you can optimise your eventual returns.
A case of the whole being greater than the sum of the parts.
The key insight MPT offers, and why it is important to property portfolio planning, is that assets within a portfolio no longer act in isolation. You are always working towards a common goal – you might state that you never want the level of risk to rise above X, while you expect to always have a minimum return of Y. The portfolio is then constructed to fit within these parameters, providing a wider context for your decisions.
In practice, this will often result in an investor being advised to diversify their portfolio. If you purchase a series of properties within a narrow geographic area, for example, the level of risk you take on increases – if prices slump in that area, you lose value across your entire portfolio. To keep risk below an agreed acceptable level, it is better to invest in properties in different areas.
Similar arguments can be made for diversifying across residential and commercial property, or including a wide range of commercial property types in your portfolio, or having a balance of assets you keep for rental income and those you earmark for resale and capital gain.
Once you have set your parameters for risk and expected return in your master plan, you then have your framework for ongoing portfolio management. Regular reviews and key decisions will be made with these criteria as guiding principles, influencing thinking in areas such as:
- How lease renewals and rent reviews can be used to increase the capital value of a property, by raising its income threshold;
- Whether equity from existing properties can be used to add more to the portfolio;
- How day-to-day costs can be reduced to increase margins;
- Whether a change in use of a property could yield higher returns;
- Whether development plans will add enough value to the overall property to be worthwhile.
All of this starts with a master plan, with a clear idea of goals you want to achieve and risks you want to avoid, which leads to clearer decision making. Click here to read more about how Fairhurst Estates can help you with your strategic asset management.