Private property issue #85 - How do I spread my risk?

Last week, we were speaking around the country as part of the Wealth Plan tour. One investor asked: “How should investors diversify their portfolios to mitigate risk?”

Great question.

It always bugs me when a developer tries to sell property investing with a graph like this.

They'll say: "Look, the NZ property market goes up almost every year.".

But, the median property price in NZ is an average of all the property markets in the country.

But sometimes Auckland is down, while Wellington is flat. Sometimes it’s the other way around. Here’s an example.

Here’s why you can’t just buy in one area

House prices in Gisborne have gone up by about the same amount as the rest of the country.

Gisborne house prices are 7.25x what they were in 1992.

NZ house prices are 7.5x what they were at that time.

But, Individual markets don’t go up smoothly like the graph of the NZ property market.

See how Gisborne (a regional property market) is more boom and bust than the country’s average.

In its worst year, NZ house prices were down 14%. But in Gisborne’s worst year, prices were down 21%.

In the best year, NZ prices were up 31%, and in Gisborne, they screamed up by more than 43%.

So, individual regions have more ups and downs than the country’s average. They’re more volatile.

Why does this matter?

Over the long term (31 years+), property prices go up at roughly the same rate.

But what happens if:

• you need to sell in 5 years, and your market is down? Or
• you want to borrow more against your investment in 10 years, but the market is flat?

The rough periods can slow you down if you only invest in one region.

So, how do you spread your risk?

One way to smooth things out is to buy in different regions.

Let’s say back in 1992, you bought 2 properties. 1 in Auckland. 1 in Gisborne. And let’s say those properties were the same value.

Over the next 31 years, those 2 properties had their share of ups and downs.

But sometimes Auckland is up while Gisborne is down. Sometimes it’s the other way around.

But look what happens when you average those property prices as a portfolio.

Your portfolio’s value more closely mirrors the NZ property market.

So you don’t get as many ups and downs. That does two things.

#1 – You’re less likely to give up.

People stop investing in property when things get too hard.

Let’s say you were only investing in Gisborne in 2007. You would have had almost 10 years of a flat market.

At that point, you might think: "Nah, property investing isn't for me".

But what if you've got another property in a region that’s going gangbusters?

You're more likely to hold your nerve.

#2 – It helps you grow your portfolio.

Let's say one market is down, but the other is up. You may be able to borrow against the better-performing property.

You can use some of that money to buy another investment property.

Bottom line: If you only buy in one region, you’re more at the mercy of what one market is doing at any one time.

Buying around the country (diversifying) evens out your returns. That way, your portfolio grows more consistently.

This keeps your wealth more in line with the overall property market. It smoothes out the bumps.