Diversified property portfolios balance growth and income

Property has long been a favourite investment among Australians.

Its strong long-term performance, income-producing potential and low volatility in comparison to other asset classes means many of us recognise real estate as an important part of our wealth creation strategy – over two million of us, in fact.

Despite our strong affiliation with property, many of us still overlook one of the founding rules of real estate investment – the rule of diversification.

In this article, I explore the importance of diversification in spreading risk in your investment portfolio, and how it can be achieved within property investment itself.

Key strategies to diversify your property portfolio

Traditionally, diversification involves spreading investments across different asset classes like stocks, bonds and property.

However, if property is your main investment focus (as it is for many Australians) you can also look to diversify within the real estate market itself.

For many investors, this might come in the form of investing across different locations to leverage the varying growth cycles of Australia’s residential markets. For others, it may be investing in townhouses or villas to diversify into alternative types of residential investments. 

But what about diversifying by wealth creation strategy?

Looking beyond residential property

The majority of us will gain exposure to real estate through residential property. This makes sense, as residential property is easier to purchase and it is generally more familiar to buyers.

In the earlier phases of our portfolio, residential property will play an important role in helping us build wealth through capital growth.

However, as we progress towards retirement or move further into our investment journey, it may not always be the best asset to meet our evolving investment objectives – at least not on its own.

Residential vs commercial property

As a general rule, residential properties tend to offer strong capital growth, but lower rental yields (or income returns).

Conversely, commercial properties are well known for their income-producing potential. This largely derives from the longer leases associated with commercial properties, as well as the structure of commercial lease terms (it is usually the tenant, not the owner, who is responsible for many of the property’s outgoings).

These different but complementary characteristics can make residential and commercial property key components of a balanced property portfolio.

By strategically including each, you can aim for the best of both worlds - long-term appreciation alongside regular income.

Understanding commercial property

Investing in commercial property might seem daunting for investors who aren’t familiar with this asset class.

The truth is, it’s not as complex as meets the eye. It does, however, require a different approach from residential investments, and it’s important to understand how these differences can play out in practice.

For instance, while a nice view is great for residential property, commercial properties will be tenanted by businesses. This makes factors like proximity to beaches less important. Instead, commercial properties prioritise factors like proximity to transportation, workforce hubs, and healthy local economies – all key points of appeal in attracting potential tenants.

Likewise, commercial leases are typically longer than residential tenancies, often running for five years or more as opposed to the 12 months typical of residential leases.

This provides regular income, but also emphasises the importance of strong tenant screening and property management to minimise the risk of longer-term vacancies.

Overcoming investment hurdles

The problem many investors have with accessing commercial property is the high entry capital required to secure high-quality commercial assets.

These costs, which typically range from $5 million upwards, can limit direct investors to owning just one or two commercial assets. This also concentrates risk, which as we know is not ideal for any investment portfolio.

Fortunately, there are ways to spread this risk while still gaining access to the benefits commercial property can offer. One such solution is investing via a managed fund.

Managed property funds: a smart way to diversify

A property fund is a form of pooled investment whereby investors purchase a share of an asset or group of assets that are held in a professionally managed unit fund.

In exchange for their unit holding, investors receive regular income distributions from the rental income of the asset (in the case of commercial properties), in addition to their portion of any capital growth realised from the sale of the asset(s) at the end of the fund.

Investing in a professionally managed fund offers a low-stress and cost-effective path to diversification. These funds can allow you to gain exposure to larger-scale properties like commercial assets with a lower initial investment, often as low as $25,000.

They can also provide access to a wider range of properties, including various types (e.g. retail, industrial, medical) and locations. This can enable you to achieve significant diversification without tying up large sums of capital in a single asset.

Achieving property investment balance

When planned out well, a balanced property portfolio doesn’t just spread your risk – it can also help you meet different investment objectives.

By strategically combining residential and commercial properties, and potentially leveraging managed property funds, you can create a well-rounded investment strategy that produces an ideal mix of robust value growth and regular income returns.