The model portfolio is the Holy Grail for share and bond investors but can it be built with property?
Kate Cowling and Matthew Smith investigate.
At its core, the portfolio features residential property across robust east coast property markets that have the best prospects for medium-term capital growth.
Diversification is added via commercial property and some counter-cyclical buying.
The portfolio is then rounded out with some international property – we did say it was for high-net-worth investors – with our global expert nominating the US, British and German markets as among the best choices.
Below is an explanation of how HNW advisers and buyers think the picture should come together.
THE MODEL PROPERTY PORTFOLIO
When inflation and bond yields are at lows, investors tend to lean on growth assets such as shares and property in order to replace the lost income from cash and fixed income, however unwise that may be.
According to AMP wealth adviser Tony Rigby, there’s no reason why an inventive investor couldn’t apply modern portfolio theory to their property holdings, with the key being knowing their goals and risk appetite, and getting the diversification right.
“If I was investing $5 million and going property all the way, I’d want to have a mix of property. I wouldn’t just rely on residential. There might be a bit of commercial office, there might be a bit of industrial in there, too,” he says.
NAB Private Wealth investment strategist Nick Ryder, who advises clients with more than $10 million in investable assets, says clients tend to have a split between commercial and residential property, with roughly one-third commercial and two-thirds residential property exposure.
The typical residential exposure might include the primary residence, beach house and inner-city investment properties that have performed so admirably in recent years.
The commercial side is frequently achieved through ownership of the headquarters of a family business, a share in an office block syndicate or other opportunities they come across in their private networks (part ownership of childcare centres or retirement homes are not uncommon).
But diversity in sectors isn’t enough, according to wealth managers, with regional businesses and residential sectors often feeling the sting of changes in local economic growth and employment fluctuations.
For this reason, the risk must be spread geographically, as well.
Riccardo Briganti, Macquarie wealth management’s head of research, offers the anecdote of the investor that confuses diversification with buying many examples of the same asset, such as three houses or 30 stocks.
Major cities, primarily Sydney and Melbourne, have become the prime targets of investors seeking capital growth, but following the herd can only exacerbate the risks.
Shane Galligan, managing director of Credit Suisse’s private banking and ultra-high-net-worth advisory arm, concedes the task of creating the perfect property portfolio is beyond most investors.
“Replicating a portfolio of diversified, non-correlated investments in a single asset class such as property is difficult if not impossible,” he says.
However, Galligan says property investors with both means and imagination can go a long way towards achieving a more balanced portfolio. He nominates the US, Britain and Germany as being among the best options for investors seeking additional residential exposure.
“A true exposure has got to be global,” he says. “The perfect property portfolio can’t all be residential, it can’t all be office, it can’t all be industrial, it can’t all be retail and it can’t all be in the one place.”
Most of the wealth advisers Smart Investor spoke to say Sydney and Melbourne are impossible to overlook as the linchpins of the property portfolio. The areas that might prove a nice hedge, however, are more contentious.
CITY AS THE CORE
Concentrating on city areas that provide more consistent returns over the long term is the basis of a sound strategy, according to Dr Andrew Wilson, Domain Group’s chief economist.
One of the reasons for this is consistent interest from investors.
The long-term historic average investor activity in capital cities, including Sydney, Brisbane, Melbourne and Perth, is about 40 per cent, Dr Wilson says.
At the moment, Sydney’s investor activity is at historic highs of about 60 per cent and during a rout it might fall as low as 30 per cent, he says, illustrating its resilience from peak to trough.
“That shows you investors don’t sell up when prices are falling as they might when the stock market falls, so those falls aren’t as exacerbated,” he says.
However, diversification between capital cities can allow investors to benefit from the macro trends driving the respective economies while reducing overall volatility, he adds.
Sydney might be red hot now but 10 years ago price growth was flat. Perth property owners would give their arms for some of that growth right now, following a surge in house prices during the mining boom.
A truly diversified investor on the other would have been able to benefit from both cycles.
The immediate growth expectations in Sydney, Melbourne and Brisbane would place them at the centre of any property portfolio of AllenWargent property buyers co-founder Pete Wargent.
If he had $5 million to spend in any property market right now, the British-born buyer would split his diversified portfolio between the three capital cities, with two units and a terrace in Sydney, ranging between $800,000 and $980,000; two houses in Brisbane for $730,000 each and a house in Melbourne for $960,000.
Wargent says that over time it’s the blue-ribbon locations that perform the best, using London property prices as an example.
“There was a lot of talk about London being overpriced and house prices were going to fall to three times salaries but, 20 years down the track, regional Britain has basically done nothing at all, while London prices are just in another stratosphere.”
Wargent labels Perth a “no go zone”, due to the mining downturn, and believes currency fluctuations mean overseas property investment is too risky.
Paul Osborne, founder of buyers’ advocate outfit The Secret Agent, says the weaker currency also attracted offshore money and supported prices, making metropolitan cities safe havens.
His advice for high-net-worth investors seeking an edge is to put their money behind a city fringe block of apartments or small block of townhouses.
“This approach would allow scale of funds to pay a commercial rate for already established apartments, while reducing risks of relying on singular tenancies,” he says.
Osborne says the strategy offered cash flow, a dilution of risk via the multiple apartments and potential for growth through refurbishments.
The question remains though – how well diversified can you be if all the property you own is within 15 kilometres of Sydney and Melbourne’s CBD?
AMP’s Rigby is sceptical.
“Just because Sydney and Melbourne may be flavour of the month, doesn’t mean they’re going to be, further down the track,” he says. “Property, just like every other asset class, is cyclical by nature. It’s safer to diversify geographically, but then get advice at a local level; at the coal face.”
If the big cities make up the growth proportion of the model portfolio, then regional hubs and second-tier metro cities may constitute a defensive buffer.
Volatility in investor demand in regional areas means investors should be cautious with their allocations to properties outside the capital cities, Dr Wilson says.
“We saw a gold rush mentality, with investors heading into regional areas such as Gladstone and Mackay, and properties were bid up to quite extraordinary levels. But many of them got their fingers burned.”
The opportunity with regional areas is the lower entry price but investors are more exposed to economic changes and the fundamental supply and demand factors.
Holiday houses are among the first assets sold in a downturn and the lack of buying support in a crisis can produce truly staggering discounts from forced sellers.
Cohen Handler associate Daniel Trelease says investors should be wary of making sizeable investments in coastal regions but there are opportunities.
“As much as Australians love regional areas and coastal towns, from an investment perspective there’s no way you’d sink a million dollars unless you were buying a block of units which then changes everything,” he says.
RISK V REWARD
While few advisers are convinced that a “model” property portfolio is attainable through direct means, many spoke of the potential to fine-tune a property exposure via the many REITs available.
Groups such as Stockland (SGP) are a natural selection for investors wanting broad property exposures, with assets spread across key market sectors, Jones Lang LaSalle head of capital markets research Andrew Ballantyne says.
The unrelenting focus on direct property from Australian investors has been known to cause considerable tension from an advice point of view.
AMP’s Rigby says overweight property exposures are not uncommon and, if it’s what the investor wants, it’s the adviser’s role to help them mitigate that risk.
The make-up of the model portfolio will depend on a number of factors, such as the investor’s objectives, income aspirations, capital growth expectations and risk-aversion, he says.
Family office and advisory firm Myer Family Co’s chief investment officer, Miles Collins, stresses the concept of a model portfolio is limited on its own unless it takes into account investors’ expectations and time frames.
“Just like equities, bonds and cash have their own characteristics and benchmarks in terms of how they’ve performed over long periods of time, so, too, does property,” he says.
For instance, equities investors can expect greater returns over a longer period compared with bonds and cash, but should be prepared to endure shorter-term volatility, Collins explains.
Similarly, different property types and locations will have unique performance characteristics, which have been determined over long time frames.
For Macquarie’s Briganti, the strategy’s major risks lie in its inability to offer total diversification.
“You’re reducing one risk, in that you’re not putting all of your eggs in one basket by buying multiple properties, but you’re increasing your exposure to a specific set of circumstances that may impact property,” he says.
“What you’re not diversified in is your exposure to interest rate changes.”
Nonetheless, for investors who want to stick to property and give themselves broad exposure and solid yield, it may be a case of getting back to the tenets of portfolio construction – think long term, be as diversified as possible, across sectors and geographic regions, watch the market and have some liquidity.
AMP’s Rigby says portfolio construction, whether it be in property or stocks, comes down to two questions: “What sort of yield am I looking for?” and “How will I manage my risk?”