There are lots of common traps that mean investors are drawn to investing in the same asset over and over – leaving them exposed to unnecessary risk. But once you understand the benefits of diversification it’s a compelling strategy for reducing risk in long-term investments.
What you’ll learn in this article
Before we teach you how to diversify your portfolio we should probably explain why it’s important.
There’s no such thing as a perfect property. But you can get close to a perfect portfolio by balancing out the pros and cons of different types of property.
– Rob Dix
Building a property portfolio isn’t easy – we know the incredible hard work and sacrifice that goes into getting even just one property under management. Raising money for a deposit doesn’t happen overnight and you’ll need to invest lots of time to properly educate yourself on strategies, areas, legal processes and much more. That’s why it’s natural to want to specialise in an area and strategy you’ve already mastered. It feels like the smart way to manage your money and risk.
Unfortunately, devoting all your time and energy to one strategy could be the Achilles heel that puts all that work at risk of being wiped out.
Diversifying your portfolio and stepping out of your comfort zone is key to protecting your investments from the highs and lows of market forces beyond your control. You’ll never find an individual property that’s resistant to slow or negative growth, but you can absolutely build a portfolio of properties that is. Similarly, almost no property is both high-yielding and high capital growth.
You can get a high rental ROI buying cheap houses or apartments in decent areas. However, the very thing that delivers a high ROI – a low purchase price – reduces capital growth. 10% capital gains on a £100,000 property will be less than 10% capital gains on a £200,000 property. However, within a portfolio you can have a few lower cost, higher yield properties bringing in income to help you save for some higher cost but lower yield properties that’ll deliver capital growth in the long term.
This is why a sizeable portfolio is a healthy portfolio. One void period will matter far less in a 25-property portfolio than a 5-property portfolio. Similarly, an underperforming property can be absorbed much better in a larger portfolio giving you more time to find a solution – sometimes the solution is time itself, as even poorly performing properties can outperform other investments on a long enough timeline.
However, scale alone isn’t enough to protect you from the unexpected. You could easily have a well-diversified 5-property portfolio that was far more robust than a 25-property portfolio if the larger portfolio was over-focused and poorly thought out. If all 25 of your properties are located in one area and a major employer goes out of business, you’re more likely to experience a wave of voids or rental arrears that could throw your whole portfolio into jeopardy as you struggle to cover them all.
This is why it’s important to think about diversification at all points of your journey, because if you start with this goal in mind, it can help you through the inevitable ups and downs of the market.
A huge benefit to combining scale and diversification is you’re significantly more likely to invest in an area that unexpectedly outperforms! That said, on a long enough timeline, all properties will wax and wane in terms of capital growth and rental demand. A diversified portfolio ensures that even if some of your properties become less desirable, you probably have some other properties in your portfolio that are surging ahead as a counterbalance.
So, how do you diversify your buy-to-let portfolio?
There are lots of ways to make sure your portfolio is diversified. You can choose one method or combine them to make sure your portfolio still suits you.
The easiest diversification strategy to grasp is location. If you invest in just one area, your portfolio’s performance is tied to the highs and lows of that area. This can be incredible when times are good but devastating when times are bad as you’re faced with a wave of voids or negative equity.
An important way that location diversification can protect your portfolio is that the 18-year property cycle sometimes plays out at slightly different times in different areas. So, while one area may recover rapidly, another may take longer and peak later in the cycle. If you’ve spread your portfolio wisely you can make sure at least one part of your portfolio is always growing – which can offset other underperforming areas.
For example, after the 2008 crash, London recovered quickly, whereas Manchester recovered later and then Liverpool had fantastic gains through the pandemic while London’s rental market faced lots of challenges.
Similarly, pressures on areas within cities during the pandemic were widely reported as we had a flight out of city centres, making a rural or suburban portfolio very competitive while creating voids, and rent decreases in some city centres. But then as the world opened-up, the allure of the country turned stale for some urban expats and offices opened again, city centre rents rose rapidly – a fact that required considerable restraint from Rob D after he predicted it months before anyone else.
Being invested in diverse locations will also sometimes mean your properties aren’t close to where you live. This can be a real sticking point for many landlords who understandably prefer to invest in an area where viewings are easier, and where they have first-hand knowledge of an area.
But if you can get over these reservations, the benefits of diversification outweigh the risks and discomfort of investing further afield. You can take some of the pain out of investing remotely by doing extra due diligence during your pre-investment research and working with an excellent letting agent for after you’ve bought.
There are other advantages to diversifying your portfolio by location. You increase your chances of investing in a property hotspot simply by sticking more pins in the map. You can also develop a sophisticated blended strategy with some locations being strong on rental income and others more focused on capital growth.
Just as different locations can be subject to dips at different times, your chosen property strategy can influence profitability. A strategy such as holiday lets can be healthy for cashflow but highly variable depending on seasons. By blending holiday lets and long-term buy-to-lets, you can smooth out some of the seasonal highs and lows and make your portfolio more predictable. The high-cashflow months can also help you raise cash for deposits much quicker.
HMOs can also generate much more income than a standard buy-to-let, but at the cost of capital growth. By diversifying between HMOs and buy-to-let, your portfolio can deliver income and capital gains. The extra income will allow you to build your portfolio quicker. Similarly, a successful flip can generate a stack of cash which you can then invest in a buy-to-let for more steady gains.
An important area where strategies can also vary is legislation; with the rules for HMOs being notably more proscriptive than a standard buy-to-let. So, by diversifying your strategies you may have to juggle far more rules, but you’ll also protect your portfolio from being totally upended by new legislation targeting one specific strategy. This is also another area where diversification of location can also help you massively as some rules are brought in by local councils, especially in strategies that can be controversial and emotive to locals, like holiday lets or ‘second homes’.
We’ve produced several guides to different strategies if you want to do further reading:
We’ve also got a course on how to pick the right strategy for you which will take you through the different strategies.
This one could be controversial, but it shouldn’t be. It’s important to have a portfolio that includes both houses and apartments if you can. People tend to fall firmly on one side of the house v apartments debate – usually based on their own personal preferences and experiences. And there are good reasons why investors prefer one or the other. Usually, investors who prefer houses say the savings on ground rent and fees make them far better for generating income, whereas fans of apartments cite the same costs as protection against the unpredictable maintenance costs of houses.
There’s also the freehold vs leasehold debate – but that’s only important for certain property investment exit strategies (not that it stops people arguing about it of course).
Apartments and houses appeal to different tenants and lend themselves to different strategies. They’re also subject to different market forces, which the pandemic was a great illustration of. At first, apartment prices plateaued, and houses boomed as people rushed to buy in rural locations with outdoor space. People with house-heavy portfolios weren’t shy about the genius of their position.
And then as the world opened again, professionals flooded back into city centres and apartments saw record price increases and rent rises.
Of course, there are considerably more than just apartments and houses in the world of property for you to diversify between, but the principle remains the same. You can also diversify by age of a property. New builds can be fantastic in terms of being up to EPC regulations, requiring less maintenance and being built with the latest amenities that tenants love (and increasingly expect).
But older properties can have stunning period features that tenants also fall in love with. By their very nature, some areas will only have older properties as there may be very little room for new developments, effectively forcing you to invest in an older property if you see the potential of that area. There are also very clear fashion trends in property. The Victorian houses that towns tore down by the street in the 60s and 70s are now incredibly fashionable.
Even the Brutalist concrete blocks that have been controversial for decades are starting to become beloved features of city skylines for some. This means if your older property is on-trend, you’ll get a higher valuation when refinancing or selling.
That said who knows what trends of the future will be? We can only imagine the Victorians, Georgians and Edwardians had strong opinions on the cookie cutter ‘new builds’ popping up all over their cities at the time – and yet now they’re very popular. We quite like the idea of 1970s council houses being hugely desirable for aesthetically minded tenants and buyers in 2070.
If you have diversified property types, you’ll have almost certainly diversified in tenant type, albeit unintentionally. Families are more likely to rent a house, young professionals are more likely to rent a city centre apartment. Being invested in different areas at different property values means that you’re unlikely to have lots of tenants all working for one employer or in one industry that could be subject to market forces beyond any of your control.
However, it’s not uncommon for people to have an ideal tenant in mind and to tailor their strategy towards attracting that ideal tenant type. This is where you’re taking on increased risk – even though you may feel you’re reducing your risk by pursing the ‘perfect tenant’.
Student lets are a good example of over– specialisation in a particular tenant type being a potential weakness. If your portfolio exclusively caters to students, you’ll have had a much harder time in the last few years. This is due to a structural decline in the student property market as university built, owned, and operated accommodation has begun to dominate. This has really taken hold in city centres and completely changed the landscape for investors.
If students were just one of the tenant types you focused on, you’d have struggled with these university housing policy shifts. And this is before we even start to think about the pandemic and how that’s changed the habits of students in uncertain and unpredictable ways, and that’ll probably continue to do so for years to come.
Diversification is all about protecting your portfolio and investments from external shocks and there’s no bigger external shock to an investor than a recession. But there’s one tenant type that’s unlikely to be affected by a recession – those who receive Universal Credit.
Some landlords are reluctant to rent to people receiving benefits because of specific challenges that need to be navigated. However, benefit income is ‘recession-proof’ and having at least some of your portfolio seamlessly chugging away during a downturn can be extremely helpful. Not to mention you’ll be providing a home for people who are going through a tough time.
Of course, if you were to make your entire strategy renting to people who claim benefits, your income would be ‘recession-proof’ – but you’d be dangerously exposed to changes to the benefits system affecting all your tenants at once.
The best recession-proof portfolio is one that caters to a variety of levels of income in different areas of the country and sectors of employment. That way you’re most likely to minimise your voids and keep your portfolio running, at least in terms of income, even if your capital gains are temporarily struggling.
There’s a lot of reasons to diversify. But like any investment strategy there are downsides, some of which are reasons why people are reluctant to diversify in the first place. It’s hard to become an expert in an area or strategy if you’re juggling more than one.
The area you know the best is likely to be the one you live in right now so you could probably make a better investment locally than you could remotely. To offset this you’d need to do a lot more research into an area further away, which is both time-consuming and costly especially if you’re visiting in person. Your time has value so immediately diversifying by location has an upfront cost.
All investments have an initial time cost in terms of research and due diligence. So, every time you diversify anything, be it location, strategy, property type or tenant, you’ll be spending more time learning before you leap. All that time learning is time you could be spending getting even more knowledgeable about the strategy you’re already focused on.
Another area where a diverse portfolio becomes complicated is how much there is to manage. Working with properties that are diversified by location can mean that self-managing is impractical, in which case you may want to use a letting agent. (We can think of one that is especially good, ours).
But what if your letting agent doesn’t cover all the locations you’re invested in? Suddenly you’re dealing with multiple letting agents or self-managing part of your portfolio while also managing a letting agent. Similarly, some letting agents specialise in HMOs and others prefer not to manage them at all, making a further split of letting agents likely if you’ve diversified by location and strategy. Now you’re managing three to four letting agents.
You could run into similar problems with solicitors, tradespeople, and estate agents – basically almost anyone you need to engage with to help you with your portfolio.
If you think these hassles are worth the benefits of a portfolio that’s protected from shocks and more stable for the long term, then there’s one final downside to consider. Due to all the reasons we’ve discussed, a diversified portfolio is much less likely to underperform – but it’s also less likely to over perform too.
If you have ten properties in a well-diversified portfolio and one of those locations overperforms you won’t be as successful as if you’d bought all ten properties in that over performing location.
Of course, the reason we diversify is that it can be very hard to perfectly predict when a location will boom and be invested there. And although having ten properties all performing incredibly at once is fantastic, because of property cycles it also means inevitably you will eventually have ten properties all performing badly at once – which can be devastating.
If you’re investing for the long-term a diversified portfolio smooths out some of the unavoidable lows and means they’re less likely to happen at all your properties simultaneously.
Even buying one property is a huge investment for most people, and it can take a long time to get your deposit together. Diversification can feel a very long way off when it’s taken multiple years to even get one property.
It’s often easier to grow your property portfolio once you’re already on the ladder as you can leverage capital growth and stack up the rental profits towards another deposit however, you’ll still need to factor in marketing timings from (with the 18-year property cycle) and consider that the barriers to entry for buy-to-let still remain high at around 25% of the purchase price
So how do you diversify when you only have one property or don’t have the cash/25% deposit to throw down?
This is where property funds can be hugely helpful.
You buy shares in a fund and a fund manager will use that money to invest in property. Usually, you get a share of rental income as dividends and the value of your investment can go up – similar to capital growth with property prices. Lots of people can invest in a property fund and a fund manager can use those funds to build a diverse portfolio for the fund.
The most common type of fund is a REIT (Real Estate Investment Trust), and they own a lot of big public buildings such as The Empire State Building.
The beauty of a property fund is that the cost of entry is much lower so you can still invest and benefit from a property-linked investment. Rather than investing in one single buy-to-let property, you’re able to invest in a fund and get exposure to all of the properties within that fund – that’s a fair bit of diversification.
Funds can be residential or commercial, and they may specialise in a particular strategy or focus on multiple strategies. This means you can invest into a fund to diversify your exposure to a variety of strategies or pick a fund that does something totally different to you, so you’ve diversified away from your main strategy. You’ll still have to do your research as investing in funds is still an investment and your capital could still be at risk, however, investing in funds allow investors to be hands-off in comparison to buy-to-let property.
A commercial fund can be invested in anything from retail or office space to the more esoteric logistical buildings like warehouses and depots that keep the wheels turning behind the scenes.
But if you’re new to the commercial world, again, research here is paramount. If funds interest you, you should be doing just as much homework here as you would be if you were purchasing the property yourself.
By investing in funds, you can be exposed to types of property you’re not invested in personally but also a quantity of property you’d struggle to achieve alone. A single REIT could have hundreds of properties sitting within in.
You can also take it a step further and invest in multiple REITs to diversify even more.
We’ve talked previously about how leverage is the secret to making serious money as an investor. One drawback of funds is that they often have a limit on the leverage they’ll have in their portfolio. This means technically you can make better use of the benefits of leverage in your own portfolio.
Not being able to use leverage isn’t the only way that a fund may end up with lower returns than a private investment. Funds also have running costs that will be paid before you get paid dividends.
Another thing to consider when investing in property funds is that they require trust. With a fund you’ll have no influence over what’s being invested in, even though it’s your money. It’s just like investing in the S&P 500 or FTSE 100, you don’t have any say on what happens within those businesses – and you can’t influence the decisions made by a REIT. You need to trust the fund managers (and have enough knowledge of the businesses sitting within the fund) to make educated decisions.
The final con of a property fund is that they can be boring. Lots of people get into property because they actually like property and navigating the highs and lows of the market. Funds are very hands-off and that can make them hard to get excited about. That said, when it comes to investing, boring can also mean stress-free.
Hopefully, we’ve demonstrated the importance of diversification as well as some of the common ways investors protect their portfolio. It can be hard to pivot a portfolio due to the nature of how time-consuming buying property can be. So whether you’re yet to begin your property journey or you have a healthy portfolio diversification is something that you need to be thinking about throughout.
A key to diversifying your portfolio is to keep learning about areas and strategies you’re not currently exposed to.