Diversifying into real estate during a recession
Recessions and market volatility always makes most investors nervous but there are some sensible ways to mitigate risk. I thought it would be a good idea to look at investing during a recession specifically focusing on using residential property as a risk mitigation tool.
Investors should also be looking at ways to ensure they are getting the best possible returns from their investments, are they “sweating their assets” hard enough? In order to do this any investor should be proactive and carry out a “health check” on their assets to ensure that performance and returns are being maximised.
Recession is nothing new
At this point it is perhaps worth pointing out that recessions are nothing new, they are a natural part of market economies and occur regularly. We have seen one in the 50’s, 60’s, 70’s, 80’s, 90’s with the most recent being 2008/2009 due to the global financial crisis. So, let’s try and keep things in perspective and remain objective when making financial decisions.
Don’t lose focus, concentrate on the long-term goals and DON’T PANIC.
The goal of any investor should be to focus on their long-term goals and not worry about the short term. When an individual is prepared from the outset for episodes of volatility on their investing journey, they are less likely to be surprised when these happen. Hence are more likely to react rationally and without allowing emotion to take over during periods of economic uncertainty.
By having an open mindset and a longer-term investment perspective that accepts short-term volatility, investors can begin to take a more dispassionate view. The answer is DON’T PANIC, stay disciplined, play the long game, take emotion out of the equation and stay invested, filter out the day to day noise and look beyond temporary market fluctuations.
Are you making the most from your investments?
This is a question any investor should be asking themselves especially now in the current economic climate. They should be exploring ways of building residual income, reducing risk and maximising returns as a way of reducing personal financial distress during a recession.
Do not to remain inactive and sit still rather why not use this time as an opportunity to check your investments are operating as effectively as they can and generating the best possible return
We should look to take positive action during a recession since there is an even bigger argument than normal for seeking ways to improve performance and reduce risk. Check you are invested strategically and your investments are allocated as you want while seeking ways of mitigating risk. It makes sense to periodically rebalance a portfolio to ensure you are not over exposed in one segment or another.
Spending some time assessing and reviewing performance will mean that sensible risk mitigation practices can be implemented and income levels investigated to ensure that maximum yields are being generated.
Don’t put all your eggs in one basket.
Spreading risk should be an integral part of any investment strategy since asset classes perform in different ways, in different cycles and represent different risk profiles.
Diversification is the art of not putting all your eggs in one basket which helps limit exposure to loss in any one investment or one type of investment. It is used to improve the stability and return potential from a portfolio by reducing the risk of loss.
When risk is mitigated by utilising diversification a portfolio’s volatility is reduced. The lower the volatility, the more diversified an investment portfolio is likely to be and hence the lower the risk.
Real estate fits well as part of a diversified portfolio because it has a number of qualities that can enhance the return from a portfolio, or reduce risk at the same level of return.
Total returns from real estate are the combination of a stable income stream plus capital appreciation and UK property has delivered consistent returns over time. Income from property can be seen to be insulated against uncertainty as income levels remain stable even in times of extreme economic shock such as experienced in 2008.
Investing into property can also act as a useful hedge against inflation not only because rising prices increase the resale value of the property over time, but because real estate can also be used to generate rental income. Just as the value of the property rises with inflation, the amount tenants pay in rent can increase over time. These increases let the owner generate income and in turn can help them keep pace with the general rise in prices across the economy.
Another significant benefit is no other asset class offers the same opportunity to use leverage in the same way as property does. Banks and other forms of finance providers will lend against property at the level they do because it is a tangible asset, it is seen as having a fundamental “bricks and mortar” value. At the moment the cost of money is cheap with most buy to let mortgages at pretty much rock bottom levels. The benefit to the investor is that they can end up with a passive income producing asset that doesn’t tie up large quantities of capital since they can use “other people’s money” to lever the investment and hence maximise returns from the capital deployed.
Furthermore, residential property can act as a strong hedge against wider economic turmoil, since real estate returns display a low correlation with returns on listed equities or bonds. This means that adding real estate to a portfolio comprising mainly equities and bonds can help reduce the total portfolio risk, potentially enhancing its risk-adjusted returns.
So, in summary the primary benefits of residential property are: attractive risk adjusted total returns, stable residual income, ability to use leverage, hedge against inflation and diversification resulting in risk reduction against volatility.
The UK Lettings Market
The private rented sector (PRS) tends to be counter cyclical to the sales market since it is more resilient with activity falling less severely and rebounding more quickly after financial and economic shock than seen in the sales sector. In times of uncertainty people still need somewhere to live but often prefer to rent rather than buy homes due to the inherent flexibility renting gives people. This means rental demand can actually increase during a recession. At the same time actual supply of stock does not tend to increase which has the effect of keeping rental inflation in positive figures. It can in fact act a bit like a safety valve when the purchase market goes into reverse. The result is we feel the sector is well placed to weather any adverse headwinds resulting from the economic slowdown.
Focus on Edinburgh
Edinburgh has been a popular place to invest for many reasons not least due to ease of access in terms of capital deployed and potential yields that can be generated.
The city is home to the second largest financial sector outside of London and the 4th largest in Europe. Some 11% of the population work in the higher earning financial and insurance sectors and 55% of households earn above £40,000 PA.
The population of Edinburgh is growing fast and broke 500,000 in 2016, this growth is expected to continue at a rate of circa 5000 PA over the next 20 years. Savills have forecasted that the number of households within Edinburgh and the Lothians has the potential to increase by 25% over the period between 2017 and 2041.
If the share of PRS households across the area remains at current levels (20%) then the number of PRS households within the region would grow by 20,000 to circa 100,000 households by 2041. However, should the sector see its share of households increase by just 3% then the number would reach 114,042 equating to a further 34,326 households.
Over half of this growth is forecast to be within the City of Edinburgh itself. Should the share of PRS households in the city itself remain at its current level of 26%, this would equate to an additional 15,123 households in the tenure in the city but should it increase to 29% this would equate to an additional 23,876 more households.
The figures above are conservative compared to the growth already witnessed even over the past six years. The result is we feel the sector in the city is well placed to weather any adverse headwinds resulting from an economic slowdown and is still offers the investor opportunity for good low risk returns but investing in the right property is critical and taking professional advice in now more important than ever.
So, are you making the most from your investments?
This is a question any investor should be asking themselves. In the current economic climate looking at ways of increasing one’s residual income and maximising returns is one way of reducing personal financial risk during a recession.
New Financial Review Service from Glenham
We are a premier Edinburgh letting agent & as a professional asset management company we understand property as an investment class. We are focused on ensuring our clients benefit from the best possible returns from their investments, whilst ensuring their regulatory and legal responsibilities are met and their risks are minimised.
At Glenham we are all about good financial planning and asset management. We always suggest our clients practice prudent wealth management and always advise them to build a diversified portfolio of assets in which property plays a crucial role offering strong returns over time with opportunity for capital growth and a regular source of income.
We are focused on ensuring our clients are optimising their Edinburgh property investment and mitigating their risk. We now offer an investment review service that will look in detail at how your property assets are performing and seek ways to boost performance.