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Concentrated area v diversification as a strategy

Discussion in 'Real Estate' started by alexlee, 29th Jun, 2006.

  1. alexlee

    alexlee Member

    25th Jun, 2006
    What do people think about buying properties in one area vs buying properties across many areas / states?

    It makes sense to become an expert in one area, and to concentrate your efforts.

    It also makes sense to spread your risk across states: lower land tax, less likely you'll get hit by a state-specific issue, and the chance of catching those special booms. e.g. most of my IPs are in Qld, but my one IP in Perth which I bought with a view to diversification caught the back end of the Perth boom and have been giving me psycho gains.

    However, to diversify almost involves information overload. For example, within my criteria (Max $250k - $300k, 3+ bedroom houses on large blocks with future development potential in the capital cities) I've found dozens of suburbs that might be suitable in Melbourne, Sydney, Brisbane and SE Qld. And I haven't done the research on Adelaide yet.

    How do people approach this issue of concentration (as Michael Yardney advocates in his book) v diversification?
  2. Jacque

    Jacque Team InvestEd

    16th Jun, 2005
    Hi Alex :)

    You've answered your own first question by the example you give us with your own investments and how they've gone. Diversification reaps rewards, as your Perth purchase clearly demonstrates. Well done! I love the term "psycho gains", by the way. Very appropriate in the current market :D

    I can also identify with the information overload, but it needn't be this difficult. Decide on which city/town you wish to concentrate on and do a bit more research. For me, I tend to use historical data first to sort out the better performing suburbs and then look at both yield and current market conditions. Rental reality formula applied also helps, though I certainly don't base my buying decision purely on this alone.
    There are the usual fundamentals about the specific property that it needs to meet (see my article on Due Diligence for a rundown) and then, of course, knowing all the comps in a particular area is essential for me to ensure that I'm not paying too much.
    Watching a particular suburb (following sales, solds, auction results etc) for at least 2 mths before purchasing is a must, if you're to really develop a feel for what is happening. Purchasing information from one of the many sales data companies for a small cost is a must and an absolute minimum requirement, though these won't always give you the most current sales results (about a 3 mth lag period). Having a RE pal who can look up more current data on RPData is always useful as well- especially if they're subscribers to the "On the Market feature", which displays all Advertising Histories and is enormously beneficial to buyers.
    The point is not to become bogged down in a quagmire of information. Pick your state, city and narrow your list down to a manageable list of suburbs (3-4 is ideal) and then proceed to know as much as you can about those selected.
    The other option is to employ a good independent BA to do the legwork for you, if it just proves too difficult doing it all long distance.

    Good luck with your decision and keep us posted as to where you're going to focus your search. With the wealth of knowledge and experience over here at InvestEd you're sure to find someone local who'll be able to assist :)
  3. -T-

    -T- Well-Known Member

    2nd Apr, 2006
    It probably also depends on how serious you are about developing. Understanding the town plan and development restrictions for 20 suburbs across four states would be a full-time job. Sure you can enlist the services of experts, but I think it's best to know what's going on to be in control.

    Also your commitment to other asset classes would play an important role. If you're also heavily into equities, business, cash, etc then your focus on property will be seriously hindered if you want to do well across all classes.

    I own property in three states, but in wanting to develop, I think I'd need to concentrate on one area. At least until I had a development or two under my belt. However, Jacque's wisdom about diversification is the reason why I may have the resources to do a development now. So in summary, who knows the best balance? :)
  4. Nigel Ward

    Nigel Ward Team InvestEd

    10th Jun, 2005
    Really good question Alex. It's the old: don't put all your eggs in one basket argument vs the put all your eggs in one basket and watch the basket very carefully! approach.

    I tend to think that with busy lives and a deluge of info, we all have to accept that we just can't be experts in everything. I guess the key is to know just enough to both keep yourself out of trouble and to know when you don't know.

    Simple mathematical rules like the rental reality formula or other performance benchmarks for your properties will help narrow the field. In much the same way as shares I suppose you can take a top down or bottom up approach.

    Once a property meets the initial criteria on the numbers then I tend to move onto both the macro (i.e. what's this suburb, city, state done in the past in terms of CG and what do I (and others) think it may do in the future as well as then honing in on the property specific again i.e. what's the upside, twist, hidden potential here that makes this worth buying?

    I think though that for every rule there are exceptions. I wouldn't scratch a property off the list necessarily if the yield was a bit weak but the upside through reno or development appeared to be strong.

    Just my 2.2 cents worth
  5. D&K

    D&K Well-Known Member

    14th Nov, 2005
    Alex, good question. Some ideas to consider:

    Not all markets are in sync, some go up before others. So you don't need to follow all markest at once, but realise when to shift from one area to another. Hence you can diversify without researching everything all at once.

    Capital cities seem to have a ripple effect, with prices rising close to the city first and then rippling to outer suburbs (generally). So you can concentrate on the inner areas first and then move out (if seeking CG). Looking for cashflow generally means starting further out but still getting in before the price rise if you can. Again, it reduces the amount of detailed research required, but you need to keep track of the overall trend (which is often 6 - 12 months before the newspapers).

    Another option is to look for stimulus in the area. New freeways or rail, jobs, rezoning, new social facilities (eg hospitals), etc.

    I have used the above to narrow down an area first and then to look for a suitable house in area, when chasing CG. I guess its a way to manage diversifying and research effort. Having said that, over half of our properties are now within a couple of areas within Brisbane/SEQ, but with different characteristics.

    Alex, congratulations on getting into Perth, we didn't as we thought it would have peaked a year ago. Sand-groppers don't seem to have been told that the party's over - good for them! So I guess that despite trying to follow trends, in order to reduce the effort of research when diversifying, you can't always pick the market (or I can't at least). :eek:

    On consolidating, we have found it easier to manage when you have one PM looking after several properties, provided that they're good ones.

    Cheers, Dave
  6. Jacque

    Jacque Team InvestEd

    16th Jun, 2005
    This is a crucial point of the research into an unknown area that some investors seem to overlook, and yet with a few calls to council and an eye on local events, can be easily done.
    Knowing of future development or changes to existing infrastructure, roads etc (or even rumours/localspeak) can have enormous ramifications and affect values significantly, both ways.