| Any professional investor knows that part of a | | | | Jim is keen to reduce his risk of sustaining a fall in |
| successful investment strategy is to balance the | | | | the value of his investments. This is best achieved |
| competing aspects of risk and reward. One of the | | | | by following a strategy of diversification. This is |
| big risks to any residential buy-to-let investor is | | | | how it is done. |
| that in essence their investment is very 'lumpy'. | | | | He increases his borrowing to £150,000 |
| That is to say it is a large investment in a single | | | | through a further advance of £50,000 on |
| asset class, in a single location. This is great when | | | | an interest only basis. Again the interest rate |
| times are good, but if times are bad for | | | | payable is 6%. This makes a total payment of |
| residential investment in that area then there is no | | | | £644.30 pm plus the interest only |
| way of avoiding poor returns. | | | | payments on the further advance of £250 |
| Is there a way around this for landlords? | | | | pm. In total this amounts to £894.30 pm |
| The secret of good investment practice is a | | | | which is still covered by the £1000 rent. It |
| strategy that aims to spread an investor's risks. | | | | is worth mentioning that rents are likely to rise |
| This means holding a range of investments in | | | | over time whilst the repayment part of the |
| different sectors. The theory being that when | | | | mortgage will start to fall. |
| one investment is doing poorly others will be | | | | Investment diversification |
| showing good returns and therefore overall the | | | | Here is the clever part. The £50,000 of the |
| investors 'pot' will keep on growing. | | | | additional loan should then be invested in high |
| For a buy-to-let property investor diversifying | | | | yielding shares and funds. In the current climate it |
| their investment portfolio may seem to be | | | | is easy to find funds & shares that pay |
| problematic if not impossible. A landlord and | | | | dividends with a 6% yield. |
| property investor does not always want to buy | | | | By doing this Jim has immediately diversified his |
| another residential investment property in another | | | | investment from 100% in UK residential to 80% |
| part of the country in order to diversify the | | | | residential: 20% shares & funds and |
| geographical spread of their residential investment | | | | according to Portfolio Theory immediately reduces |
| portfolio and thereby reduce their risks to a fall in | | | | his risk of sustaining an overall loss. |
| residential property prices in one part of the | | | | For example the share portfolio that Jim has |
| country because of the very practical difficulties | | | | invested in does reasonably well and rises by |
| of having to remotely manage a buy-to-let | | | | £20,000 or 40% over the 5 years. The |
| investment property. Also by buying another | | | | result being that this cancels out the loss of equity |
| residential investment property a landlord is buying | | | | sustained by his residential property. |
| an investment in the same asset class. This is not | | | | The 'win win' scenario is obviously that both the |
| really diversifying an investor's portfolio and | | | | values of his shares investments and his |
| therefore reducing the risk to the landlord of their | | | | residential investment property continues to rise. |
| investment performing badly. | | | | Risks |
| What a landlord and property investor really | | | | The risks to Jim of this investment strategy is |
| needs to do is to use their residential property | | | | that his share portfolio does badly; however |
| asset as an investment vehicle to finance a | | | | careful stock selection and in sectors away from |
| portfolio of diversified investments thereby | | | | the UK should mean that if the UK economy goes |
| providing a landlord with their own diversified | | | | into a slump other markets will be doing well. |
| investment pot. | | | | The other risk of this strategy for Jim is that |
| FOR EXAMPLE | | | | mortgage rates rise meaning his increased |
| Jim Smith's 2 bed terrace house in York | | | | borrowing costs exceed his rent. Hawkeye can |
| Jim has a buy-to-let investment property in York | | | | hedge against this by fixing the interest rate |
| worth £200,000. | | | | payable on all or part of his buy-to-let mortgage |
| The annual rental income is £12,000 which | | | | for the period. |
| gives the residential investment property a gross | | | | This strategy is not for the faint hearted landlord. |
| yield of 6%. Therefore as it stands Jim is 100% | | | | However, for landlords who are comfortable with |
| invested in UK residential property and specifically | | | | managing their own financial affairs and want a |
| in this case in the York housing market. | | | | way to reduce their exposure to the UK |
| To finance this residential investment property Jim | | | | residential investment market it offers a solution |
| has taken out a £100,000 repayment | | | | to a real investment conundrum faced by |
| buy-to-let mortgage over 25years on which he is | | | | landlords of how to reduce the risks of a landlord |
| paying 6%. This costs £644.30 per month | | | | sustaining a loss as a result of a falling or |
| in repayments on his buy-to-let investment | | | | stagnating residential investment market. |
| mortgage. Repayment of the mortgage leaves | | | | Final words |
| Jim with a net income after paying his mortgage | | | | What a landlord needs to do is go beyond thinking |
| of £355.70 (in reality this will be eaten into | | | | just of their individual residential investment |
| by other expenses). | | | | property as an investment but to see it as |
| Jim therefore has equity of £100,000 in | | | | almost an investment vehicle with which to create |
| this residential investment property. Now say | | | | a diversified selection of investments with which |
| house prices fall over the next five years by | | | | to achieve a landlord's individual financial goals. By |
| 10%. This means the value of Jim's property | | | | using the undoubted income generating capacity |
| drops to £180,000 thereby reducing his | | | | and excellent long-term capital appreciation |
| equity to £80,000. | | | | prospects landlords can then create their own |
| How can landlords reduce their investment risk | | | | diversified specialist investment vehicle. |