What impact does spreading a portfolio out across the country have on returns? And does it reduce risk if markets move in different directions?
In short, the answer is yes. Larger portfolios spread across the country nearly always perform better than smaller ones concentrated in a single location.
The objective of diversification is usually to avoid putting all your eggs into one basket. This means being able to enjoy house price growth in Liverpool while prices might be falling in London. Over the medium-term, the UK property market tends to be quite cyclical; what happens down south often plays out further north a few years later.
"Over the long term, there's been little difference in returns between predominantly Northern and predominantly Southern-based portfolios."
This is reflected in the chart below, which shows how portfolios with at least 75% of their homes in the North or South of England have fared. Over the long term (i.e. +15 years), there’s been little difference in the returns between predominantly Northern and predominantly Southern-based portfolios. In the short term, however, the differences can be quite stark.
Over the last five years, annual returns (including rental income and capital growth) from predominantly Northern based portfolios have averaged around 9.0%, well above the 5.6% returned by predominantly Southern-based portfolios. However, had the same analysis been run a decade ago, the two figures would have essentially reversed, with the South outperforming as a consequence of a strong price recovery following the 2008 financial crash.
Where these returns come from also changes. Over the last 20 years, 69% of returns from predominantly Northern-based portfolios have come from rental income, rather than capital growth. By comparison, the same figure for Southern based portfolios is 52%. But looking at just the last five years, these figures are completely reversed, with 57% of returns in the South coming from rent as house price growth has slowed, compared to 48% in the North.
"Over the last five years, more diverse portfolios have outperformed even better, with annual returns of 1.1% above similarly sized portfolios which aren't as diverse."
So, for investors with longer-term horizons, there is an argument that diversification doesn’t matter quite as much in the property world. This differs from investing in stocks and shares, where investing in one company can prove very risky, even in the long run.
Based on past data, regardless of your niche in the private rented sector, history shows that returns tend to even out in the long term. This is regardless of whether returns were predominantly driven by capital growth or rent. However, over shorter time spans, particularly under 15 years, our analysis suggests that diversification really does matter.
This means that over the last decade, more geographically diverse portfolios have outperformed less diverse portfolios by around 0.4% per year (across both capital appreciation and rental returns). Whilst this may not sound like much on paper, over a decade or so, this can make a significant difference to profitability. Over the last five years, more diverse portfolios have performed even better, with returns of 1.1% above similarly sized portfolios which aren’t as diverse.
Alongside diversification, the other buffer to volatility is scale, although often the two go hand in hand. Here, we measure risk as the annual volatility in returns (i.e. how much returns differ between each year). So a portfolio with high returns one year followed by negative returns the next year is classified as more risky than one with lower returns that are fairly similar each year.
On average, moving from owning a single property to a small portfolio of between two and five homes typically reduces volatility by around 12%. From then on, risk reduction follows the law of diminishing returns. Additional properties further reduce volatility, but by slightly less each time. A portfolio with 50+ homes is around a third less risky relative to owning a single property.
