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Farmland and property, risk and return

When considering an investment you need to consider the risks involved. You cannot receive any level of excess return from an investment without taking on some level of risk. Even the risk free interest rate offered by the central bank still contains the risk associated with the possibility of default.

The greater level of risk you are willing to take, the greater the rewards are likely to be. But what is the risk of investment? What does risk mean?

Historical data show’s that UK equities have grown at an average of 9.9% a year and residential property at 5.8% a year for the last ten years. If you look at the 10 years before that you will see similar results, and you will see the same again if you go back another 10 years.

Taking this trend into account, I would generally describe the risk of an investment as a combination of three things:

  1. The short term fluctuations in value of the asset
  2. The risk of default or bankruptcy
  3. The opportunity risk associated with what else you could have invested in.
If you diversify your portfolio adequately you can minimise the risk associated with the second two components. This is because, if for example one of the companies you have invested in goes bankrupt, and you have a completely diversified portfolio, then in theory, you can expect its competitor to take the bankrupt companies costumers. As you will have an equal investment in the competitor this will dampen the loss you made with the now bankrupt company.
Above is a very primitive example, but it does illustrate my point that if you have a well diversified portfolio the risk of bankruptcy and the opportunity risk can be minimize as the well performing assets will offset the failing assets.
This leaves the first component, the short term fluctuations in value of the asset. Your initial thought may be that surely these fluctuations will also be offset by a well diversified portfolio, and you are right, most of the time.
When the equity markets collapse and the property bubble explodes, all the short term fluctuations in price will be negative and have a real effect on the value of a well diversified portfolio.
However, as I mentioned earlier, the equity and property returns for the past ten years are not far off any ten year period you choose to measure even though that period contained the financial crisis of 2008-2009.The short term fluctuations in the value of the asset should only be taken into account, if you plan to sell that asset in the short term. If there is a crisis, then as long as you are able to hold on to it, you needn’t worry too much, history tells us its value will return.
This is why financial advisors, superannuation funds or life funds will generally recommend younger people gear their portfolio towards the riskier equities market, because they know that a market collapse will have little effect on their final portfolio value when they retire in 30-50 years. However for retirees this could have serious detrimental effects, completely changing the life they were hoping to live in retirement, which is why the funds or advisors will generally recommend moving towards assets with less short term fluctuations as you get older.
Property is an asset class with low short term price fluctuations and is great example of an asset class to move into once the volatility of the equities market becomes a concern to you.
There are however different types of property and different levels of risk associated with each.
If you are looking to achieve substantial returns from a property investment I would consider purchasing farmland with the intention to seek planning permission for housing, or repurposing farmland you already own for housing (tax and other implications taken into consideration of course).
As noted earlier, you cannot achieve such returns without taking in additional risk. The risk in this situation is not associated with a loss in the value of the farmland you own should the application for planning permission fail, the risk relates to the money you put into the planning and management of the application.
However these risks can be reduced. With a good experienced team behind you, managing, planning, and submitting your application, your chance of achieving planning permission can be significantly increased. That’s exactly what we do here at Woolley, we minimise risks to our clients by using the wealth of experience we have in our possession to put forward the strongest case possible for our clients to achieve planning permission.
Author: Woolley
Published on: Friday, November 20th, 2015
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