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Playbooks / Risk

Concentration limits

A concentration limit is a rule set in advance about how much of your net worth any single asset, building, tenant, employer or currency may represent, and its purpose is to make the decision while you are calm rather than while you are being persuaded.

The rule

Nobody sets out to be concentrated. Concentration is what happens when a series of individually reasonable decisions accumulate in the same direction.

How it happens

An investor buys an apartment in a building they know. It goes well. They buy a second in the same development, because they now understand the building, the agent and the service charge. The third comes from the same developer because the relationship exists.

Every step was defensible. The result is a portfolio exposed to one developer, one owners association, one micro-market and one chiller plant.

Add that their salary comes from a company in the same city and their savings sit in a currency pegged to the same dollar, and the entire balance sheet needs one set of conditions to hold.

The exposures worth limiting

Single asset. What share of net worth is in one property. For most people the honest answer, including the home, is uncomfortably high.

Single building or development. Two units in one tower share a service charge regime, a reserve fund, a handover glut and a reputation.

Single tenant. Especially for anyone letting to one corporate tenant, where a lease ending and a vacancy are the same event.

Single employer. Salary, and in the Gulf frequently residency, and sometimes shares or a bonus scheme. One employer can be three exposures.

Single currency. Covered in currency risk and the peg, and worth counting here as a line rather than assuming it is handled elsewhere.

Single counterparty. One bank, one broker, one platform.

Setting a limit that survives

The limit has to be written down before the opportunity appears, alongside the rest of your investment policy statement, because the whole point is that the good opportunity is exactly when you will want to breach it.

Pick numbers you can live with rather than numbers that sound rigorous. Something like: no single property above a stated share of net worth, no more than two units in any one building, no more than a stated share of liquid assets with one institution. The precise figures matter far less than having them at all.

Then write down what you will do when a limit binds, because it will. The useful answer is rarely sell something. It is more often stop adding, and let the rest of the balance sheet grow into the gap.

The awkward truth

Most wealth is built through concentration and most wealth is lost the same way. A concentration limit does not maximise expected outcomes, and someone who never set one will always be able to point at somebody who did better without one.

It is insurance against the version of events where the concentrated bet does not work, chosen deliberately, priced in foregone upside. That is a trade worth making consciously, and a trade almost nobody makes by accident.

The arithmetic

Write these down before you need them. Single property <= x% of net worth Single building <= n units Single tenant <= x% of total rent Single employer salary + equity + residency counted as one exposure Single currency <= x% of assets, matched to expected spending Single institution <= x% of liquid assets When a limit binds first response stop adding second response grow the rest into the gap last response sell, because selling illiquid assets costs 8-10% and takes months The test If one bad event happened, what share of the balance sheet does it touch? That is the real limit, whatever the spreadsheet says.

Where it breaks

  • Limits set as percentages of net worth move as net worth moves, which means a falling market can breach a limit without any decision being taken. Decide in advance whether the limit is checked on the way down as well as up.
  • It reduces expected return. Concentration is how most large fortunes were made, and a limit is a deliberate trade of upside for survivability.
  • The primary residence distorts every ratio and there is no consensus on whether to include it. Pick a treatment and stay with it rather than switching to whichever answer is more comfortable.
  • Illiquid assets cannot be trimmed to a limit. For property the only enforceable version is a limit on what you add, which means the limit has to exist before the purchase.
  • Counting exposures separately hides the correlation between them. Salary, residency and local property are one exposure wearing three coats.
  • A limit you will breach for a good enough opportunity is not a limit. It is a preference, and it will not be there on the day it is needed.

When to use it

Before the second property in the same building, which is where most concentration begins. Also as a standing annual review, because concentration accumulates without any single decision creating it.

Run it on your own numbers

The Safe Withdrawal Rate does this arithmetic for you, in your currency, in about thirty seconds.

Open the calculator

Sources

  1. Bank for International Settlements, property price statistics
  2. Dubai Land Department, transaction data

Last reviewed . Educational research, not personal advice. Disclosure standards.