Portfolios are made up of individual properties. If one property performs poorly, then the other properties have to perform much better to compensate. Holding a small number of properties therefore risks one adverse event or poor decision hampering the performance of the whole portfolio.

On the flip side, it takes time to manage and monitor properties, so holding too many properties is a drain on resources. Holding more properties also increases the need to acquire assets with less attractive expected return characteristics. Reducing risk in the portfolio through additional assets therefore reduces expected return.

A balance is therefore required between too few properties in a portfolio, due to too much specific risk, and too many properties due to dilution of returns.

An optimal number of properties will not diversify all specific risk and it will also expose the portfolio to market risk. A theoretical ranking of the fair value of all properties in a portfolio is likely to have assets of one or two types in one or two regions at the top of the rankings. However, this means that these properties are exposed to the risk that the prospects in these markets / regions were overly optimistic or were hit by the same adverse event. A concentration of assets in a small number of sectors or regions therefore exposes the portfolio to the same market risks.

A balance is therefore also required between selecting properties with the most attractive return prospects against any sector and region concentrations in order to minimise portfolio risk.

The RES Asset Allocation Model estimates both the residual specific risk in a portfolio and the market risk.