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Diversification in Real Estate

You normally hear the term “diversification” from financial planners and stock brokers. But you don’t hear the term used so often when it comes to real estate investing. The goal of diversification, regardless of the investment, is to reduce the investor’s overall risk.

Diversification in real estate is easily achieved by purchasing income-producing properties in different markets around the country. In some cases, investors even purchase property in other countries. By creating a real estate portfolio of income-producing properties across multiple and separate markets, they reduce their exposure to risk.

Because real estate markets don’t move up and down in value at the same time, or at the same rate, investors can reduce and limit their risk through diversification.

Finally, real estate investors should also realize that diversification tends to reduce both the upside and downside potential of their portfolios. That may sound a little counter-productive but, remember, the reason investors want to diversify is to protect their real estate portfolio under a range of economic conditions. They want to avoid being committed exclusively to a single market.

  1. Comment by Mitch Painter
    January 25th at 9:32 pm 

    There really are so many ways to diversify in real estate. I’ve done over 250 deals and currently own 154 apartment units. I believe to create wealth one really needs to own real estate assets (in which the tenants rent pays the mortgage +). With that said, owning and holding real estate long term takes A LOT of work. To own more then a few building one must have a team he/she can rely on to handle leasing and maintenance. I keep a very close eye on our holdings, so it helps to have them close. Also for economies of scale it’s nice to own buildings all very close to each other. Just some ideas….

    Mitch Painter

  2. Comment by D. Hom
    February 7th at 11:17 pm 

    Here are my thoughts as a real estate investor in Oklahoma:

    There are definitely benefits and trade-offs here.

    1. Success becomes less dependent on picking the right markets.

    Let’s say that you’re a better than average market timer and that the typical market you pick has a 20% chance of rocketing up, a 40% chance of moving up slowly, a 30% chance of going sideways, and a 10% chance of crashing. The goal is to NEVER get wiped out, not even 10% of the time. Who wants to start over? By picking markets that you think will be strong but yet not correlated to each other, you can minimize risk.

    Let’s say, for kicks, that you buy some in Oklahoma for the oil and gas economy, some in the northern Midwest to bottom fish and catch the early stages of an agricultural boom, and a real estate investment trust in commercial properties to bet on demographics and a growing economy. If you’re wrong about oil and gas but right on the nationwide recovery (think 1983 onward), you’ll be hit hard, but you stand a better chance of surviving.

    2. The markets in early bull markets typically have much better cash flow. Properties are still coming off multi-decade bottoms in the case of Oklahoma and Texas, and rents will go up if your thesis is right. The cash flow gives you more holding power.

    3. Real estate investment trusts are typically not leveraged and can be purchased in IRA accounts without all the issues that come from trying to borrow money in an IRA. This gives you steady, tax-deferred growth in the IRA and leverage with tax benefits outside the IRA.

    Now for the trade-offs:

    1. Real estate is definitely a business. Success depends on managing the business properly. At a distance, you are dependent on property managers, brokers, appraisers, and lenders to do what they’re supposed to do. This sounds like it’s not a big deal… well, until it is. Running a business is not easy, and real estate is no exception.

    2. You can’t see and touch your investments as easily. When buying locally, you know the neighborhoods, values, and appreciation potential (hopefully). This is not the same thing as not being able to see and touch the company issuing a stock. Most of us don’t own stocks; we own funds composed of dozens of companies that remove much of the risk of single-company ownership. And in a sense, I can touch and feel mutual funds. It’s much easier to get a sense of what’s going on in an industry than an apartment building, as this involves no plane trips or balance sheets, no tenants or local governments.

    3. Real estate is illiquid. It’s hard to sell quickly when you need to without taking a 10% to 30% hit on the price after ALL expenses are paid. That amount may be all of your equity. Again, this is not a big deal until it is. The friendly folks at AIG may know something about illiquid assets.

    Is diversifying all over the country worth the risk? I think it depends on what kind of investor you are (buying value and timing markets) and what kind of businessman you are (manager at a distance). Triple-digit returns have been there in the past for people who are very leveraged and who are good at both. That’s my two cents, anyway.

  3. Comment by wmeallian
    February 21st at 4:37 pm 

    There would be some sort of diversification as there are too many property to choose from real estate, commercial or land . But I would recommend to look at the budget and property value in long term.

  4. Comment by Dennis Brooklyn
    May 1st at 10:01 am 

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  5. Comment by Kris Patel
    June 10th at 7:54 pm 

    Did diversify in apts, office, and STNL Walgreens. First 2 failed due to TIC’s mismanagement, and third one is doing great!

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