Diversification is a risk management strategy that mixes various investments within a single portfolio. The purpose of diversification is to not get caught with all of your eggs in one basket during a significant downturn, thereby preserving capital for the long haul.
How many of you reading this have a financial advisor that has claimed you are “diversified” despite only being invested in stocks and mutual funds? I know I have. Mine was only invested in stocks as well. As we are now observing, once the market goes full bear, being all-in on stocks or mutual funds may not be the best strategy.
Advisors should be stating that they are diversifying your mutual fund portfolio only. Your entire portfolio is not diversified if it is only invested in paper assets.
Diversifying Your Real Estate Portfolio
Similar to your advisor diversifying your mutual fund portfolio, a real estate portfolio can be diversified. We can’t predict the future market, but based on historical data, we know to expect cycles. Market corrections and recessions occur, so it is essential to prepare your portfolio to withstand those fluctuations. Below are five ways to diversify your real estate portfolio to help preserve your wealth during a downturn within a specific market or asset class.
#1 – Asset Type
Within the real estate world, there are various asset types to invest in. You can invest in retail, industrial, multi or single-family housing, office space, self-storage, and more. By varying the types of properties you invest in, you are hedging against broader changes to the economy.
Immediately after COVID, multifamily and industrial boomed while office and retail values lagged. If you were all in on the latter two, you likely lost a lot of wealth.
#2 – Location
At any given time, one city might be booming while a neighboring area may be experiencing a lull. Savvy real estate investors desire properties in regions experiencing job and population growth. You can hedge your bet against a correction in one area by diversifying across multiple cities, counties, or states.
The challenge in diversifying across geographical locations is obtaining the research and connections you need to feel comfortable investing in the area. One of the benefits of passive investing is leveraging a sponsorship team with market knowledge, contacts, and experience in that particular area.
#3 – Asset Class
Aside from asset type, there are also different asset classes, ranging from poorly conditioned class C buildings to new luxury class A developments. B and C workforce housing assets may do better during rough economic times. On the other hand, luxury developments may do best in a booming economy. Having both asset classes in your portfolio can protect you during different economic cycles.
#4 – Hold Length
The hold time of a real estate syndication often ranges from 3 to 7 years. Consider varying the hold time of your assets so you are not entering and exiting more than one deal at a time.
#5 – Funds
Investing in a real estate syndication fund is another way to diversify. Funds pool investor capital to buy various assets within a specified period. Funds can be defined by geography, asset type, or asset class.
Conclusion
Real estate markets are hyperlocal. One city or area of a town can be booming and another in decline. Keep these five strategies to diversify in the back of your mind as you explore potential deals. Doing so will help you find opportunities to diversify your portfolio, no matter the market cycle.