Whenever you hear about investing, you hear the word diversify. Usually, the financial advisor suggests that you don’t put all your eggs in one basket, divvying up your money between stocks, bonds, futures, real estate, and other investment sources. However, diversification is also beneficial when looking exclusively at your real estate investment portfolio.
When you first start real estate investing, you are likely to focus on one property type. This helps you get your feet wet and learn the ropes. The most typical property type is single family residents because it is the easiest place to start. However, once you’ve have moved beyond the beginner stage, it is time to consider diversifying the types of properties you buy.
Why Should You Diversify Your Portfolio?
The reason for diversifying your real estate portfolio is exactly the same reason you would diversify any investment portfolio – to mitigate risks. Although real estate has a more stable return on investment than many other investment strategies, there are still ups and downs in the market.
Additionally, specific types of properties and specific locations also have specific risks. A single-family home could attract a deadbeat tenant. A multi-family property near the coast could be at risk for hurricane damage. Commercial property in a city that recently lost its anchor industry could be at risk for vacancies. However, if you have several properties across several locations, even when some properties are not providing a cash flow, others will, keeping you from an overall loss.
Three Ways To Diversify
When it comes to real estate, there are three main ways to diversify. Let’s discuss each briefly:
You may be hearing that real estate market in the United States is growing, but the growth will be flatter this year than last. If you were to only listen to this report, you might be tempted to hold off on investing. If you happen to have property in an area that is flat or even declining, you may be tempted to think that real estate is not a good investment.
However, the United States is an awfully big region with thousands of individual markets. It is true that some small towns in the rural South are still depressed. However, other nearby cities are finding rapid growth. For instance, the rural town of Sanford, NC shows a 12% drop in the year-over-year median sales price for homes. Just 32 miles away, Raleigh, NC shows a 9% rise during the same period of time.
What does this mean for you? Real estate rarely loses value over the long haul but can lose value for the short term. If you only owned homes in Sanford, you would be losing money. However, if you were diversified and owned homes in both Sanford and Raleigh, your portfolio would be more even and far less risky.
Although I agree that working with someone you know and trust is a great way to go, I also suggest that you find a variety of people you know and trust. If you always work with Investor A, you will always be investing in properties that Investor A specializes in. If, however, you work with Investors A, B, C, D, and E, you will have a broader field from which to choose. Make an effort to network with a variety of people so that you can open your portfolio up to a wider range of choices.
Types of Properties
When investing in stocks, you are counseled to invest in an array of stock categories. The same is true for real estate properties. When you spread your portfolio among different property types, you protect yourself against losses specific to property categories.
- Multi-Family properties carry less risk than single-family units because it is unlikely that a multi-family unit will sit completely vacant, which can and does happen with a rental house.
- Commercial properties tend to have much lower vacancy rates and higher income potentials, which lead to a steady cash flow.
- REITs are a good choice for those looking for regular streams of income and capital appreciation. However, REITs are more closely associated with the state of the real estate market nationally, rather than by local segment.
As you grow your real estate investing portfolio, you should consider diversification to minimize your risks. Balancing your portfolio will help to ensure your success.