Have you ever watched a suspenseful thriller movie? Movies like Stephen King’s “It”? The movie can be going along somewhat normally, with people talking, walking down the street, and doing other normal things…then all of a sudden, BOOM…the monster grabs someone.
When you watch one of those movies, you know that’s going to happen. So you always keep a little on edge for a scare, even when the director wants you to feel a little more at ease. You have to expect the unexpected.
Diversifying Your Real Estate Portfolio
Similarly, it’s important to expect the unexpected with your real estate portfolio. We can’t predict the future, but based on historical data, we know to expect market cycles. Since market corrections and recessions occur every so often, it’s important to prepare your portfolio so it can withstand them.
One of the most powerful strategies used to successfully weather economic
cycles is diversification. Even within the real estate market, you can diversify and maximize the long-term growth of your investments. And by investing in a variety of different real estate assets, you can lower the risk overall. Here are 5 ways
to do this:
#1 – Location
At any given time, one city might be doing well, while a different market might
be in a lull. Savvy investors look for properties in areas where growth is occurring or expected.
By diversifying across multiple cities, counties, or states, you can take advantage of the potential across several markets and hedge your bets against a correction in any one area. You can also hedge against the possibility of a natural disaster like an earthquake, flooding, tornado, severe storm, or hurricane. For example, the weather that causes hail damage on someone’s property in Wilmington, North Carolina won’t affect their property in Phoenix, Arizona.
One big challenge in diversifying across geographical locations is obtaining the research, understanding, and team that you’d need to feel comfortable investing in them. This is what makes passive investing so attractive – you can leverage the expertise of the sponsor team in each market.
#2 – Asset Type
Within real estate, there are a variety of different asset types to choose from. You can invest in retail, multifamily, industrial, office space, self-storage, and more. By investing in multiple types of properties, you can hedge against broader changes to the economy.
#3 – Property Class
Aside from asset type, there is also property class, referring to the range of conditions within an asset type. For example, take an apartment complex and consider the range between modestly priced units for the working class (likely C-class), nicely developed units for the upper-middle class (likely B-class), and finally, the ultimate luxury apartments that are available in some areas (A-class).
Certain property classes do well during recessionary periods, like C-class and especially B-class properties. Luxury A-class properties do best during an economic boom. You might decide to have both in your portfolio, so that at any given point in the economic cycle, your portfolio is profitable.
#4 – Hold Length
Syndicated real estate investments have an associated hold time which can range from 2 -10 years or more. You may wish to consider investing in properties with different projected hold times, so you’re not entering and exiting more than one deal at a time.
#5 – Funds
One of the easiest ways to diversify quickly is to invest in a real estate syndication fund. A fund pools together investors’ money to buy a variety of assets within a specified period of time. Funds can be defined by geography, asset type, or property class.
At some points in the market cycle, it feels like the market will go up forever. Conversely, when things are going poorly, it may feel like the market will continue
a downward spiral forever. We know that neither of these are true, of course, and that during one phase of the cycle, portfolios should be diversified in preparation for the next phase.
Keep these 5 ways to diversify your portfolio in mind as you explore potential deals. Doing this will help you find various opportunities to diversify your portfolio, no matter the current market cycle.
Further reading: 5 Undeniable Reasons to Invest Outside Your Local Market