Should You Go Big in One Market or Diversify Across Many?

20 Replies

I recently closed on an apt community which puts my company controlling $190,000,000+ worth of apartment communities. We have 11of them and…11 out of 11 are in Texas. In fact, 9 out of 11 are in Dallas Fort Worth (DFW). I’ll get to the relevance in a second.

But first, after every closing, I document a lesson learned to try and help others who want to do similar things. You can read about the lessons from those closings here:

https://www.biggerpockets.com/forums/432/topics/461447-here-is-when-it-makes-sense-to-buy-nicer-properties?page=1#p2858544

https://www.biggerpockets.com/forums/432/topics/429543-how-i-just-bought-over-500-units-in-a-hot-market?page=1

https://www.biggerpockets.com/forums/223/topics/397337-just-reached-over-100-000-000-in-apt-communities-lesson-learned?page=1

https://www.biggerpockets.com/forums/223/topics/359926-investor-analysis-after-closing-on-a-296-unit-2-lessons-learned

https://www.biggerpockets.com/forums/223/topics/316836-closed-on-320-unit-last-week-6-ways-to-break-into-the-biz

https://www.biggerpockets.com/forums/223/topics/294621-closed-on-155-units-in-houston-yesterday-3-lessons-learned

https://www.biggerpockets.com/forums/223/topics/217842-closed-on-250-apartments-in-houston-texas-yesterday-2-lessons-learned

https://www.biggerpockets.com/forums/223/topics/369032-closed-on-a-200-unit-one-simple-lesson

Now, let’s look at my company’s portfolio a little closer and dig into this lesson learned (or really an observation I had).

We’ve got 2,613 apartment doors and 2,208 doors (85%) are in DFW. So clearly, we are going deep in a market and are not currently diversifying across multiple markets. But, I frequently hear about how real estate investors should diversify.

I don’t agree.

As multifamily owner/operators, if we were to diversify across other cities/states for the sake of diversification then I believe we would actually incur more risk. The reason why is because all real estate deals have risks. And those risk-factor categories are:

1. Risk in Market and Submarket

2. Risk in Deal

3. Risk in Team

By sticking to one market that we know very well and have a proven mgmt. team in place with economies of scale that allows us to mitigate risk factors 2 and 3 (not eliminate, but mitigate). Conversely, if we were to branch outside of our market then we would have to find the following:

- Program mgmt. (one of the biggest keys to success. Yes, we have a plan but it must be properly executed)

- Vendor contacts (not as big of a deal if you hire a 3rd party mgmt. company but big deal if you don’t)

- Local legal experts for contracts (a bad one can burn you)

- Knowledge of taxes assessments (fairly easy to figure out but still a learning curve)

- Best local lasagna place (I love lasagna…just make sure you’re still paying attention! J )

- Build a reputation among the brokers (intangible that is a real thing to help you get better deals)

Not to mention we’d have to actually qualify the market and submarket. Basically, we’re opening ourselves up to all 3 risk factors if we branch out. So when we do decide to go deep in one market then the keep is to make sure that market is solid.

Here are the primary things I look for in a market: 

1. Job diversification: no one industry making up more than 20% of jobs

2. Population growth over last 5 years and current projections of population growth in market

3. Supply and demand – look at vacancy trends for the area and absorption rate (broker can get this info for you)

Of course, as with all generalizations, there will be exceptions. Here is a couple I can think of:

Two exceptions to the rule of going deep instead of diversifying:

1. This is only in reference to being an owner/operator (i.e. active investor). If you are a passive investor and can passively invest with multiple owner-operators (i.e. syndication or turnkey companies) who have the systems in place in different markets then that seems like a good strategy to me. Because in that passive scenario the deal and the team (risk factors 2 and 3) are already given to you. Assuming they are good is something you’d obviously need to qualify but conceptually it makes sense to diversify if you’re a passive investor

2. While we are going deep in DFW that doesn’t mean we’ll always only be in DFW. In fact, we actively get sent deals across the country every week (lots of them). However, in order for us to branch outside of DFW it’s going to take an extraordinary deal combined with a local expert partner to compel us to pull the trigger.

So, to summarize, I believe you lower risk when you go deep in a market and it’s better not to diversify across multiple markets unless the opportunity is significantly better than what you can get in the market you are already investing in.

What do you think? Should you go big in one market like us or are you finding success diversifying across multiple markets? 

@Joe Fairless congrats on the deal and your business! Very impressive. You have very valid points and I do feel everyone should have a niche, and if your niche is your market and knowing it in and out better than anyone else (or most), then I think you are doing the best by sticking there. 

The market there is strong and as long as different industries continue to move there, you are going to be fine. There are many developers here in Cali, who only invest in Cali. Same in other industries (In N Out Burger, etc). 

From a personal standpoint, you should have your own net-worth a bit more diversified in the markets and other investments, so if anything happens to these investments, your entire personal wealth is not destroyed. 

Keep it up man!

sjw

@Joe Fairless I think your points are valid and do significantly lower your risk on each new deal you close. You know with very little variation how each deal will perform and who will execute on it. (Congrats on the new milestone by the way!)

Speaking wayyy outside my breadth of experience here, but where the risk comes in with lack of geographic diversity is a list of factors that could affect all or the majority of your company's deals/properties at the same time. And that impacting every investment at once effect can be devastating. I'm sure a whole horde of people on BP could come up with a better list than me, but some that immediately come to mind are:

1) Natural disaster

2) Significant changes to insurance rates (see #1)

3) Changes to state or city laws regarding fees, taxes and rates, code requirements, zoning, rent caps, tenant-favorable laws, etc (you have more exposure here being in primarily one city area as well)

4) Changes to state or regional labor market, especially in regard to contractors

Now in terms of rental market shift exposure, I think a geographically-centralized portfolio can still achieve diversification within a large enough city or region through properties in different geographic neighborhoods, Class A/B/C areas, tenant demographics, and general rent amounts (high/medium/low in the market).

Now whether those (unlikely) risk factors are worth giving up all the home field advantages you've built up is a lot harder to answer, but that's every investor's decision. I always think back to the Black Swan by Taleb though - no one even *measures* the risk that no one saw coming.

@Stephen Anthony very good points. For example on the insurance front flood insurance in Houston after Hurricane Harvey increased on renewals. Appreciate your thoughts.

@Shawn Ward thanks for the props and I'm sure those California-only investors have been doing pretty well over the last couple years. 

@Joe Fairless I think the need to diversify will depend on the market and submarket. If a majority of your properties are in Uptown Dallas versus the older areas of downtown Dallas I don't think your company has a need for diversification. Congratulations on the successful business!

@Joe Fairless I agree on focus, but ehat about if after a couple of months you still have not found anything worthwhile pursuing?

@Joe Fairless I'll be humble here and avoid giving my opinion to someone much more successful than me but I'll quote a man more successful than both of us:

Wide diversification is only required when investors do not understand what they are doing.

[Warren Buffett]

I think you got it covered ;-)

@Diogo Marques  When I got started (not implying that you are just getting started, just mentioning my experience) it took me 10 months to find a house to buy so you're only 20% of the way there! :) 

But, more specifically, I'd say if you aren't seeing results after a couple months then change your approach. There are tons of ways to get deals and I'm sure there's a forum post on BP that has creative ways to get deals in your market. Some off the top of my head: 

- relationships - talk to lawyers, accountants, title companies, vendors (HVAC, carpet installers), and, of course, real estate agents and brokers 

- go to the courthouse and visit eviction court - those landlords might be more likely to sell vs someone who isn't have to go through the eviction process with their tenant/s 

- direct mail to the owner 

- drive around neighborhoods, identify distressed homes, look up owners and reach out 

- tell people you know locally you'll pay a bird-dog fee if they send you a deal that you close on 

- get on wholesaler lists 

- also, in my BP podcast interview, I tell a story of how I bought a $30M portfolio in a hot market and how you can apply those same learnings for any deal size 

In general, you'll want to have at least 3 reliable ways that are consistently sending you deals. Test all the above out (plus other things I didn't mention) and then you'll find those 3. Once you have the 3 you'll then get a deal. 

@Joe Fairless

@Joseph Gozlan

Also, along the same lines as what Warren Buffett said, you diversify when you don't know what you are doing, especially in risk management.

Once you develop an expertise in a particular area, making money there is easy, but not necessarily completely risk free.

Just for an example since I only invest in Class "A" and "B" neighborhoods in Brooklyn, NY, there are a huge amount of industries that will pick up the slack if any one particular industry falls. During the 2008 Financial Crisis, while Wall Street was Ground Zero when that explosion happened, all the other Industries that NYC is known for kept our investments afloat.

HOWEVER, that doesn't mean we will survive all disasters! Two of them are impossible to protect against, a dirty nuke bomb and rising sea levels as NYC is a Coastal City. Both are inevitable, but because I know this, helps me to constantly research and be proactive in trying to see what I may have to do before it's too late.

I'm not too knowledgeable about the DFW area, but I would also keep an eye out for it's future industries.

For instance, if Oil is one of those industries in the Energy Sector, then knowing how oil is being affected by thinks like Peak Oil and competition with renewable energy that is not already located in your area which keeps the economy going, I would certainly stay on top of that.

@Llewelyn A. overall agree with your point about markets not surviving all disasters. But one thing I did want to mention is that we do have Terrorism coverage which would probably (although I haven't verified this) cover us on your dirty nuke bomb example. 

Originally posted by @Joe Fairless :

I recently closed on an apt community which puts my company controlling $190,000,000+ worth of apartment communities. We have 11of them and…11 out of 11 are in Texas. In fact, 9 out of 11 are in Dallas Fort Worth (DFW). I’ll get to the relevance in a second.

But first, after every closing, I document a lesson learned to try and help others who want to do similar things. You can read about the lessons from those closings here:

https://www.biggerpockets.com/forums/432/topics/461447-here-is-when-it-makes-sense-to-buy-nicer-properties?page=1#p2858544

https://www.biggerpockets.com/forums/432/topics/429543-how-i-just-bought-over-500-units-in-a-hot-market?page=1

https://www.biggerpockets.com/forums/223/topics/397337-just-reached-over-100-000-000-in-apt-communities-lesson-learned?page=1

https://www.biggerpockets.com/forums/223/topics/359926-investor-analysis-after-closing-on-a-296-unit-2-lessons-learned

https://www.biggerpockets.com/forums/223/topics/316836-closed-on-320-unit-last-week-6-ways-to-break-into-the-biz

https://www.biggerpockets.com/forums/223/topics/294621-closed-on-155-units-in-houston-yesterday-3-lessons-learned

https://www.biggerpockets.com/forums/223/topics/217842-closed-on-250-apartments-in-houston-texas-yesterday-2-lessons-learned

https://www.biggerpockets.com/forums/223/topics/369032-closed-on-a-200-unit-one-simple-lesson

Now, let’s look at my company’s portfolio a little closer and dig into this lesson learned (or really an observation I had).

We’ve got 2,613 apartment doors and 2,208 doors (85%) are in DFW. So clearly, we are going deep in a market and are not currently diversifying across multiple markets. But, I frequently hear about how real estate investors should diversify.

I don’t agree.

As multifamily owner/operators, if we were to diversify across other cities/states for the sake of diversification then I believe we would actually incur more risk. The reason why is because all real estate deals have risks. And those risk-factor categories are:

1. Risk in Market and Submarket

2. Risk in Deal

3. Risk in Team

By sticking to one market that we know very well and have a proven mgmt. team in place with economies of scale that allows us to mitigate risk factors 2 and 3 (not eliminate, but mitigate). Conversely, if we were to branch outside of our market then we would have to find the following:

- Program mgmt. (one of the biggest keys to success. Yes, we have a plan but it must be properly executed)

- Vendor contacts (not as big of a deal if you hire a 3rd party mgmt. company but big deal if you don’t)

- Local legal experts for contracts (a bad one can burn you)

- Knowledge of taxes assessments (fairly easy to figure out but still a learning curve)

- Best local lasagna place (I love lasagna…just make sure you’re still paying attention! J )

- Build a reputation among the brokers (intangible that is a real thing to help you get better deals)

Not to mention we’d have to actually qualify the market and submarket. Basically, we’re opening ourselves up to all 3 risk factors if we branch out. So when we do decide to go deep in one market then the keep is to make sure that market is solid.

Here are the primary things I look for in a market: 

1. Job diversification: no one industry making up more than 20% of jobs

2. Population growth over last 5 years and current projections of population growth in market

3. Supply and demand – look at vacancy trends for the area and absorption rate (broker can get this info for you)

Of course, as with all generalizations, there will be exceptions. Here is a couple I can think of:

Two exceptions to the rule of going deep instead of diversifying:

1. This is only in reference to being an owner/operator (i.e. active investor). If you are a passive investor and can passively invest with multiple owner-operators (i.e. syndication or turnkey companies) who have the systems in place in different markets then that seems like a good strategy to me. Because in that passive scenario the deal and the team (risk factors 2 and 3) are already given to you. Assuming they are good is something you’d obviously need to qualify but conceptually it makes sense to diversify if you’re a passive investor

2. While we are going deep in DFW that doesn’t mean we’ll always only be in DFW. In fact, we actively get sent deals across the country every week (lots of them). However, in order for us to branch outside of DFW it’s going to take an extraordinary deal combined with a local expert partner to compel us to pull the trigger.

So, to summarize, I believe you lower risk when you go deep in a market and it’s better not to diversify across multiple markets unless the opportunity is significantly better than what you can get in the market you are already investing in.

What do you think? Should you go big in one market like us or are you finding success diversifying across multiple markets? 

 It seems like the groups with over 1000 units tend to focus on one market or have like you at least 85% in one market. They can overtime pick up all the nooks and crannies inbetween or expand to good locations nearest present units. The ones I see do this tend to be in better than average areas as well and will pay market rate if needed to keep higher quality cash flow rentals vs just highest initial cash flow deals. I think control for them factors heavily too. 

Good luck!

Loved reading your post! Congrats for your closing.

In my opinion , if you stay in on market only you put yourself in the mercies of that market trends and cycles meaning you will go up and down with the market.
By diversifying you somewhat spreading your risk. If your local market is declining and your "neighbor market" is inclining ?
What if the recession hits and mexico's economy is inclining ?

As you said, there's many things to take in count and eventually it all come down to the people you have(I'm a huge believer !) but on the other hand there's a lot of sense in going into more than one market

Again, congratulations man!

Originally posted by @Joe Fairless :

- Best local lasagna place (I love lasagna…just make sure you’re still paying attention! J )

 Wait, where is there good lasagna in DFW? As a transplant I often rave about the great food here, with the exception of Italian. 

In all seriousness, I agree with the comment by @Stephen Anthony...and you listed it as risk #1 too. What if, for whatever reason, this wasn't such a good market anymore? The amount of growth here is amazing. If your deals are dependent on the current level of growth, that seems risky. If you're buying conservatively enough that you're still going to make money when some other place becomes what DFW is today, then maybe you have nothing to worry about. 

"Put all your eggs in one basket, and then watch that basket." - Andrew Carnegie

"Deworsification, I mean diversification, is for those that don't know enough to concentrate."  - Just made it up

Not sure if geographical (same MSA) risk is as big a deal to me, since I am concentrated all within 40 miles as well, but asset-type risk would be my concern.  I remember the days when massive apt communities were giving away free tv's AND a free month's rent to fill a vacancy while houses or my smaller townhouse communities were filling quickly for top dollar with recently foreclosed on homeowners.  

Apartment-ville doesn't have renter loyalty I don't think.  An apt is an apt. I understand ease of scale with 300+ unit towns of apts, but you may find an exodus of vacancy someday if oversupply and/or unemployment/migration rears their ugly heads @Joe Fairless   

@Joe Fairless but i am getting started.:-) My goal is to get to 160,000 units until 2020 under management.

Since i live outside the US, i think there are some items that are a bit harder to do. Nevertheless:

Current Status:

1/Relationships - this is working and also cold calling brokers.

2/go to the courthouse and visit eviction court - for this i guess you would need someone there

3/direct mail to the owner and drive around neighborhoods - same as above

4/no reply so far

wish you all the best.

Originally posted by @Steve Vaughan :

Not sure if geographical (same MSA) risk is as big a deal to me, since I am concentrated all within 40 miles as well, but asset-type risk would be my concern.  I remember the days when massive apt communities were giving away free tv's AND a free month's rent to fill a vacancy while houses or my smaller townhouse communities were filling quickly for top dollar with recently foreclosed on homeowners.  

Apartment-ville doesn't have renter loyalty I don't think.  An apt is an apt. I understand ease of scale with 300+ unit towns of apts, but you may find an exodus of vacancy someday if oversupply and/or unemployment/migration rears their ugly heads @Joe Fairless   

We're in a golden age of apartments right now...demographics are on our side. But that could change. A few examples:

-If there are really 10-11 million people in this country illegally, and a serious effort was made to remove even a fraction of that number, demand would decline significantly. I am sure Texas would be hard hit. 

-Lending standards could loosen again, or something else could make homeownership much more appealing, or easier to do. Again, reduced demand for apartments. 

-Some sort of disruptive change to the industry, like an advance in construction technology (or reduction in the permitting process) that made apartments cheaper to build could dramatically increase supply beyond the demand. One of the advantages of Class B and C apartments today is that the supply is constrained. It is only economical to build Class A in most markets, and even if they get overbuilt, they are rarely competing for the same tenants as Class C.

@Paul B. those are three very real risks to multifamily investing. Especially #1 and Texas in particular. Appreciate the input on this. 

@Joe Fairless , congrats on closing yet another apartment deal in the Dallas area. I am sure I'm not alone in saying that I appreciate the fact that you provide your newest, real world syndication advice after closing on a deal. Also, this particular advice makes me feel much more comfortable with my current investment strategy in the Cincinnati market (focusing on one market that I know really well).

Looking forward to hearing the lesson you learn on your next multifamily close.

@theo 

@Theo Hicks you're going to be building an empire in your city and already have a strong start. Grateful for our friendship! 

I think your strategy is sound, but take a look at Billionaires like Sam Zell and Donald Trump and you will see they have holdings all over the US and world, along with other businesses. You can also look at a guy like Donald Bren, who has most of his portfolio is Southern Cal (although diversified through many types of RE). 

My guess is the companies that have "diversified" did it more for positive growth opportunity than for diversification purposes due to fear of markets. Whether you are just in DFW or expand to another market across the country, it comes down to the plan, the team and the execution. 

If you are still finding deals in DFW and the economics make sense, which seems to be the case, then staying put makes a lot of sense. If you start seeing cracks in DFW, then expanding to a new market may be necessary. 

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