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