What does diversification look like for real estate investors?
Rental Property Investor · San Jose, CA · Member since 2018 · 152 posts · 159 votes
What does diversification look like for real estate investors?
Most Popular Reply
Real Estate Broker · Bay Area · Member since 2018 · 1k+ posts · 3k+ votes
7yWell, Warren Buffet said “Diversification is a protection against ignorance," "It makes very little sense for those who know what they’re doing.”
I agree with what Warren says. I think when it comes down to real estate and diversification it's more important to be properly leveraged and have the proper reserves to withstand different economic conditions than to be diversified. If you are properly leveraged it doesn't matter if you have all SFRs or multi-units.
I also don't think an investor should have properties all over the country. Example homes in Seattle, Houston, Memphis, and Florida. Pick 1 or 2 and stick with it. That's a lot of areas and time to divert your attention away.
52 Replies
- Rental Property Investor · Maryville, TN · Member since 2018 · 80 posts · 53 votes7y
I'm still new to REI and looking to grow, so by no means am I an expert yet.. I only have 2 rental properties at the moment with a third under contract.
I'd imagine diversification looks like having different types of deals - Multi-family, single family, partner deals where you may split risk, etc...
Then I've also read that it could be considered diversification if you end up changing up markets once you've got your feet wet (at least 5-10 rentals in one area) to help balance any risk if one location suffers and the bottom falls out.
- Rental Property Investor · San Jose, CA · Member since 2018 · 152 posts · 159 votes7y@Will Gates That makes sense. Im wondering if anyone is doing some kind of stock market/other form of diversification. Most of us are in real estate because of the power of leverage and cash flow. Does that power outweigh any investment outside of Real Estate? Even though we know we can likely get better returns and control over our money, should we still invest in the stock market for a balance? I’m honestly really torn on this.
- Rental Property Investor · Maryville, TN · Member since 2018 · 80 posts · 53 votes7y
@Jess White . I think you'll get a mixed bag of answers from others. If you're comfortable with the stock market and you understand it, then it may be a worthwhile opportunity. If you're already involved with REI, then you're familiar with risk, and there will be risk in the stock market, too. Looking forward to others chiming in to get their thoughts!
- Real Estate Broker · Bay Area · Member since 2018 · 1k+ posts · 3k+ votes7y
Well, Warren Buffet said “Diversification is a protection against ignorance," "It makes very little sense for those who know what they’re doing.”
I agree with what Warren says. I think when it comes down to real estate and diversification it's more important to be properly leveraged and have the proper reserves to withstand different economic conditions than to be diversified. If you are properly leveraged it doesn't matter if you have all SFRs or multi-units.
I also don't think an investor should have properties all over the country. Example homes in Seattle, Houston, Memphis, and Florida. Pick 1 or 2 and stick with it. That's a lot of areas and time to divert your attention away.
- Rental Property Investor · San Jose, CA · Member since 2018 · 152 posts · 159 votes7y@Frank Wong I really like that idea of cash reserves. That’s a really good point. The ability to withstand any kind of downturn with sufficient reserves is a great way to keep yourself afloat and in the game.
- Real Estate Broker · Bay Area · Member since 2018 · 1k+ posts · 3k+ votes7y
Originally posted by @Jess White:
@Frank Wong I really like that idea of cash reserves. That’s a really good point. The ability to withstand any kind of downturn with sufficient reserves is a great way to keep yourself afloat and in the game.Hi Jess,
It's so important. Probably one of the biggest mistakes RE investors make is not having enough reserves. Having a lot of cash on the side also allows you to buy when someone makes a mistake.
- Rental Property Investor · San Jose, CA · Member since 2018 · 152 posts · 159 votes7y@Frank Wong Thanks for the insight Frank. How many months of cash reserves do you like to see per property?
- Rental Property Investor · Spanish Fork, UT · Member since 2015 · 40 posts · 18 votes7y
@Frank Wong Maybe this is a newbie question but what exactly do you mean by "properly leveraged"?
- Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 17k+ votes7y
Originally posted by @Jeff Mills:
@Frank Wong Maybe this is a newbie question but what exactly do you mean by "properly leveraged"?
That you have enough cash reserves/access to cash that a roof replacement or a heating system or 6 months of vacancy doesn't bankrupt you. Just as an example. If you own a property that is virtually completely leveraged, and it doesn't provide very strong cash flow, you need to have additional reserves set aside to deal with it. If it does provide strong cash flow, you should divert some of that flow to cash reserves for a "rainy day".
Skyline Properties - Real Estate Broker · Bay Area · Member since 2018 · 1k+ posts · 3k+ votes7y
Originally posted by @JD Martin:
Originally posted by @Jeff Mills:
@Frank Wong Maybe this is a newbie question but what exactly do you mean by "properly leveraged"?
That you have enough cash reserves/access to cash that a roof replacement or a heating system or 6 months of vacancy doesn't bankrupt you. Just as an example. If you own a property that is virtually completely leveraged, and it doesn't provide very strong cash flow, you need to have additional reserves set aside to deal with it. If it does provide strong cash flow, you should divert some of that flow to cash reserves for a "rainy day".
Jeff,
Exactly what JD said.
- Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes7y
I like diversifying with different asset types in RE. Like rebalancing in the stock market, the RE market offers rebalancing opportunities if you seek them.
While everyone was/is buying single-families, submitting retail offers with few contingencies, I was selling mine while looking at industrial warehouse, self-storage, retail and mobile home parks.
Zig while others zag and you will have a diverse portfolio naturally.
- Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes7y
@Frank Wong that Warren Buffet quote can be taken out of context. His business, Berkshire Hathaway, is very diverse in holdings. His point wasn't not to diversify. His point was don't diversify just for the sake of diversifying. Buffet owns railroads, reality companies, insurance companies, Dairy Queen, Fruit of the Loom, jewelry companies, construction companies, major shares in Apple and the list goes on. The common theme is he invests in undervalued assets. He buys strong brands in profitable areas. He is not investing in new technology or flashy startup companies. He likes businesses with a proven track record that are currently undervalued due to a short term or fixable situation.
@Jess White I own single family homes, all within 5 miles of each other. All have two car garages, two bathrooms, 3-4 bedrooms and rent for $1200-1400. I try to paint them the same color and install the same type of appliances. This may not sound diverse, but that is intentional. I understand the neighborhoods, the schools and I fully understand the tenant base for these type of properties. If I have two vacancies, I can show both properties to the same person. Rent value is in the high middle range, so not low end but also not premium. It is the sweet spot.
I don't need diversification in the properties, because I have it within a single market through my tenants. Within my tenant base I have a nurse, mechanic, IT professional, hotel manager, police, teacher, etc. My rent comes from a diverse collection of businesses and industries, all stable. My market has had annual population growth every year - even during the great recession when other markets saw mass exodus, we grew.
I am interested to hear other opinions on this.
- Member since 2019 · 7 posts · 6 votes7y
> What are you doing to stay diversified,
As you say - diversification with real estate and financial assets
- within financial assets: stocks and bonds (though at these rates I prefer money market fund) and further within financial assets some global stocks (though there are reasonable arguments to be made for USA S&P 500 having lots of international exposure).
- also within real estate diversify - I am looking at a 2nd location in a different sate (I am uncomfortable with how much of my assets are in real estate in 1 geographic location). There are many good reasons to buy real estate locally - expertise in the market, ease of management... But from a perspective of diversification buying in a 2nd location can make sense (and then a 3rd...). You can also look at things like vacation rental (v. SFH rental, apartments, cheap v. expensive rentals...), business real estate (retail, office space...). You can use REITs (useful for example for those not interested or able to do business real estate directly). There are many risks to being geographically and type concentrated.
- An easy way to see the risk is if say you owned all airbnb vacation rentals in 1 city and the city passed laws that restrict or kill your business? The legal risk - local and state and federal tax law changes are real (and not just airbnb restriction law changes though that airbnb example is easy for most people to see). Also the economy of that location or state could be harmed and you would be harmed (even if you did really well in a downward spiraling market the market forces may overwhelm you advantages).
Diversification is definitely a wise move to be safe. But how you do that is debatable and not as easy as just wishing to be wisely diversified. Most people not on these boards would benefit from diversification by adding real estate to their investments (while many on these board probably could benefit by diversification with non-real-estate investments).
Warren Buffett's argument against too much diversification basically boils down to him wanting to spend a lot of time becoming an expert on 10 companies he owns vs. buying some of 200 companies (as he doesn't think anyone can really be an expert on 200). His statements on diversification in this manner was essentially a response to questions about comparing him to stock pickers from managed mutual funds (where they owned 100 or 200 or more stocks and he often owned huge amounts of under 10 - he also bought out companies completely so really he has over 10 but...).
Warren Buffett also believes just buying very diversified stock market funds (unmanaged with low costs) is a very good strategy for nearly everyone (excepting himself and a few others). Basically Warren Buffett says diversification is a good way to get average returns (if you can smartly beat the market over the long term diversification will dilute your ability to beat the market moving you to average). But for the vast majority of investors over the long term the reduced risk that comes with diversification is wise and pays off for them.
- Rental Property Investor · San Jose, CA · Member since 2018 · 152 posts · 159 votes7y@Joe Splitrock what a fantastic answer. I love that your are diversified by your diversity of tenants. That’s such a powerful point that a lot of people forget. Thanks for sharing that Joe. Do you do any stock market investing? If so, how do you feel about that as diversification?
- Lender · Pensacola, FL · Member since 2017 · 658 posts · 626 votes7y
You're not truly diversified until you own something (within reason) you don't like. If your CORE portfolio consists of directly owned real estate and you don't like index funds, your EXPLORE portfolio might want to consist of a small position in index funds.
Buffett talks about the circle of competence. He says it's important to know where the boundaries are and to stay within them. He says if you have more money to invest, you can become quite wealthy by adding it to your best idea rather than your seventh best idea.
I'm not smart enough to know what is going to work, so I divided my types of income streams into buckets. I believe in strategy diversification: asset allocation (index funds with a robo adviser), dividend growth (cherry-picked Dividend Aristocrats), and alternative assets (crowdfund offerings, which include private equity and real estate, that were available previously only to institutional investors and accredited investors).
- Specialist · Carolina Beach, NC · Member since 2016 · 390 posts · 496 votes7y
The wisest real estate investors I know diversify across Asset Class, Geography and Operator.
Even the successful active investors, house flippers, self managing single family and small multifamily owners are wise to eventually diversify their portfolio into more passive diversified assests like syndications and mutual funds.
Asset Class: Multi-Family, Self-Storage, Mobile Home Parks, Assisted Living Facilities, etc. (four asset classes we prefer long term for a lot of reasons). If all your portfolio is in commercial industrial buildings and there's an event that severely impacts the demand for commercial industrial, your heavy exposure to that one asset class could really hurt.
Geography: Dallas, Cincinnati, Las Vegas, Phoenix, Jacksonville, Columbia, Birmingham, etc. If you aren't concentrated in one region of the country, you're less likely to get wiped out by a regional black swan event (weather event, economic slow-down, etc.)
Operator: There are a lot of good syndicators out there, there are a lot of bad ones. How good are you at picking out the good ones? We get a lot of repeat businesses from our investors, but even our happy ones eventually start rolling part of what they've made with us into other syndicator's deals. Even a good syndicator could have something unexpected happen. If all your portfolio is tied up with that one syndicator/operator, his misfortune could become your misfortune.
- Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes7y
@Jess White. True diversification would be investing in a reit or large syndication that owns assets in all different classes in different markets. Most people don’t do that, so I would say diversify your deal type and don’t have all your net worth tied into real estate
I follow the approach as described by @Neil Henderson. Couldn't have said it better myself. Multiple asset classes, multiple geographies, multiple operators. You can develop your own niche - as @Joe Splitrock has. In that case, you may want to consider placing some funds with another operator that has a different niche. For instance, maybe someone that's buying large multifamily properties in Dallas, TX. The important part is finding people [partners] you trust.
- Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes7y
Originally posted by @Jess White:
@Joe Splitrock what a fantastic answer. I love that your are diversified by your diversity of tenants. That’s such a powerful point that a lot of people forget. Thanks for sharing that Joe. Do you do any stock market investing? If so, how do you feel about that as diversification?I do invest in the stock market. I have some individual stocks, but only a small number of companies I understand that are a long term value play and pay dividends. (ATT, Microsoft, Disney, 3M) The rest is invested in a market index fund. That money goes up or down with the market. I believe around 25% of my wealth is in the stock market. It is mostly inside retirement accounts which will be tax free withdrawal.
- Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes7y
Originally posted by @Steve Vaughan:
I like diversifying with different asset types in RE. Like rebalancing in the stock market, the RE market offers rebalancing opportunities if you seek them.
While everyone was/is buying single-families, submitting retail offers with few contingencies, I was selling mine while looking at industrial warehouse, self-storage, retail and mobile home parks.
Zig while others zag and you will have a diverse portfolio naturally.
Two steps ahead of me as usual... I love the zig while others zag. It reminds me of the Rodney Dangerfield quote from Caddyshack. He is talking about the market and I forget the exact words, but essentially he says "everyone is saying buy, buy, buy and I say sell, sell, sell". The richest people always find the contrary move as the best way to profit. Great advice Steve.
- Investor · Indianapolis, IN · Member since 2015 · 764 posts · 953 votes7y
@Jess White Income Producing Apartments (in varied markets), Lots of Liquidity and some Gold as a hedge/insurance play.
"Diversification is for idiots!"
Mark Cuban
- Specialist · Tampa Bay Area, FL · Member since 2018 · 106 posts · 72 votes7y
@Jess White
Hi Jess,
This is a great question, thank you for thinking it up!
All of the above answers are excellent perspectives. Generally, diversification in real estate, specifically, is a process of risk allocation. A savvy investor (in real estate) will “diversify” by buying across asset type and market, for example.
Diversification is a response to risk profile. Your risk profile will be contingent upon your overall resources, strategy, and goal. This is assessed more easily on a personal/individual level; there is great skill involved in tactfully developing a risk appetite profile for let’s say a pension or institutional fund, or even a potential private investor. Risk parity, although more commonly applied to stocks and bonds, is a studied portfolio management theory that you may find interest in and find you are able to glean knowledge that transfers directly into real estate.
Take care! Thank you for asking such a good question 😉.
All the best to you,
Daniel Reyes
- Specialist · Tampa Bay Area, FL · Member since 2018 · 106 posts · 72 votes7y
@Neil Henderson
Yes, very good I agree.
This is what I like about BP. I just read the entire thread and have learned a lot. I've been listening to the realestateradioguys' podcasts and they have good offerings for diversification like owning a coffee farm in Panama or cacao farm in Belize. Check them out. https://realestateguysradio.com/
- 7yIan IppolitoBusiness MemberInvestor · Tampa, FL · Member since 2015 · 1k+ posts · 1k+ votes
I agree very much with @Neil Henderson that unless a real estate portfolio is diversified across asset class, geography and operator then it isn’t fully diversified.
However I would add two more things: strategy and vintage year. The different strategies are (in order of risk) core, core plus, value added and opportunistic (ground up development). If you follow a core/satellite approach to diversification, you’ll put most in your core as conservative allocation, and a smaller satellite portion with more risk. I’m conservative, so I don’t have any opportunistic at this stage of the cycle. But someone who is more aggressive might.
The other thing is vintage year. For example, there is a value added multi family sponsor that I love (multiple real estate cycle experience without any investor money lost, conservative 65% leverage, long term holds with fixed rate long term debt, 1031 pipeline to defer taxes indefinitely, etc.) But after investing in 4 of their properties last year I passed on a 5th even though it looked good. By diversifying across vintage year, you can minimize the chance that the majority of your portfolio was invested at the wrong time.
Here’s how I am personally diversified across asset classes, and using a core/satellite approach. About 50% of my portfolio is in single-family rentals that I own directly. These are my conservative court because I have no debt on them which I feel hardens them against a severe recession. Someone who is more aggressive will prefer debt.
My next largest holding is about 30% in short term debt. That is the safest portion of the capital stack, and first position the safest way to loan. It's all conservative and less than 65% LTV. I diversify across strategy here also with some in a construction fund and the rest in a rehab/acquisition fund. (Broadmark and Arixa)
My next largest holding is in triple net lease. (Broadstone Net Lease). These are equity investments in properties with extremely long term leases to credit worthy tenants in recession resistant/Amazon industries like medical offices, quick service restaurants and industrial.
The next is the value added multi family sponsor I mentioned above.
The Real Estate Crowdfunding Review
Join the conversationCreate a free account to reply, vote on answers and follow this thread.