3 Ways to Reduce Risk in Your Real Estate Portfolio

by | BiggerPockets.com

Real estate is an excellent way to diversify an overall investment portfolio, but what happens when the real estate portion of your portfolio gets too big? In order to avoid having too much tied up in a single type of asset, you need to start thinking about ways to change up your real estate investment strategy.

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3 Ways to Diversity Your Real Estate Investments

The concept of diversification isn’t some newfangled idea or even something that’s specific to managing a financial portfolio. It’s been around for centuries and is frequently used as a form of hedging.

“Hedging has always been significant for the agricultural community as a way to protect the producer from price fluctuations or to ensure that they will be able to lock in a profitable price for their crops. But hedging is not an investment tool reserved for those who grow corn, wheat, and beans,” says Laura Taylor, a Senior Market Strategist for RJO Futures.

Whether you’re a farmer or a businessman, it’s always a good idea to hedge your bets and diversify your portfolio in order to enjoy steady returns without succumbing to unnecessary risk.

risk-paradox

For a lot of people, real estate is something they use to offset a stock-heavy retirement portfolio. But there comes a point in time where having too much of a single-type of real estate becomes problematic.

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This doesn’t mean you need to stop investing in real estate, but rather that you should hedge your bets and diversify. Here are some practical ways you can do this.

1. Invest in different types of real estate.

There are plenty of different ways to diversify, but the first and most obvious is to add a number of different types of real estate to your portfolio. For example, instead of just investing in single-family residential rentals, you might also throw in things like duplexes, apartment complexes, commercial properties, land, industrial warehouses, or even mobile home parks.

The more you invest in different types of real estate, the less likely that a single factor will impact your portfolio. It could potentially safeguard you against something like a new piece of tax law or a turn in the market.

2. Change up locations.

Conventional wisdom says that it’s best to purchase real estate in your local community, especially if you’re going to be managing it as a rental property (or some other form of investment that requires regular oversight and involvement). And while, generally speaking, this is a sound approach, you shouldn’t be afraid to change up locations.

By changing up locations and investing in real estate in different cities, states, and even countries, you become much less susceptible to a market downturn. Yes, a large-scale crash like 2008 could still do you in, but you aren’t going to be severely impacted by regional slumps.

3. Try REITs.

Maybe you’re tired of the involvement that real estate requires, but would still prefer to have your money attached to it. REITs, or real estate investment trusts, are good long-term investments that typically provide healthy dividends plus the potential for capital appreciation over many years.

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With a REIT, you pool your money with a bunch of other investors and gain an ownership stake in different pieces of real estate and developments. While the return isn’t quite as good as if you owned it all yourself, it has the benefit of being hands-off.

Eliminate Unnecessary Risk

Investing—no matter the strategy, asset, or mechanism—is inherently risky. The key is to take on an appropriate amount of risk and avoid putting yourself in a situation where you could potentially lose everything. And when it comes to real estate, spreading out your assets across multiple types of investments is the best way to safeguard against a sudden downturn in the market.

How do you manage risk while investing?

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About Author

Larry Alton

Larry Alton is a professional blogger, writer and researcher who contributes to online media outlets and news sources. A graduate of Des Moines University, he still lives in Iowa as a full-time freelance writer and avid news hound. In addition to journalism, technical writing and in-depth research, he’s also active in his community and spends weekends volunteering with a local non-profit literacy organization and rock climbing.

3 Comments

  1. Curt Smith

    I’ll add these risk and stress reducers:
    – reserves. Cash on hand. Could be a HELOC on your primary for emergencies. You need cash reserves to cover a bunch of roofs, hvacs AND vacancy at the same time.

    – Low LTV. Fortunately Dodd Frank helped force lower LTV loans upon landlords etc.

    – Only do deals with decent DSCR. IE the amount of free cash flow off each financed rentals. My line in the sand is DSCR >1.6. My portfolio is around 1.8+ . DSCR of 1.6 would be rent of $1k / mortgage PITI of $625. IE you have head room to drop the rent and still cover the mortgage.

    – Buy decent houses in decent school districts that will always have renter demand. See my paper on how to Buy a Bullet Proof Portfolio a file I uploaded to my profile down on the right. Nicer houses (but not too nice else DSCR will drop off) are safer bets.

    – Stay on top of your problems, keep houses maintained, tenants happy so they will stay forever.

  2. karen rittenhouse

    Multiple Streams of Income.

    Diversify so something is always working – when one area is weak, another is strong: rehabs, rentals, wholesale, lending, property management.

    There are unlimited options in real estate and so many ways to produce income. We use many but change our focus depending on the economy.

    Thanks, Larry.

  3. Paul Moore

    Nice post, Larry. You mentioned diversifying locations, which is a great idea. I would add that if you can get into locations that have strong positive net population migration, but are not overheated, that can be a big plus.

    Dallas and San Antonio are examples where there is great population growth but they are not completely out of reach price-wise. Austin and Denver have population growth, but prices are out of reach for most investors.

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