If you are like most of us, we are watching the stock market, awaiting other moves from the Federal Reserve regarding interest rates, and trying to decide how best to weather what could be an upcoming storm.
Most experts advocate diversifying your portfolio, which is one of the core principles driving investing in real estate. It generally is not correlated with the stock market and delivers capital appreciation along with current income and some nice tax benefits.
But should you keep your allocation to real estate all within the same kind of real estate?
5 ways to diversify
I’s important to expect the unexpected with your real estate portfolio just like the stock market. We can’t predict the future, but, based on historical data, we know to expect cycles. Market corrections and recessions occur every so often, so it’s important to prepare your portfolio to withstand those fluctuations. We may be on the verge of a cycle right now.
One of the most powerful strategies used to successfully weather economic cycles is diversification. Even within real estate, you can diversify and maximize the long-term growth of your investments. By investing in a variety of different real estate assets, you can lower the risk overall.
Here are 5 ways to do this:
#1 – Asset Type
Within the real estate world, there are a variety of asset types to choose from. You can invest in retail, industrial, multifamily, office space, self-storage, and more. By varying the types of properties you invest in, you’re hedging against broader changes to the economy.
#2 – Location
At any given time, one city might be booming while a neighboring area may be experiencing a lull. Smart real estate investors desire properties in growing areas or those expecting growth.
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.
The challenge in diversifying across geographical locations is obtaining the research, connections, and more 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.
#3 – Asset Class
Aside from asset type, there is also asset class, which is a range of moderate-to-luxury unit prices within each asset type. Take an apartment complex, for example, and consider the range between moderately priced units, nicely developed units for the upper-middle class, and finally, the ultimate luxury apartments that are available in some areas.
Certain asset classes, like the more conservatively priced units, do well during rough patches in the economy. Luxury properties do best during the so-called booming economic years. It’s important to have both in your portfolio so that at any given point in the economic cycle, your portfolio is profitable.
#4 – Hold Length
Real estate syndication investments have an associated hold time which can range between 3 -10 years (or more). Consider varying the hold time of your investments, 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 asset class.
Conclusion
At certain points in the market cycle, it will feel as if the market will go up forever. Conversely, it may feel like the market will continue a downward spiral forever. We know that neither of these is true and that during one phase of the cycle, portfolios should be diversified in preparation for the next phase.
Keep these 5 ways to diversify in the back of your mind as you explore potential deals. Doing so will help you find various opportunities to diversify your portfolio, no matter the current market cycle.
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