How to Build a Diversified Real Estate Portfolio
A diversified real estate portfolio can help you achieve higher returns and minimize risk on your investments, as you are not solely dependent on the highs and lows of a single market. In this article, we explore how to put together a diversified real estate portfolio, highlighting four key ways you can diversify, and show you how to balance the benefits of diversification with the risks involved.
Create a Diversified Portfolio Based on Geography
Geography is a key factor that many investors focus on when creating a diversified portfolio. The desirability and risk involved in investing in property greatly depends on its location. You can diversify by focusing on different neighbourhoods, cities, states, and regions. Each geographical area has its own charms and drawbacks when it comes to choosing the right location for your diversified investments.
You can use location to guide the diversification of your real estate portfolio by focusing on primary (think New York, San Francisco, Chicago, or Washington D.C.), secondary (such as Austin, Portland, Seattle, or Salt Lake City) and smaller tertiary markets. Primary markets generally refer to areas with the highest populations. Primary markets are often attractive choices for commercial real estate investors, as they tend to offer the largest return on investment.
In addition, certain areas are better for different sectors. Consider which market is most profitable for your asset type. For example, if you are thinking about investing in office space, consider limiting your location of choice to primary and secondary markets, as these offer profitable job growth and a strong economy. However, tertiary markets generally offer lower barriers to entry. Several tertiary markets are also experiencing rising populations and above-average job growth. As such, choosing to invest in property across different markets can help you mitigate risk and maximize your profits.
You can easily use Reonomy’s geographic search filter to help you find diversified investments across the US. With Reonomy, you can search for off-market properties based on state, county, city, zip code, or street.
Create a Diversified Portfolio Based on Asset Class
You can also diversify your commercial real estate portfolio by investing in different asset classes. By investing in properties across different asset classes, you can maximize your chances of seeing above-market returns and ride out the financial highs and lows of each individual market. Industrial real estate, office space, and retail are some of the areas to consider when diversifying your portfolio.
You can use Reonomy’s asset class filters to help you source diversified investments. If you decide to focus on a handful of key markets, Reonomy helps simplify the diversification process by allowing you to search for several different asset classes at once. In addition, you can also use our asset filters to search within each asset class. For example, with our retail filter you can refine your search to focus on bars, department stores, or convenience stories.
Create a Diversified Portfolio Based on Risk Profile
There are four main categories to consider when it comes to diversifying your real estate portfolio based on risk. The four key categories are core, core-plus, value-added, and opportunistic. Core assets are defined as stable assets. Core assets are generally low risk and offer low return on investments. In contrast, core-plus assets share many similar features to core assets. For example, the asset in question might be older or just outside a central location.
Third down on the ladder of risk are value-added assets. Value-added assets often boast discount prices because they demand that an effective business plan be put in place in order to address property problems. Many value-added assets may require renovations. The rise in risk associated with value-added assets also means that you will likely see higher leveraged returns on your investments.
Opportunistic assets are the riskiest of assets. Opportunistic assets, also known as distressed assets, call for a strategic game plan to overcome major issues, such as pressing financial difficulties or prevalent structural problems. To successfully manage opportunistic assets, you will generally need extensive expertise and experience in that specific market.
Creating a diverse real estate portfolio, made up of assets associated with different levels of risk, allows you to balance dependable, lower risk, low-maintenance properties that offer lower returns with high risk, more demanding properties that promise higher returns.
Diversifying Your Real Estate Portfolio by Investing in REITs
Another way to create a diversified real estate portfolio is by investing in REITs. A real estate investment trust (REIT) refers to a corporation that owns or finances income-producing commercial property. REITs function in a similar way to stock. You can buy shares in several commercial properties and receive dividends on the rent payments collected by property management.
While REITs are vulnerable to share price volatility and come with a certain level of risk, REITs also offer you the potential to see large returns on investment for minimal work, as property management is taken care of for you. In addition, by combining REIT investments with investments in your own property, you will offset much of the risk that comes with relying on REIT investments alone.
Curious to find out more about REIT investing? Check out our guide to REITs.
Beware of The Risks Tied to a Diversified Portfolio
As noted above, diversifying your real estate portfolio is a great way to mitigate risk and enjoy high returns throughout the year. However, diversified investments also come with a number of pitfalls that you need to be mindful of.
A diversified portfolio demands that you get to grips with the workings of several different markets, locations, and property managers. Each of your diversified investments will bring a new challenge in terms of knowledge and competency within that market. By focusing on a fewer number of assets, you will quickly build up your expertise in your chosen markets and avoid the overwhelm of learning the ins and outs of a new area.
In addition, you may also run into unexpected problems when dealing with an unfamiliar property management team. If you find yourself the owner of a problem property, you will likely find your energy and time is drained by those issues and impacts how successfully you manage your other investments.
The Pros and Cons of Diversified Investments
There are a number of ways to diversify your commercial real estate portfolio to boost your returns and minimize the risk tied into commercial real estate investing. Additionally, it is also important to keep in mind that managing multiple assets can become stressful and demanding if you diversify too extensively.
If you’d like to get started with Reonomy to help you source off-market assets for your diversified real estate portfolio, why not begin with a free trial of our platform?