How to diversify your property portfolio
Every investor knows the importance of diversification as a way to reduce risk and increase the consistency of your earnings over time. Investing in a wide range of different assets, such as stocks, bonds, and real estate, can help you earn more and resist the impact of major events like recessions.
But it’s also important to diversify within each of these asset classes; for example, if you invest in real estate, you’ll need to diversify your property portfolio to see the best possible results. But why is this important and how can you do it?
The value of diversification
Diversifying your property portfolio has several benefits, including:
- Reducing volatility. First, diversification has the power to reduce the influence of volatility on your portfolio. If there’s a sudden drop in housing prices in a given area, only a fraction of your properties will suffer from it, since you’ll have properties in other areas. This is especially important as you grow older, when your risk tolerance decreases.
- Minimizing vacancies. Most of your property portfolio will depend on occupancy to turn a profit; without tenants paying rent, you’ll still be responsible for paying ongoing expenses, resulting in a loss over the vacancy period. With more properties in your portfolio, vacancies aren’t as impactful; you’ll always have income coming in to offset your costs.
- Greater exposure. Diversifying also serves the purpose of exposing you to different markets and different segments. You’ll be more likely to find a sector with a propensity for high growth, ultimately increasing your earnings.
How to diversify a property portfolio
So what steps can you take to diversify your property portfolio?
- Invest in different areas. The first and most obvious option is to invest in different areas. On a small scale, you can invest in properties throughout your home city and its suburbs; chances are, real estate prices and demand will fluctuate differently in these different areas. You can also invest in different cities throughout the country, and even in different countries. If you’re not able to physically attend to the property, you can always hire a property management company to step in and take care of it on your behalf.
- Focus on multi-unit buildings. You can also invest in buildings with multiple units, rather than single-family homes or single-unit commercial properties. With multiple units available, you won’t have to worry about vacancies as much; when someone leaves, you’ll still have several units generating revenue to offset the expenses. Of course, multi-unit buildings also tend to be more expensive, so it may be hard to generate momentum here.
- Invest in both commercial and residential real estate. Commercial and residential real estate each have advantages and disadvantages. Many new investors gravitate toward residential real estate because it’s straightforward, but commercial real estate can be more lucrative (if you make the right decisions). You can also invest in both commercial and residential real estate simultaneously by investing in mixed-use property, which is especially valuable for diversifying your portfolio.
- Snowball your investments. Coming up with the capital for a property investment can be tough, so many property investors attempt to snowball their investments. They invest in a single property initially, collect the profits from that property and use them to invest in a new property. For example, if the property generates $5,000 in income each year, you can invest in a new property after 2 years. Those properties can collectively provide enough income for a new, third property after a year. Soon, you’ll have enough income that you can buy multiple new properties each year.
Factors to consider
While diversifying your portfolio, there are several variables you’ll need to consider, including:
- Risk. What is your personal risk tolerance? How much risk are you trying to offset? How much risk is introduced by a new property and what kinds of risks are associated with it? Every property is going to come with risks, so it’s important to understand and carefully consider those risks.
- Cost. Just because a property seems like a good fit doesn’t mean it’s a wise – or even an achievable investment. Calculate the costs of purchase and ownership carefully.
- Geography. Always study the area in which you’re buying. What are the unique features of this geographical area? How is this different from the other areas in which you’ve invested? How will you manage this property?
It often takes years to fully balance your real estate portfolio, so don’t be in a rush to do everything at once. If you’re low on capital and you still want to be exposed to the market, you could also consider investing in real estate investment trusts (REITs), which can be traded on the market like ETFs and stocks.