Diversify Your Real Estate
Are all Your Eggs in One Basket? Diversify Your Real Estate – Within Real Estate
By Chris Miller
Who is doing the best in this slow economy? Whose investments are performing the best in this environment?
The portfolios of real estate investors who have learned to diversify are. Every several years, an economic downturn like our current situation hits – as it did at the beginning of this decade, as in the early 1990’s, etc. Once we climb out of our current situation, another one will come along in several years. Smart investors, like those that I advise, have learned by watching these cycles – and know the value of diversity. This article will discuss diversifying within your real estate portfolio.
So – I don’t need to trade my real estate for stocks, bonds, or gold?
Heavens, no! If you had sold half your real estate and put it into the stock market in 2005, where would you be now? Many of my investors are comfortable with real estate because they understand it, it can yield excellent cash flow with tax advantages, and because property allows investors to use the power of leverage (through loans).
How do I diversify my real estate portfolio?
Diversifying your real estate portfolio means owning properties:
In several asset classes
In multiple geographic locations
With a diverse tenant mix
Owning Different Asset Classes
I typically refer to this as “diversifying by product type.” For example, hotels as an asset class are suffering as a result of decreased business and personal travel during this recession. There is a silver lining in this cloud, however; lenders today are hesitant to supply funds for construction of new hotels. An under-supply of hotels is likely to result – just like after September 11, 2001. Back then, a similar downturn in travel produced just that, and we saw high room rates result from undersupply in many high-demand areas – like in Manhattan, New York. Just like other business cycles, those boom times may be coming. Having parts of our portfolio in, say, retail and multifamily properties would lessen the temporary pain now.
Own in Multiple Geographic Locations
I often hear that most real estate investors own within 20 miles of their home. Investors who owned in pre-Katrina New Orleans or in Northridge when the 1994 earthquake hit experienced a bit of “concentration risk.” Since different regions of the country can have distinct economic cycles as well, it makes even more sense to invest in multiple areas. For example, the retail space vacancy rate in Orange County rose from 3.2% in 2006 to 7.2% today. Tampa, Florida has seen a much milder rise of 4.2% to 6.2%. So, rather than having two retail properties in Orange County, having one local and one in Tampa can reduce your risk by exposing you to more markets.
Diverse Tenant Mix
Owning 20 Mervyn’s stores or renting your apartments exclusively to “Big Three” assembly-line autoworkers may have seemed like a good idea 20 years ago, but 20/20 hindsight shows the flaws in that thinking. Similarly, we would like to diversify real estate portfolios among companies, industries, and markets.
How I achieve this diversity?
I work with several national real estate syndicators who buy and manage properties all over the country – of all product types. Although the opportunity to buy all of a large, institutional property always exists, few have the means to make a $20 million down payment on such a property – even fewer can do it and stay safely diversified.
One solution is to buy partial interests in these properties. When the investment is structured correctly, these partial interests can be purchased as part of a tax-free 1031 exchange. So an investor can sell his management-intensive properties and exchange into, perhaps, part of a high-rise office building in downtown Chicago. By doing so, he can potentially get a better quality asset, better tenant quality, long term leases, freedom from day-to-day management, diversification, and sometimes better cash flow than he was getting on his own.
Many of my investors have been using this method for years. By selling just one of their properties and exchanging into a partial interest, my clients can achieve lower portfolio risk through diversification and often increase their cash flow while doing so. As a bonus, they offload day-to-day property management responsibility to a professional company, and have more free time as a result.
If you would like to explore diversifying your property portfolio, but aren’t fond of buying properties in asset classes you aren’t familiar with, then perhaps partial interests is a topic worth exploring.
This is neither an offer to sell nor a solicitation of an offer to buy an interest in any properties. Offers are made solely pursuant to a Confidential Private Placement Memorandum.
Christopher Miller is a Senior Consultant with Midpoint Financial Services in Tustin, California and specializes in tax-advanted investments including 1031 replacement properties. Call him toll-free at (877) 313-1868
