What is Diversification, and How Do I Diversify my Real Estate Holdings?

28 Aug What is Diversification, and How Do I Diversify my Real Estate Holdings?

In your lifetime you will see every single asset class endure value drops of 30 to 70 percent. Rather than panic, you ideally want to have money available to buy assets at rock bottom prices. In the dot com bubble burst of 2000, tech stocks crashed to a fraction of their recent highs. In the Great Recession of 2007 to 2008, residential housing prices and commercial property values dropped as much as 60 percent in some markets. In 2020, the stock market fell 34.7 percent in just seven weeks as COVID-19 caused shutdowns around the world. At the beginning of 2020, brent crude oil was selling at $70 a barrel, and on April 12th, 2020 it fell to $9.12 a barrel. Cryptocurrency like Bitcoin has seen selloffs of 70 percent in 2022 alone. Bitcoin has gone from a high of around $69,000 to a low of just under $19,000 in less than a year.

It is a natural human tendency to stick with what you know. If you ask a financial advisor what you should invest in, a common reply is stock and bond funds. If you ask a crypto expert what to invest in, they’re predisposed to recommend cryptocurrency. A serial saver will talk about the rates on a Certificate of Deposit from their bank. People who buy stocks tend to buy most stocks from their own country and very few, if any, from other countries. A day trader may not have much in terms of long term holdings. A longtime employee of a company may only be buying their employer’s stock and nothing else.

A person who invests solely in commercial properties told me that the only good choice out of all investments is commercial real estate. A house flipper told me that flipping is the best way to make money in real estate. A financial advisor told me that the stock market always beats the returns from the real estate market. Always? In each of their minds, they were right…for the moment. In 2021, as cryptocurrency values skyrocketed, news reports fawned over newly minted cryptocurrency millionaires. Many of those millionaires said they weren’t selling and were instead buying all they could. (Dogecoin hit 70 cents per coin right before Elon Musk went on Saturday Night Live, and as of this date it is at 6 cents. Ouch!)

About 70 percent of retail investors tend to buy high and sell low. They buy at times of maximum optimism after watching others seemingly get rich. Then they sell at times of maximum pessimism, when asset prices are low and probably likely to rebound.

So how do you avoid losing it all when one or more asset classes are plunging in value? Diversification. Everyone has heard not to put all their eggs in one basket. Diversification is a risk management strategy to mix a wide variety of assets in an investment portfolio to reduce risk and increase returns. If one investment or asset class declines in value, other investments buoy the portfolio. Periodic rebalancing of the portfolio helps a disciplined investor increase their long-term returns.

As outlined in Money: Master the Game and Unbreakable: Your Financial Freedom Playbook, both by Tony Robbins, here are four ways to diversity:

1. Across different asset classes. Don’t just own commercial real estate and nothing else. Put your money in different asset classes. Asset classes include stocks, precious metals, bonds, real estate, cryptocurrency, and even collectibles like fine art or antique automobiles.
2. Within asset classes. Don’t put all of your money in Tesla stock. Own stock of different companies or even an index fund.
3. Across markets, countries, and currencies around the globe. Invest in assets from other countries.
4. Across time. Give your investments time to grow and compound. Don’t just day trade or flip houses. Hold, collect rents, yields, or dividends, and reinvest that money.

How do you diversify within the real estate asset class? You could own residential rentals and maybe some mixed-use or commercial rentals. Perhaps you could own in more than one area of town. You could also own shares of a REIT (Real Estate Investment Trust). You could participate in a real estate syndicate, such as a consortium of accredited investors who are building homes in a Build-For-Rent (BFR) community. You could lend some money as a private lender, secured by a mortgage and note. You could even own stock in Home Depot, Lowe’s, a homebuilder, a real estate brokerage, a title agency, a homeowners’ insurance firm, or another company that provides real estate services. If you are flipping houses, consider keeping one or more as a rental. (A rental could even be a long-term flip, in that you rent it for a few years and then sell it. Your capital gains tax will be lower.)

I mentioned disciplined periodic rebalancing of your portfolio. That technique helps people accelerate their returns over time. Imagine if you had bought 10 houses in 2008 when the real estate market had crashed, and imagine you had rented them for years. Then imagine you had sold them in early 2022 when the real estate market had peaked. You would have made a fortune in rent and in capital gains. Then imagine you had taken some of those capital gains and bought cryptocurrency and stocks when they tumbled in the spring of 2022.

The idea is to know what percentage of your investment portfolio should be in each asset class. Then when an asset class does really well and another does poorly, you can sell some of what has done well and buy cheap assets in the other class that has gone down. To be especially disciplined, you can set dates in your calendar when to consider rebalancing, such as once a year, twice a year, or every quarter. That way you keep the percentage of holdings the same. Furthermore, you sell into strength and buy into weakness. In other words, you sell high and buy low.

Tai DeSa is a graduate of The Wharton School of the University of Pennsylvania.  He became a full-time real estate investor in 2004 after serving in the U.S. Navy.  Tai has made colossal mistakes in investing (and learned some things along the way).  He has helped hundreds of homeowners avoid foreclosure through successful short sales. Check out Tai’s books on Amazon.com. Tai may be available for coaching and speaking engagements on a variety of real estate topics.  Send an email to tai@investandtransform.com.