Building a diversified real estate portfolio should be the goal of every real estate investor. Not only is this approach the most effective way to generate high returns and build wealth, but it is also the perfect hedge against abrupt market downturns. A great real estate diversification strategy spreads the risk across different locations, strategies, and types of income properties, allowing you to navigate any housing market trend and come out unscathed. In this article, we will show you how to build a diversified real estate portfolio and explore the different approaches you can take in order to do so.
How to Create a Diversified Real Estate Portfolio
When building a real estate portfolio, spreading out the risk as much as possible should be your main focus. To do this, you need to allocate your real estate investments across different categories. Here are some of the options that you should explore.
- Use a real estate diversification strategy that is based on location
- Build a diversified portfolio by investing in different types of properties
- Invest in properties of varying levels of risk
- Build a real estate portfolio that relies on various investment and rental strategies
Let’s now take a closer look at how you can use each real estate diversification strategy in a simple and effective manner.
1- Diversify your portfolio by investing in multiple locations
This is the simplest real estate diversification strategy that you could use. Buying income properties in multiple locations limits your exposure to the risks that are inherent to one particular real estate market. The key to reducing the impact of sudden market shifts is investing in various areas that have different features and qualities. Long distance real estate investing is highly advisable in this case. For example, you can build a diversified real estate portfolio by investing in major markets such as Los Angeles and New York as well as smaller markets like Brentwood, TN and Melrose, MA
Another approach to real estate portfolio diversification is investing in neighborhoods of varying economic standing. This will allow you to capitalize on an upward trend within a local housing market. To identify the best neighborhoods to invest in, you should consider using a real estate heatmap. This tool uses predictive analytics and property data and employs visual cues that enable real estate investors to locate the top areas on a map.
Related: The Best and the Worst Locations for Investment Properties
2- Spread your investments across different types of property
A good method of creating a diversified real estate portfolio is to invest in a wide range of property types. A good portfolio should include everything from single family homes and multi family homes to condos and apartments. These property types go through cycles of increased and decreased demand and investing in each one is the best way to navigate these fluctuations.
To start looking for and analyzing the best investment properties in your city and neighborhood of choice, click here.
It is also worth noting that savvy real estate investors can take this approach a step further by looking beyond residential real estate. In fact, other asset classes make for profitable and diversified real estate investments. Some of the options that are worth considering include retail, office, and industrial real estate. With that being said, beginner investors are better off looking at residential investment properties.
Related: Pros and Cons of 5 Different Types of Residential Properties
3- Create a real estate portfolio based on the level of risk
Risk is an inherent component of real estate investing. The higher it is, the bigger the reward will be. Investors need to mitigate this risk and get the highest possible return on investment without running the risk of tanking their real estate investment portfolio. In order to do this, the investments should be spread across all levels of risk. Here the four main risk profiles in real estate investing:
- Core: These are the safest assets that you could invest in. Generally speaking, these are standard income properties that are located in stable real estate markets. They are usually situated in upscale areas and their occupancy rates tend to be very high. But on the flip side, their average return on investment rarely reaches double digits.
- Core Plus: Assets that fall under the core plus category boast most of the features of core assets. However, they are slightly riskier. For example, these investment properties are generally older and their tenants tend to have a less stellar credit score. As for the expected return on these investments, anything from 10% to 15% is within the realistic range.
- Value-added: This is where the level of risk starts to rise. These are investment properties that require quite a bit of work before they can turn a profit. Real estate investors who acquire these assets might need to use a good business plan in order to boost occupancy or undertake some repairs to improve the condition of the property. If done properly, such an investment can yield returns as high as 20%.
- Opportunistic: These are the riskiest assets in a diversified real estate portfolio. These are usually distressed properties that are either unlivable or in a bad financial situation. A major turnaround is needed if you want to generate a profit from these assets. When executed well, the return can exceed 20%.
4- Rely on different real estate investment strategies
Using various investment strategies is key to building a diversified real estate portfolio. Your real estate portfolio should rely on a mixture of short term investments and long terms investments. A buy and hold strategy allows you to build a lot of equity whereas a short term strategy offers quick returns and protects your portfolio from uncertain market cycles.
Another important aspect of diversified investments is the rental strategies that you should use. Combining Airbnb rental properties with traditional long term rental properties is a good way of getting the most from the rental market. The high rental income of short terms rentals coupled with the consistent cash flow of traditional rental properties will help maintain the balance of your portfolio.
Related: Rental Strategy 101: A Beginner Investor’s Guide
The Bottom Line
Success in the housing market starts with a diversified real estate portfolio. Taking the necessary steps towards spreading out the risk in your investments will allow you to create a solid basis on which you can build a profitable real estate business.
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