Most real estate investors share one goal, and this is growing their real estate portfolio. While owning an investment property and renting it out is a great way to make money in real estate, it’s much better to own more than one investment property and grow your real estate portfolio at every opportunity. Although buying, owning, and managing multiple properties sounds like a very risky investment strategy, there are ways for property investors to reduce risks while growing their investment portfolios, and the best way is by diversifying their real estate portfolio. But how does diversification reduce risk in real estate investing?
Well, have you heard the phrase “Don’t put all your eggs in one basket” before? This applies directly to real estate investments! Spreading out your investment properties help you balance risks and rewards. Not only that, but diversification can also minimize the total impact of a bad investment on your real estate portfolio while giving you the ability to counteract the loss. This is the biggest reason why real estate investors aim to diversify their real estate investment portfolios.
Here are some ways and tips for you, as a real estate investor, to diversify your real estate portfolio and enjoy returns without succumbing to unnecessary risk.
Reduce Risk in Your Real Estate Portfolio by Investing in Multi-Family Properties
When diversifying real estate investment portfolios, nothing may be more compelling to real estate investors than multi-family properties. These properties – commonly referred to as multi-dwelling units (MDU) – are a type of residential real estate properties with two or more housing units under one roof. Although they are not the most popular type of residential properties, there are many benefits of investing in multi-family properties, especially when diversifying your real estate portfolio. Not only do these investment properties produce a larger sum of cash flow compared to single-family homes, but they carry less risk regarding:
- Vacancy: One of the biggest risks when it comes to rental properties are high vacancy rates. This risk typically occurs when a rental property fails to attract tenants. Naturally, this results in the loss of rental income, which will leave a negative impact on your real estate portfolio. When investing in multi-family investment properties, a real estate investor has the ability to generate larger pools of tenants, thus low vacancy rates, thanks to the wider availability of housing units.
- Cash Flow: Investing in multi-family properties means a real estate investor has a unique opportunity to generate more rental income from one single investment. As a result, this type of investment properties provides property investors with financial freedom, in addition to a passive income for retirement.
Reduce Risk in Your Real Estate Portfolio by Investing in Commercial Properties
Investing in a commercial investment property is yet another path real estate investors can take to diversify their real estate portfolio. Essentially, this investment type consists of purchasing investment properties and leasing them to businesses for an income. This offers property investors with plenty of attractive benefits such as a steady cash flow, lower vacancy risks, higher income potential, and more. In addition, commercial properties can be a great source of tax breaks, a retirement strategy, or paying mortgages on your other investments. That being said, learning how to invest in a commercial investment property is not simple.
Benefits of diversifying your real estate portfolio with a commercial investment property include:
- Less Competition: Owning commercial properties, like office buildings and shopping centers, is a major investment for many real estate investors. This type of investment is often too complicated or outside of the average property investor’s comfort zone. However, commercial properties present a lucrative opportunity for property investors to increase their financial wealth and stay ahead of the competition.
- Cash Flow: Because commercial properties leases are generally longer than residential properties, commercial real estate investors have a unique advantage over traditional property investors to earn a relatively consistent and reliable income. Moreover, a commercial investment property typically generates a better return on investment (between 6-12%) compared to residential properties (typically between 1-4%).
- Triple Net Lease: Another benefit of investing in a commercial investment property for diversifying a real estate portfolio is something known as the Triple Net Lease. This means that, in addition to monthly rent, tenants will pay for the commercial investment property’s taxes, property insurance, and maintenances costs. Therefore, the only payment that property owner is responsible for is mortgage payment!
Reduce Risk in Your Real Estate Portfolio by Investing in REITs
A real estate investment trust (or a REIT, for short) is a company that owns or finances real estate properties. It works like a mutual fund where big and small real estate investors invest in a pooled, managed property. Essentially, REITs enable a real estate investor to own a share of the value of the property, while also earning rental income from leasing it.
This method is very beneficial for the average real estate investor who doesn’t have a big capital or the time to focus on real estate as a full-time job. Some of the advantages of REIT investments include high yields, simple taxes, and excellent liquidity. Not only that, but REITs also offer a high level of diversification in your real estate portfolio! Naturally, the more diverse the investment portfolios, the fewer the risks associated with them. With that being said, investing in REITs is a great way for property investors to diversify their real estate investment portfolios.
Reduce Risk in Your Real Estate Portfolio by Investing in Different Locations
When investing in real estate, many will argue that it’s best to buy an investment property in your local market, especially if you’re the one who’s going to be managing the property. Generally speaking, this is a very sound approach. However, investing in different real estate markets and locations is a great way for a real estate investor to diversify his/her real estate portfolio!
When investing in real estate in different cities, states, and even countries, real estate investors become much less vulnerable to a market downturn. Yes, a large-scale crash (like the 2008 market crash) could still affect you, but you won’t be harshly impacted by regional slumps.
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Reduce Risk in Your Real Estate Portfolio – Conclusion
When it comes to a real estate investment, there is always some sort of risk. Real estate investors can reduce these risks by diversifying their real estate portfolio. Spreading out your investment properties across multiple types of investments such as multi-family properties, commercial properties, trying out REITs, or investing in different locations are the best ways and methods to having a diversified real estate portfolio and reducing risks.
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