Deal Diversification
Robert Newstead
🌆 Debt & Equity for Multifamily & Commercial Real Estate Owners 🏙 Real Estate Investments
A Strategy for Real Estate Investing Success
Warren Buffett once said, "Diversification is protection against ignorance."
Do you think that's a true statement?
Honestly, you can argue this either way.
On the one hand, focus and concentration is important. Understanding a segment of the market, spending time and effort in that segment of the market, and investing in that segment of the market all builds on itself to help you become more successful over time.
On the other hand, diversification is important so that you are not too concentrated in one investment or even one asset class, which could wipe you out if that deal or asset class, respectively, does not perform.
Why Deal Diversification is Important
I am a Buffett, Munger, and Benjamin Graham fan. I am a strong believer in finding deals with both value and upside potential.
However, I strongly believe that deal diversification is an absolute must when it comes to real estate investing.
From what I have seen and experienced during my 20-year plus real estate finance and investment career, the importance of sprinkling your net worth around multiple deals (and in multiple geographies with various Sponsors) is imperative.
I had a couple of clients lose properties during the Great Financial Crisis. Luckily, they were not financially ruined due to the foreclosures because they had diversified their wealth into multiple investments.
I had one client that got pushed to the brink by having too much of his net worth in one, large deal. In fact, at one point, that deal represented a significant portion of his net worth. When his occupancy fell from nearly 100% to below 50% with an extremely large loan compared to value, he started getting financially stressed. He ultimately sold the asset, but was only able to re-coup approximately 55% of his original equity. He lived to fight another day although the experience was not without pain and stress.
I also know many clients currently as I write this in 2024 who are completely invested in office properties. While these clients are diversified across multiple office investments, they are not diversified as well as they should be in my opinion across asset types.
They would argue that their focus on a particular asset class has been paramount to their success, but I know the level of pain that some clients are having given the slow return to the office post-Covid, the slow market demand, the low velocity of leasing and sales transactions, the inflationary pressures these clients have felt with their expenses, and the lack of capital available for office.
In each of these cases, I believe that it shows that it is better to be well diversified across various deals and asset types.
A Strategy To Consider
While it is important to have more than one investment over time, everyone has to start somewhere.
That is usually with one deal, but the goal should be to get the first deal invested in so that you build confidence and can then move onto investing in other deals.
Again, if you only have one property and something bad happens to that property or the market, you could be putting your personal finances at risk.
Everyone's personal situation is different, and you have to evaluate what makes sense for you and your situation. Personally, I don’t know what the right number of deals is for you, but I can let you know what I do.
I take a fairly conservative approach.
I spread out my investment dollars over a number of deals. I invest in both the public and private markets, I invest directly on my own, I invest with partners, and I invest with other real estate companies that I know.
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As an example, if I have $100,000 to invest, I would generally prefer to invest $25,000 in four deals rather than $100,000 in one deal.
In that same example, I would prefer to invest in different asset types across multiple geographies with a variety of Sponsors.
An example of how that could look follows:
Investing smaller dollar amounts over a range of deals just makes sense to me.
Depending on your Net Worth, your available capital to invest, and your personal situation, you may be able to start larger than my example or you may need to start smaller first.
What I want to do here is show what is possible.
Just like you can diversify your overall investment portfolio in stocks, bonds, private equity, venture capital, and real estate, you can also further diversify within a broader asset class such as real estate.
You can do so by investing in the following asset classes to name a few:
Conclusion
Real estate is a long-term investment where diversification is important.
Asset types that are in favor now change over time in the same way that some geographic markets become better at attracting jobs and people.
Following trends in real estate is important to assist you with creating your own investment thesis about the asset types and locations that you want to invest in.
It is important to have a number of different real estate investments over time so that you are not too concentrated in one asset type or geography.
While the market is challenging to navigate currently given uncertainty with global politics, economics, and interest rates, I continue to believe that things get better over time and that the market has an upward bias.
As such, I am playing the long game with real estate, and my hope is that by diversifying my portfolio, lady luck shines favor on me over time.
* I started a weekly newsletter on January 1, 2024 called Cash Flow Net Worth with the goal to provide actionable real estate investment ideas and insights to help you increase both your passive cash flow and net worth over time. I would be honored if you would sign up here.
Please note - this is not investment advice. This information is provided for generalized informational and educational purposes only and without warranty of any kind.