Diversification is essential to mitigating your risk as a passive real estate investor. Chances are you became a passive real estate investor because you did not have enough time to devote to your investment business or because you do not have the knowledge required to become a successful active investor. However, there is another very important reason to become a passive investor and that is the opportunity to diversify, even within your real estate portfolio.
Why Diversify?
Most people know that if you put all your eggs in one basket you increase your risk. Even if you diversify your total investment portfolio by putting capital into real estate as a passive investor, you can diversify further within that sector. Imagine that all of your real estate investments are located in one geographic area, and that area suffers a devastating tornado or hurricane. Or think about what would happen if a major local employer decided to relocate its facilities overseas. Consider the impact such disasters would have on the demand for your investment property. That’s why it’s important to diversify your real estate properties.
How Passive Investors Diversify their Holdings
Passive investment is a good way to diversify and mitigate your risks. The examples above are related to geographic diversification, but you can also diversify across asset classes. While you may not choose to invest in every asset class, it makes sense to have a mix of asset classes in your real estate investment portfolio.
Geographic Diversification
Investors who are just starting out tend to invest locally. However, concentrating all your investments in your local area can put you at risk for any kind of local economic problem. Real estate markets do not increase and decrease at the same time and they don’t move at the same rate, so geographic diversification can lower your risk. When a local market in one area dips, you can keep your investments profitable overall with the proceeds from an investment in another geographic area where the market is high. To diversify, passive investors may use a contiguous region approach and invest in locations near each other or look for different geographic areas with similar demographics like high income or a large percentage of college-educated residents.
Asset Class Diversification
Another way to diversify your real estate holdings is by investing across asset types, and as a passive investor, you will have that opportunity. Diversifying across asset classes can give you the advantage when the economy is performing well and protect you during a downturn. Retail with major anchor tenants tend to perform well during an economic downturn, and self-storage properties may perform even better. You can further diversify within your asset class to mitigate your risk.
Summary for Diversifying your Real Estate Holdings
Becoming a passive investor is the easiest way to diversify your holdings. Not only will you have the benefit of active partners who perform due diligence to provide you with investment opportunities with good potential, but you will also have the advantage of professional management to conserve your time.
Real estate is a popular investment choice because it can offer a stable asset that produces an immediate cash flow. You can leverage the capital investment to build wealth faster…
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