One of the biggest challenges I faced in growing my real estate investment portfolio was expanding my coverage. For example, I asked myself ‘will I focus on a particular asset type or area? Or will I include new kinds of properties in other real estate markets, so my eggs aren’t all in one basket?’
I had to consider multiple factors to reach a decision, and I didn’t know where to begin.
It took me years before I arrived at the real estate investment portfolio I have today: 60% residential, 20% commercial, and 20% private equity real estate funds. I diversified my portfolio to have an active role in property management while generating both active and passive income.
My strategy wasn’t borne by luck, though. Unfortunately, there’s no one-size-fits-all answer to choosing between specialising and diversifying one’s real estate portfolio. That’s why there are many investors out there still facing this dilemma—perhaps it’s why you’re reading this article!
As you build your real estate investment portfolio, I recommend that you weigh the advantages and disadvantages of both growth strategies. Your goal is to determine which real estate business plan best fits your personal investment goals.
Let’s take a look at the differences between specialising and diversifying your real estate portfolio.
Specialising vs. Diversifying Your Portfolio
Here are the three main differences between the two real estate investment business plan approaches. In a nutshell, they help real estate investors achieve different objectives and fit contrasting situations:
|Investment Goals||Best for generating consistent income (e.g., from rent), as you can estimate your revenue accurately.||Best for equity gains and investing in appreciation, resulting in a large profit when you sell.|
|Level of Experience||Best for newbies to real estate investing. Specialising only requires one investment model, and repeating what you’ve already done to multiply your successes.||Best for experienced investors looking to manage different types of properties to expand their coverage.|
|Type of Market||Best for suburban areas where there are limited property types. Often just a lot of single-family and multifamily homes.||Best for urban markets where there are various residential and commercial property types to invest in.|
Whichever one you choose, here are their respective advantages and disadvantages:
|Pros:||Increases your potential gains, as you can focus on managing high-quality investments that give you the highest returns.||Reduces your volatility and potential risk, as those performing poorly can be offset by those performing well.|
|You can focus on the strategy that works, and take advantage of economies of scale.
You can also estimate the profitability of an investment opportunity more accurately.
|You can have a combination of long-term gains and monthly income (e.g., from rent).
For example, single-family homes for good appreciation rates and multi-unit properties for high cash-on-cash return.
|Cons:||Increased risk in your portfolio, as you’ll be at the mercy of the area you’ve invested in.
You won’t have other investments that can offset any drop in performance.
|Limits potential gains and is likely to produce average results.
You might spread your financial capacity and general capability too thin, as there’ll be more complexity and hands-on management.
My advice for you is to consider all of these factors with your goals as a real estate investor. The correct strategy is the one that fits your desires and financial situation the most.
How You Can Diversify Your Portfolio
Specialising isn’t difficult to do, since it’s just focusing on one asset type and repeating the strategy you’ve proven effective. On the other hand, diversifying can be done in various ways.
Here are the different ways you can diversify your real estate investments:
Diversifying by Sectors
The first method in diversifying is by investing in different sectors of the real estate market. For example, you can buy all three kinds: residential, industrial, and commercial properties:
- Residential Properties: Properties used for residential purposes can range from a single apartment unit to a whole high-rise apartment complex, and can either be affordable or expensive. These homes can generate significant returns from rental income, where tenants can lease for 12 months at a time.
- Industrial Properties: These are factories, warehouses, or data centres that host activities such as manufacturing, storage, and production. Lease lengths can reach ten years, which offers investment security for you. While they do require a larger capital, they can yield higher returns than residential investments.
- Commercial Properties: Properties for commercial purposes include office buildings, retail buildings, and shopping malls. They have a higher income potential than residential properties, with lease lengths of around three to five years.
An example of diversifying across sectors is having a single-family home, a plot of land with a small factory, and a floor or two in an office building all in your portfolio. Then, when an unprecedented event such as the recent pandemic hits, you’ll still earn from your single-family home rental income as companies give up their office for work-from-home set-ups.
Diversifying by Location
The second way to diversify your portfolio is by investing in multiple real estate markets. You can do this across cities, regions, or even countries to avoid concentration risk.
For example, you can be an out-of-state investor with apartment buildings in three of the world’s hottest rental real estate markets: the USA, Germany, and Canada. Alternatively, you can also have single-family homes in undersupplied rental markets in Australia: Wanneroo in Perth, Onkaparinga in Adelaide, and Loganlea – Carbrook in Brisbane.
You’re not bound to one location—you can invest your money where the most favourable opportunities are. Because of this, diversifying by location makes the most sense when you’re living in an area with a slower real estate scene. Expand your investment opportunities by cherry-picking the best spots.
Diversifying by Strategy
Lastly, the third option to diversify your portfolio is by investing in properties for different purposes. The three purposes you can divide properties into are:
- Core Investments: Core properties are your most stable, low-risk investments. These should be in good conditions, have low vacancy rates, and can generate rental income consistently. These properties often follow a buy-and-hold model, generating high rental yields instead of focusing on capital appreciation.
- Value-Add Investments: Value-add properties have higher risk compared to core investments. These tend to perform slower and require rigorous property maintenance and management. Once the properties meet rental standards, however, these can be rented out at higher rates than your core investments. Moreover, you’ll gain equity from the increase in property value.
- Opportunistic Investments: These are underperforming properties that you buy below market value, such as distressed homes and undeveloped land. You’ll have to make significant renovations and redevelopments to “flip” the home and sell it at a higher price, or build a building based on market demand. Most of your returns will come from capital appreciation.
With a mix of core, value-add, and opportunistic properties in your portfolio, you can figure out the perfect balance of mitigating risks and enjoying long-term gains.
Choose the Strategy that Meets Your Investment Goals
Your goal is to choose the portfolio expansion strategy that meets your objectives as a real estate investor. Now that you’ve mastered your first investment property, you need to determine what you want to achieve by adding more properties to the mix. Only then will you figure out which growth strategy to pursue.
If you need more help in expanding your portfolio, you’re more than welcome to talk with our team of expert property managers. We can assist you in identifying the ideal growth strategy to meet your investment goals.