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Diversifcation in Real Estate

Is it smart to be diversified in real estate just like in the stock market? Instead of putting all your money into one stock or one sector, why not own a range of stocks in different areas. Well, does that strategy make sense in real estate, too.

So, as a landlord and owner of real estate, is it better to own a condo and a single family home or two condos? Is it better to own a condos in one area of town or spread out in different types of neighborhoods?

Many of these sectors or investor types also overlap, so they’re not necessarily one or the other, but many times a combination. For instance, an investor might buy a foreclosed home and turn the home into a triplex if the local laws and regulations allow for this.

Also, you may have noticed that these properties are a mix of residential real estate and commercial real estate. Both of these types depend on different variables that affect their market in the future, such as interest rates for the former and job growth for the latter. Use these factors as clues to help you decide where and what you invest in.

REMEMBER: Diversify, have a plan, get creative, and you will stay in the game.

So far, we’ve discussed how beneficial diversification is and why people do it. But there’s another perspective to the matter. Suppose you’re new to real estate investing but don’t want to take a huge risk with just a single piece (or type) of property. Anything could go wrong, such as a market failure in the near future, a natural disaster, or other unforeseen events that could reduce the value of your property, or worse, ruin you.

These are understandable concerns, and people are often very hesitant about placing all their eggs in one basket, especially so early in their investing career. As a result, investors diversify their real estate portfolio, so that all their investments as a collective unit will buffer the failure of one property if that should ever occur. This means that their risk is spread across many sectors, as it were, rather than concentrated into only one.

Only professional investors—or those who know exactly what they’re doing—concentrate their investing efforts into a single type of property. These people have the experience and the know-how to make the right decisions, such as where to invest, what type of property to acquire, whether or not the market is conducive to profits, etc. However, the pros were once amateurs too, so all you need is a lot of practice and experience to become a pro as well, if that’s what you want.

But all this is not to say that diversifying your real estate portfolio will protect you completely from a market crash. For example, the Chicago Tribune featured an article about one woman’s $1.5 million real estate empire (including a four-unit apartment building, a duplex, and a small home next to her own home) which was intended as a retirement fund. However, the soft market in her hometown of Orlando, FL had her worried about her empire’s ability to sustain her through retirement. Learn more about her situation here.

If there’s a moral to learn from Susie, it’s that you never know what will happen no matter how promising the market appears. Always be wary of these situations and try if you can to prepare for the worst.

Links
• This site provides in-depth information, detailing exactly what the concept of diversification entails. Although it’s aimed specifically at the stock market, it has relevant implications for real estate investing, particularly the involvement of risk. http://www.investopedia.com/articles/05/021105.asp

• An interesting article that evaluates the diversification capabilities of REITs, mainly Hybrid REITs.

• Staying on track with REITs, here’s another website that explores the possibilities that REITs may offer when seeking to diversify in real estate.

The Journal of Real Estate Research featured two articles where diversification was explored:

Journal of Real Estate 1
Journal of Real Estate 2

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