Apartment investing diversification
Diversification and the goal of having a diversified portfolio, in general, is an overly abused concept. It is an ideal made popular through a strong push by the equity investment, investment publishing, and journalism communities.
Diversification isn’t inherently bad either. It’s just the wrong focus.
What we advise our clients to do is to consider diversification as they look to invest capital, but never make it the end goal.
Warren Buffett, probably the greatest investor in the world, states unequivocally that,
“Diversification is a protection against ignorance. It makes very little sense for those who know what they are doing.”
It was never Buffett’s end goal to diversify. He simply looked for business cycles, industries, and companies that made sense, and diversification occurred naturally over time.
What’s the cost of the deal?
The wealthiest people believe in the concentration of capital. Sure they diversify, but they don’t do it by having hundreds of smaller investments. They can hold as few as five to ten investments and have all the diversification they need.
Imagine trying to invest in 30 – 50 great apartment investment properties or any other asset and manage them after you’ve invested. It would be overwhelming, and most likely you would not gain the same advantage as you would by selecting a few great investments. So think about concentrating your capital into a manageable number of investments you know, understand, and can follow.
There is also a cost to every deal, so perform your due diligence and select your investments wisely. Ensure that your deal is meaningful enough to merit the time, focus, and expense you will put into it.
Important Investment Diversification Tests
Apartment Investment Diversification or any diversification decision must pass the following tests.
1. Must be uncorrelated to your current investments
If you are investing in multifamily apartment investments to get uncorrelated returns, you must invest in different markets. Remember, all real estate is local. You can also invest in different asset classes in the same market. Our experience and research have shown us that multifamily apartment investments provide the best mix of passive income and safety. Ultimately, however, there are literally thousands of different assets one can invest in.
2. Must be as safe or safer than your current investments
Diversification provides no value if it doesn’t support or improve your risk profile. We have seen investors opt to increase their risk profile in the name of creating a complete investment mix when it would have been better to either keep their capital in cash or wait for a better project.
3. Must have both a historical and future expectation of positive returns
When diversification becomes the goal itself, realistic and required return and safety expectations go out the window. And, this happens more often than one would hope. Your investment must show that it has been providing positive returns, and hold the promise that it will continue to do so into the future.
Focus on investments the increase Permanent Wealth. Diversification will come in time.
Rick TheilenApril 6, 2011
I am in agreement. Most diversification benefits the brokers selling the diversification. Isn't marketing wonderful. Buffett is right, if you are not completely knowledgeable about what you're investing in, invest across the board so you are "less likely" to lose everything. It is like knowing the laws of Physics. When you know them you can literally fly.
Chad A. Doty (Co-founder | Principal)April 6, 2011
That's our goal Rick. We want everyone to be as knowledgeable about real estate investing that they can be. It is such a proven wealth builder, but... it does require specific knowledge. Once you have it though, there's very little that you can't do.
wayneApril 7, 2011
I love the quote from Buffett. I often get advice to diversify but thankfully we invested in real estate instead of the stock market. The properties are mostly within a few minutes of my house in a part of the country which I foresee increasing in value. My diversification at this point is in diversity of real estate - single family houses, small multi-family, commercial retail. And my vacancy rate is very low even in a bad economy.
Chad A. Doty (Co-founder | Principal)April 8, 2011
You've done well Wayne. Another way to think about it is to "invest in what you know." I think a lot of folks diversify across assets that they don't know, which has been proven to be riskier than just concentrating focus, time, and dollars on what you do know - what you've done.