I was recently talking with a lifelong friend (we’ll call him Hank) about the question of real estate diversification. He has been a successful house builder all his life and at age 74 owns dozens of top-quality houses that he rents for a substantial income.
These houses are all in one subdivision in one town.
My wife and I on the other hand own real estate in England, North Carolina, Florida, and Ecuador.
“Which plan is best,” my hank’s wife asked.
According to one of the best investors in the world, Warren Buffet, “Diversification is protection against ignorance,” Buffett famously says, “It makes little sense if you know what you’re doing.”
Buffets tactics in stocks, buy at attractive valuations, hold investments for the long term, and keep costs low are important in real estate investing as well.
My friend definitely knows what he is doing, but I think Hank could use a bit of diversification.
First, there are a number of types of diversification. Asset class is one. An investor can diversify in real estate or in equities or precious metals or bonds, etc.
Such diversification can create safety, but not always. Hank for example, does really well in real estate, hates the idea of equities and is not comfortable with other asset classes. He would not feel comfortable holding other investments. Would he be better off, safer?
Maybe not because his discomfort could make him fiddle in inexperienced area, which normally means buy high and sell low.
“What are you comfortable with”. The answer should be part of your diversification equation.
Another form of diversification is location. My friend’s rental houses are in an area with some serious earthquake risk. Maybe his insurance would cover, but if the quake destroyed the local economy for some time, how would his renters find jobs to pay their rent. Diversification into other regions might add safety.
However, consider this. I have quite a few of houses in Mt. Dora Florida. This I believe is and will remain a growth area. If I am right, diversification might not be so good. But I like to diversify so also have real estate in other locations.
This type of diversification creates absentee ownership problems that can dive you nuts!
Just when I arrive in Florida, plumbing breaks in North Carolina, or a squatter moves onto my Ecuador farm (yes that happened).
So diversification of this type can add safety, but also requires additional management skills.
Be sure you have management set up in each location if you want to diversify location.
I did my own management, summer’s in North Carolina, Winters in Florida. Good idea. Right?
I currently have two very nice mountain cabins, sitting empty. We did very well with them using AIRBNB, all summer long. Circumstances now make our summer’s in North Carolina difficult and I have not cracked the management, house cleaning at a distance, nut.
In this case, diversification is costly or looked at in another way, it’s good I am diversified in Florida rentals too.
The further away our real estate is, location-wise, the greater the danger of absentee ownership problems.
For example, I like to invest in residential houses. Should I diversify into commercial real estate or agricultural property or land? A recent article I posted here, “Anchor of Value” looked at why we choose residential because it is in our comfort zone.
I cannot stress the importance of comfort. Most of us as investors are subject to Risk Aversion because as humans, loss has a more profound impact on us than profit. Having worked with thousands of investors for over 50 years, I believe that “Risk Aversion” is one of the great investing dangers. Diversification into investments we do not understand so well, can increase Risk Aversion.
Finally, we should take into account the fun and fulfillment factor. When you love what you are doing, Risk Aversion is reduced and there is less feeling of sacrifice. Even if we lose, we are more likely to carry on and if our decisions are sound, perseverance is a highly valuable tool.
Merri and I have invested in real estate in five US states, Hong Kong, England, Isle of Man, Dominican Republic, Fiji and Ecuador. Not once was profit the only, or even the main motive. We wanted the investments to be profitable, but we seeking adventure, fulfillment and a better lifestyle too.
Diversification, a little can increase safety. Too much diversification almost guarantees mediocrity at best.
When you diversify a little to learn, grow, have an adventure, do some good or just take advantage of a darn good deal, you are probably on the right track.
Diversify too much, especially into areas where you lack, experience, skill or adequate resources, especially in areas of real estate management and you can muck up your entire profitability.
Diversification is like medicine. Medicine is dose.
