A Deep Dive into Real Estate Portfolio Diversification

Posted by David Wieland on Jun 5, 2020


Ask any investment banker or financial planner about the best advice when it comes to building and maintaining a portfolio designed to provide steady returns, and the answer generally boils down to one word: Diversification.

Diversification is a risk-management strategy that combines asset types within a single portfolio. The idea behind diversification is that different, non-correlated assets will mean better returns, while lowering the risk inherent with individual securities. Diversification is also the basis behind Modern Portfolio Theory, which was discussed in a previous blog (chapter).

While diversification is a great strategy for stocks and bonds, it becomes problematic with fee-simple real estate investments. With fee-simple ownership, the investor is given the property title and, more often than not, is responsible for managing it. This type of ownership means the costs of buying, holding and selling different types of real property can be prohibitive to benefit from diversification can be prohibitive. 

Real Estate Diversification Structures

There are, however, different real estate ownership structures that lend themselves nicely to portfolio diversification, which include the following.

Delaware Statutory Trust. A Delaware Statutory Trust (DST) is a trust that owns and manages portfolios of professionally managed real estate holdings. To participate in a DST, the investor acquires a fractional ownership in the trust, which, in turn, owns the property titles. The trust is also responsible for maintaining the real estate asset(s), selling it/them when the hold period ends. DSTs are typically long-hold investments, and selling interest ownership can be difficult.

Tenant-in-Common. A tenant-in-common — or TIC — arrangement is an investment structure in which each investor has an undivided, direct interest in a property. While similar to DSTs in that fractional ownership is in play, each investor in a TIC directly owns, and has title to, a portion of the property. Sometimes, a TIC might have a sponsor, which handles property management activities and sells the asset when the partners agree to end the hold. A TIC investor can also sell his or her interest during the hold period.

Real Estate Investment Trust. While real estate investment trusts have “real estate” in the name, REITs are actually in the securities category. REITs consist of companies that own or finance income-producing real estate across a range of property sectors. Through a REIT, investors actually place their capital into a company which, in turn, buys, sells and manages real estate. Cash flow comes from dividends. Additionally, REITs are more liquid, as investors typically sell shares on public exchanges.

Sponsorship and Knowledge

Thanks to the above structures, programs offered by companies such as IPWM™ can help investors achieve real estate asset diversification. Through asset allocation and inter-asset optimization. Asset allocation is an investment strategy that gathers stocks, bonds and other assets to help balance an investor’s goals, risk tolerance and timeline with ideal returns and cash flow. IPWM’s™ real estate-specific strategy creates DSTs, combines them with REITs, then develops diversified portfolios geared toward an investor’s risk appetite. These portfolios offer more liquidity, as well, because of IPWM™’s DST secondary market, which supports the buying and selling of shares in the trust.

Inter-asset optimization, in the meantime, combines real estate and traditional assets to build and maintain a well-performing portfolio. Real estate investments, in the past, have typically been managed separately from traditional investments, such as stocks and bonds. Through inter-asset optimization, however, IPWM’s™ analyzes, acquires and holds a variety of assets, resulting in an efficient portfolio with projected returns that align with investors’ goals.

Though direct real estate ownership doesn’t lend itself well to diversification strategies, use of various real estate structures can do so. Implementing such assets into an overall portfolio can help lead the way to diversification, more reliable returns and a sound risk management strategy when it comes to investment goals.

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Discover Ways To Help Manage Risk In Your Investment Portfolio

Discover Ways To Help Manage Risk In Your Investment Portfolio

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