Does Real Estate Diversify a Portfolio?

Posted Oct 24, 2022

what is the 10% rule in real estate investing?-1034104166Diversification is crucial to a balanced investment portfolio because it can help investors potentially reduce their exposure to unsystematic risk factors. These factors can include liquidity, financial and business risk, and investors can attempt to manage the impact these factors may have on their portfolios by diversifying their investment capital across a broad swath of industries, financial instruments, and alternative investment options. 

Systemic risk, on the other hand, affects the market broadly and remains outside the control of individual investors. These largely unavoidable risk factors can include regulatory changes, rising inflation and interest rates, and market risk, or the broad ups and downs usually seen in public equities markets. 

Real estate is one option for investors seeking portfolio diversification. Below we’ll take a look at some potential benefits of adding this alternative investment to your portfolio. 

How Real Estate Can Help Diversify a Portfolio 

Traditional investments such as stocks, fixed-income securities, and cash often form the backbone of investment portfolios. Alternative investments, which generally include investments such as real estate, cryptocurrencies, art, collectibles, private equity, and hedge funds, can provide diversification because they aren’t strongly correlated to public equities markets. Bear and bull runs in the stock market usually don’t have as strong an impact on alternative investments as they do with equity investments. 

There are many ways investors can seek increased portfolio diversification by investing in real estate. You can invest in a broad range of asset classes, such as residential, retail, multifamily, and office. Spreading your investments across these different asset classes can help manage risk. A good example is how the Covid-19 pandemic adversely affected the retail and hospitality markets while greatly lifting the tide for industrial warehousing and distribution facilities.  

Diversification also can come by investing in varying asset grades. The commercial real estate industry, which covers everything but residential properties, uses a grading system from A to C to denote a property’s characteristics and perceived quality. A-class properties are at the top of this grading scale and generally command the most interest, often from accredited and institutional investors, along with higher acquisition costs. C-class properties, on the other hand, are often older properties positioned in less-competitive areas of regional real estate markets. Investors with extensive experience in commercial real estate investing often pursue C-class properties because they can leverage their experience to improve operations, add value, and generate increased returns. 

Lastly, diversification through real estate can come from investing in a broad range of geographical markets. A diversified real estate portfolio could include a residential property in Boise, a duplex in Akron, a storage facility in California, and a standalone retail building in Austin. This type of diversification can potentially alleviate the effect a downturn in real estate prices or rental rates in one market might have across the entire portfolio of real property investments. These investments also may be suitable for risk-averse investors seeking to shift their investment capital away from unstable equities markets. 

The Bottom Line 

Investing in real estate can bring increased portfolio diversification, but real property comes with its own set of risk factors. These factors can include unpredictability, changes in supply and demand, location, vacancy, costly maintenance expenses, turnover, and a lack of liquidity. 

Real estate investors have the potential to realize benefits such as recurring passive income, tax advantages, and asset appreciation, but like any investment, there’s no guarantee that diversification into real estate will pan out. Some optional ways to invest in real estate without direct ownership include investing in REITs or Delaware Statutory Trusts, as well as Tenants in Common or joint tenancy ownership arrangements. Consulting with an experienced financial advisor before entering the field of commercial and residential real estate investing can help guide your decision making process and potentially avoid some costly missteps. 

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. 

Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. 

All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure. 

Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk. 

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Discover Ways To Help Manage Risk In Your Investment Portfolio
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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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