Diversification is a cornerstone principle in real estate investment, offering a shield against volatility while fostering sustained growth over time. By spreading resources across different asset classes, industries, and markets, investors can mitigate risks associated with any single investment. Real estate, with its tangible nature and unique characteristics, emerges as a pivotal component within a diversified portfolio. It provides a hedge against inflation and presents an array of investment avenues, ranging from Multifamily properties to commercial real estate, and non-traditional asset classes. Tailored to accommodate varying risk tolerances, these diversified options within the real estate sector offer investors flexibility and stability in pursuit of their financial goals. This article explores several investment types to help investors diversify their real estate portfolios.
Building Wealth Through Asset Class Diversification
An asset class is a group of investments that share common characteristics and exhibit similar behaviors within the market. The traditional trio of equities includes stocks, bonds, and money markets. Real estate and commodities are two common “alternative investments.” Diversifying your asset classes is essential to building wealth. This involves allocating your funds to several different asset classes that are not correlated but complementary to one another. This strategy minimizes overall portfolio risk, as investing in multiple asset classes reduces the impact of any one underperforming investment.
For example, when diversifying your real estate portfolio, if you allocate your investment solely to one property, you bear the full risk associated with that specific asset. However, by diversifying your investments across three or more properties, the potential impact on your wealth, whether positive or negative, is distributed more evenly.
Taking it a step further, diversifying risk across multiple properties spanning various markets and asset types ensures the creation of a truly diversified real estate portfolio.
The Vital Role of Multifamily Properties in a Diversified Portfolio
Multifamily syndications offer investors the opportunity to participate passively across a wider spectrum of properties without the time constraints of single-family investments. These investments generate monthly cash flow from rent income and have a payout at the time the property is sold. Additionally, the cost of entry is much lower for multifamily investments than for single-family since the cost is split among all investing partners.
Multifamily real estate syndications are a popular choice among investors due to their unique position in the real estate market. These investments are based on a fundamental human need: shelter. Unlike other real estate sectors like office, retail, and storage, the demand for multifamily real estate comes from this essential need. Multifamily properties can be found in every city, job environment, price point, and demographic in the United States, making them a great option for diversification within the real estate sector.
Multifamily Apartment Property Classes
Multifamily properties are classified into four categories based on their physical, geographic, and demographic characteristics. These categories are Class A, Class B, and Class C, representing different risk and return levels.
Below is a detailed description of the factors that differentiate these property classes:
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Class A:
Location in Prime Markets:
Class A multifamily properties are generally located in primary markets with strong economic fundamentals. These areas are near major employers, educational institutions, healthcare facilities, and cultural attractions, making them highly desirable residential locations.
Accessibility:
Class A properties often provide easy access to transportation networks, including highways and public transit systems, which enhances their appeal to tenants seeking convenient commutes and urban amenities.
Condition and Amenities:
Most Class A buildings are newly constructed with modern amenities and upscale finishes. However, older properties that have undergone extensive renovations to align with contemporary standards can also qualify as Class A, showcasing the importance of quality and maintenance in maintaining this designation.
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Class B:
Condition and Age:
Class B multifamily properties are typically older or have slightly less pristine conditions compared to Class A properties. Often times they are several years old and require maintenance or renovation work to maintain attractiveness.
Location:
These properties are typically located on the outskirts of primary markets, such as submarkets adjacent to downtown areas. While not situated in prime locations like Class A properties, they still offer proximity to urban amenities.
Maintenance Considerations:
Maintenance costs for Class B properties are typically higher than those for Class A properties. Investors should consider potential renovation needs, common area improvements, system replacements, and other upgrades in their financial projections.
Management:
Many Class B properties are managed by high-quality third-party management companies, ensuring efficient operation and tenant satisfaction despite the property’s slightly lower classification.
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Class C
Age and Condition:
Class C buildings are typically older, often exceeding 20 years in age, and show signs of significant wear and tear. They may require extensive renovation and suffer from visible deterioration, such as crumbling facades and neglected landscaping. Moreover, these properties often lack modern amenities due to their age.
Physical State:
Many Class C properties have poor physical condition, outdated appliances, wiring, plumbing, and structural issues due to lack of maintenance over the years. These deficiencies can affect livability and require significant investment to correct.
Location:
Class C properties are typically located in neighborhoods with lower income, less infrastructure, and amenities. Some even have higher crime rates compared to more desirable markets.
Pricing and Investment Considerations:
Class C properties are less expensive than Class B and Class A properties because of their location and condition. Investors should be prepared for significant upfront costs to overcome renovation, maintenance, and management challenges. These expenses include physical renovations, marketing efforts to attract tenants, and ongoing management tasks.
Non-Traditional Real Estate Asset Classes
Self-storage and mobile home parks have become popular real estate assets in recent years due to their lower risk profiles and diversification benefits.
Self-Storage
Self-storage is a complementary investment to multifamily real estate. Integrating modern building management systems, self-storage facilities offer a myriad of conveniences, including remote monitoring, keyless unit access, centralized lighting and temperature controls, and mobile app integration for seamless reservation and check-in/out processes. Additionally, operators leverage technology for efficient fee collection and leasing, making self-storage an appealing addition to your investment strategy alongside multifamily real estate.
Self-storage facilities offer a cost-effective way to store your belongings. Despite having lower per-unit rent than multifamily properties, these facilities can have hundreds of units on a small plot of land, resulting in an excellent lot size to revenue ratio. The units come in different sizes, climate-controlled and non-climate-controlled versions, with indoor or outdoor access, and with or without utilities. Additionally, self-storage facilities are located in various metro and suburban areas, providing diversification within this asset class itself.
Mobile Home Parks
Mobile home communities have had a negative reputation for many years. Buying a mobile home park used to be a challenge because the future sale was so uncertain. However, things have changed. Today, mobile home parks are a highly sought-after investment opportunity because they are the last affordable housing option available and with no zoning to build more. Another factor influencing the popularity of mobile home parks as a strategic investment is the tiny house trend, allowing residents to park their tiny homes in these communities. Lastly, the housing shortage in other parts of the country has also contributed to the legitimization of mobile home parks. With high-interest rates and a housing shortage, many people are looking for alternative places to live and call home.
The Takeaway
Developing a diversified real estate portfolio is a smart approach to minimize investment risk while maximizing earnings. You can reduce your exposure to market fluctuations and inflation by diversifying your portfolio across different assets, regions, property classes, and investment levels. At Viking Capital, we believe in the power of portfolio growth through diversification. We achieve this by investing in properties in diverse locations with strong economic growth potential and varying risk profiles and property classes.
Take a look at our latest investment opportunity, Villas at Sundance.
