How to Diversify Your Portfolio With Real Estate This Year
How to Diversify Your Portfolio With Real Estate This Year
Real estate abounds with diverse opportunities to expand your investment. It’s a stable and valuable addition to your investment portfolio. The stability of real estate investments helps you create a tangible balance when compared to other assets like stocks and cryptocurrency which are more volatile. As an investor, a strategic approach to diversification will help you maximize opportunities in the real estate market.
What Is Diversification?
Diversification is the process of managing risks by allocating capital, funds or resources to various investments. A diversified portfolio includes a mix of assets and investments from various industries, companies and markets. The aim of diversification is to maximize returns for each level of risk and to cushion the impact of losses that could come from a single investment. Diversification helps you achieve a portfolio that is more stable and consistent.
Why is Diversification important?
Diversification is a need for every investor because of the uncertainty that clouds various investment markets. Most times, one has to make investment decisions based on observations and speculations. Because an “all things being equal” situation is hardly achievable, it is only prudent to consider how the resources available should be spread across diverse assets, sectors, industries and markets. Also, because financial markets and assets differ in their level of exposure to risks, diversifying your investment portfolio is an avenue to spread the effects of these risks in the event of a market shock.
How Does Real Estate Give You A Strong Portfolio?
To get it right with diversification, there are a few important factors that must be considered. A strong diversification strategy maximizes the risk-adjusted returns of your portfolio. This means that it fully considers your risk tolerance level and seeks to optimize your combination of assets for the best returns. Investing in assets that have little or no correlation is the best way to ensure that you have to deal with less volatility in your investment.
Highly correlated investments are exposed to the same risks. Therefore, what happens to one affects the other. If one investment incurs a loss, there is a high probability that a correlated investment will suffer the same loss. On the other hand, in a portfolio that is diversified across assets that are uncorrelated, there is a cushioning effect whereby some assets will make up for the loss incurred on another asset. You can be certain that they would not be rising or falling at the same time.
Smart Diversification: The Real Estate Market is Uncorrelated
Choosing the right diversification strategies will help you get strong returns on your investments. Truly, there is no investment without exposure to risk. However, while most investors understand the risks associated with investing in a single industry, stock or asset type; they are yet to identify the risk that follows investing in a single market. Most investors are familiar with investing in multiple assets within the same sectors or industries within the stock market which. This market has become more consolidated and highly correlated. Therefore, diversifying into a different market has become necessary.
The real estate market has a low-performance correlation with the stock market. This makes it a welcome addition to your diversification strategy. With real estate, you can be sure to have strong returns on your investments. Although a level of volatility stills exists here, the real estate market is marked by high-value assets which are constantly appreciating. It’s a more stable environment and has a predictable future value determinant. Real estate investment also provides a more regular income stream for those who do not hesitate to maximize its benefits.
Access to Liquidity
The real estate market has a low level of liquidity. This means that assets cannot be bought and sold in the same manner as the public market investments like stocks and bonds. While the public market promises a high level of accessibility, the liquidity premium is a price to consider for investors who are more oriented toward long-term returns. This does not favour them. With the real estate assets which are illiquid, investors can access high returns on investments in the long run either through income (rental, lease etc) or value appreciation.
Market Structure Diversity
Real estate is publicly traded through REITs and mutual funds. This is significantly different from the private real estate market which can take various forms and structures. Depending on which markets they are traded, REITs have diverse structures pertaining to risks, fees, return systems and potential. These differences present a strong potential for portfolio diversification. So, with real estate investment, you have access to publicly-traded REITs or the various private real estate offers.
4 Ways to Diversify Your Portfolio With Real Estate Investments
There are various opportunities for diversifying into real estate. Of course, this is dependent on the availability of funds and a commitment to getting the best from your investment portfolio.
1. Active Investing
As an investor, you can maximized active real estate investing which gives you access to valuable returns. Investing in properties helps you gain returns through rental income. This is a steady flow of income that helps you realize the capital invested and the profits from rental repayments. You can also sell these properties at an appreciated value in the future. Although it requires large initial capital requirements, you can take advantage of the mortgage payment which will be realised upon the lifetime of the property investment.
House-flipping is another way to enjoy active real estate investing. Although it comes with higher risks and liabilities, it takes a shorter time period to get your returns on capital invested.
2. Passive investing
Passive real estate investing lets investors participate through professionals in the real estate market. Passive investments offer a vast portfolio of real estate opportunities and give more liberty for diversification. These investments are more flexible and also allow investors to earn loan interest repayments through debt investments with private real estate projects or companies.
3. Private Equity Funds
A private Equity fund adopts a model which allows investors to make investments through a pool of money. The investors assign an individual or group management to handle the fund operations.
Only institutional and accredited investors with high net worths have the permission to initiate private equity funds because of the high investment minimums that are required. Usually, these minimums are not less than $100,000 but they vary depending on the group and the asset class in view.
It is important to understand the impact of equity funds on your portfolio because each structure offers a different diversification potential. This is because the investment capacity of private equity funds is not the same.
4. Real Estate Investment Trusts (REITS)
REITs, or real estate investment trusts, are organizations that own or finance income-generating real estate in a variety of property sectors. As stated earlier, real estate can be publicly traded through these organizations. We also have private REITS which provide a vast real estate investment portfolio.
Like private equity funds, private REITs have high minimums and are limited to accredited investors. Legally, A REIT must earn up to 75% of its gross income through real estate and invest assets up to 75% in real estate. It is also mandatory that it disburses 90% of its taxable income to its shareholders each year.
It is important to have the necessary real estate and financial knowledge before investing here. Individual REITS have varying structures. However, a typical REIT structure requires high fees in form of formation fees, ongoing management fees and sometimes, carried interest fees.
Conclusion
As an investor, you get to choose which assets are the best fit for your portfolio. You should understand that a solid portfolio helps you manage risks. Diversifying within a single market is great, but there is better potential when you diversify into a different and more stable market. Real estate investment offers the right balance. Opportunities abound within the commercial and residential space. Taking a strategic approach to various real estate offers will help you create a portfolio that has both immediate and long-term benefits.
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