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Why You Should Diversify Your Portfolio in Times of Crisis

03 Sep
Diversify your portfolio

Why You Should Diversify Your Portfolio in Times of Crisis

A Diversified Portfolio Will Fare Best In Times Of Crisis

I’ve written before about real estate investors writing in or coming up to me at conferences questioning my position on diversification of one’s real estate portfolio. Usually, they’re newer investors who haven’t seen the market or type of investment they focus on… fall.

Two that I will always remember are the 20-something kid who invested with his father in hard money loans in Iowa and the 30-something investor who had only invested in rental properties in Phoenix after the 2008 and 2009 global crisis, picking up deals that generated great rental returns.

The kid from Iowa was curious of why he should invest in anything else than what he was doing already, as he was making 12% a year in what he thought was low-risk investments. This was in 2005 when real estate everywhere was doing gangbusters. The father-and-son team were doing so well that they had T-shirts made with their phone number on them for people to call for project funding.

I heard a recent quote from a CEO of a large company that fits this kid’s attitude. “Good times builds confidence. Bad times builds character.”

This kid certainly had confidence… well, really arrogance. He had only seen good times and had no idea what was coming in a few years.

I understood his business model. I was invested with a hard money lender who funded renovation projects in the same way as this father-and-son team. It was a good model, until a global market phenomenon hit like it did in 2008. The lender I was invested in had the ability to foreclose on the project properties, but when the market fell through the floor, there were no buyers to sell half-finished properties to. His investors didn’t get all their capital back. I’m sure the same thing happened to this kid and his father… and they weren’t diversified into anything else.

The guy from Phoenix was making good money ever since he bought for cash cheap properties after the 2008 and 2009 crash. His rental yields on his initial cash investment were great. He continued to buy more properties and eventually started taking out loans to buy more. His portfolio was significant, but everything was in one market.

The Global Crisis

He was doing well, and while open to the idea of diversifying, he questioned whether it was worth his time when he had a system and infrastructure in place for buying and managing his properties. Investing in other markets would take more time and be more complicated than doing what he was already doing. He had only been investing for less than a decade, and it was a recovery decade from the last crash. Now he and many other landlords across the globe, but especially in the U.S., are facing the coronavirus crisis and the possibility—if not the likelihood—that their rental income is going to disappear even if they have tenants.

The working population that rents is the one that is likely to lose their jobs first, unless they are essential workers like nurses and garbage removal workers. Those are the renters the guy in Phoenix has.

Of course, with a global crisis like the one we’re facing, even a diversified portfolio will take a broad hit. Rental income from short-term rental properties has come to a screeching halt. Long-term rentals in many markets face the same potential loss of income if tenants can’t work.

Agriculture properties should fare better but aren’t immune. Farmers in some countries can’t get enough migrant seasonal workers right now. Transportation infrastructure is slowed… from trucks to ships… due to the coronavirus lockdowns around the world.

Food consumption patterns have changed with restaurants and hotels closed. Wholesalers are having to shift their distribution models.

Still, even with a global crisis like the one the world is facing with this virus, where every market is affected one way or another, a diversified real estate portfolio will hold up better than one focused on a particular market or a certain type of property.

My pieces of raw land don’t care about the virus. They sit there holding value even though I couldn’t easily sell any of them right now. That said, I got an email last week from someone interested in buying one property that isn’t even listed for sale. We’ll see if and how that proceeds.

The timber properties I own don’t care about the virus. The trees continue to grow.

My office rental properties continue to generate rent, but my short-term rental properties don’t.

Only you can determine what your real estate portfolio should look like. Yes, it’s easier to focus on one market, especially if it’s where you’re living so you can manage everything yourself like the guy in Phoenix. But easy doesn’t equal low risk.

Chasing higher returns because they are right in front of you doesn’t mean you shouldn’t own other investments, even if the returns are a bit lower. That’s something the kid from Iowa learned a few years after I met him.

One thing this coronavirus crisis has reminded us all about is that you can’t prepare for every potential disaster or market shift… and you don’t know when something or what could affect your investments. So it’s best to have a broad portfolio where the average return is less volatile over time than a narrow portfolio that generates above average returns… until it doesn’t.

Lief Simon