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Why You Should Diversify Your Portfolio in Times of Crisis

23 Aug
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Why You Should Diversify Your Portfolio in Times of Crisis

What The Pandemic Is Teaching Us About Diversified Investing

I’ve written before about real estate investors emailing or approaching me at conferences to question my position on the definition of a truly diversified real estate portfolio. Usually, they’re newer investors who haven’t seen the stock market or whatever type of investing it is that they focus on do what all types of investments do eventually—which is to fall.

Two conversations in particular stand out in memory—one with a 20-something kid who was investing with his father in hard money loans in Iowa and another with a 30-something investor who had built a portfolio of rental investment properties in Phoenix after the 2008 and 2009 global crisis, picking up deals that generated great rental returns.

A Portfolio Of Hard Money Loans

The kid from Iowa wondered why he should invest in anything other than what he was already investing in. He was making 12% a year from what he thought were low-risk investments. This was in 2005 when it was easy to make a good return from almost any kind of real estate investment anywhere. The father-and-son team were doing so well that they’d had T-shirts printed with their phone number so people could call for project funding.

The kid’s attitude reminded me of a quote I heard once from the CEO of a large company—”Good times build confidence. Bad times build character.”

This kid certainly had confidence… that crossed the line to arrogance. He had only seen good times and had no interest in even the suggestion of the idea that good times don’t last forever.

Indeed, very bad times were just a few years around the corner.

I understood his business model. I, too, had invested with a hard money lender who funded renovation projects in the same way as this father-and-son team. The lender I was invested with had the ability to foreclose on the properties he was funding, but, when the market fell through the floor in 2008, there were no buyers for half-finished projects. His investors, including me, didn’t get all their capital back. I lost a little on what amounted to a very tiny percentage of my overall portfolio.

I’m sure the father-and-son team lost, too… only they weren’t diversified into anything else.

A Portfolio Of Rental Properties

The guy from Phoenix had built a portfolio of cash-producing properties he was able to buy cheap after the 2008 and 2009 crash. Yields on his initial cash investment were great… so he continued to buy more properties of the same kind… and eventually started borrowing to be able to buy more properties of the same kind.

His portfolio was significant, but it was all in one market.

He had a system and he’d built infrastructure to manage his rentals. Diversifying in other markets would take time and create complications. He knew how to do what he was doing and what he was doing was working for him… so why spend the time and money to learn how to do something else?

The Global Crisis And Rental Investments

The guy had been investing for less than a decade, and it was a recovery decade following the last crash. Now he and many other landlords across the globe, but especially in the United States are facing the coronavirus crisis and the possibility—if not the likelihood—that their rental income will shrivel or disappear.

The working population that rents is one very likely to have lost their jobs in the current crisis. Those are the kinds of renters the guy in Phoenix had as tenants.

Indeed, rental properties globally of all description—those renting short term, those renting long term, and those renting to tourists—have struggled as a result of the pandemic. We’re just beginning to see the return of rental income in first-recovery markets like Panama and Belize.

The Global Crisis And Agriculture Investments

Agriculture investments haven’t been immune. Farmers in some countries haven’t been able to get enough migrant seasonal workers to harvest their produce when it needed to be harvested. Transportation infrastructure has slowed, from trucks to ships, meaning produce couldn’t get where it needed to be to find a buyer in time.

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

Surviving The Global Crisis

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 holds up better than one focused on a particular market or a certain type of property.

One colleague with short-term rentals in four different countries saw almost no income in three of those countries, but in the fourth, Colombia, his occupancy rates have gone through the roof thanks to local, in-country tourists.

The raw land I own in Panama, Belize, Nicaragua, and Canada doesn’t care about the virus. It lies there holding value. That said, I got an email last week from someone interested in buying one parcel of land I hold that isn’t even listed for sale. We’ll see if and how that proceeds.

Neither do the timber properties I own care about the virus. The trees continue to grow.

My office rental properties continue to generate rent despite the work-from-home requirement that started last year.

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 making it possible for you to manage everything yourself like the guy in Phoenix was doing. 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 is that you can’t prepare for every potential disaster or market shift.

The only protection is a broadly diversified portfolio generating an average return over time.

That’s a far smarter strategy than a narrow portfolio that generates above-average returns…

Until it doesn’t.

Lief Simon