How to build a diversified real estate investment portfolio


A recent study by National Real Estate Investor magazine indicates that nearly 60% of high net worth investors are expected to increase their allocation to investment real estate over the next 12 months. Millions of Americans are investing in alternative assets, including real estate. This is an important step towards diversifying a portfolio with investments that do not necessarily correspond to the stock or bond markets.

Once you decide to invest in real estate, the challenge is to create a diversified portfolio.

Buying a property and actively managing it yourself is one way to participate in the market, but it usually requires a substantial initial investment – often hundreds of thousands of dollars to pay all at once. One downside to this approach is that you put all of your eggs in one basket.

Owning and managing real estate yourself also means managing the three T’s: toilets, tenants and garbage. If you have the time and take care of whatever interests you, this might be the way to go. Alternatively, you can invest with others in a diverse basket of properties. Diversification is even more important now with the pandemic and the additional risk it creates as looming fears of further economic distress continue to raise concerns.

Here are five tips for creating a diversified real estate investment portfolio that has the potential to generate income and appreciation, as well as potentially withstand the shock of events, including recessionary downturns and, potentially, extraordinary events like the pandemic and future recessions or even depressions. Remember that diversification does not guarantee profits or protection against losses.

Tip # 1: Diversify by asset type

Investors should diversify their real estate portfolios by asset type to avoid the risk of over-concentration in a particular category of property, in the same way you would avoid over-concentration in a single security. Instead, invest capital in all types of assets, such as industrial buildings, multi-family dwellings, triple net rental retail, doctor’s offices and self-storage.

Tip 2: diversify by geography

Likewise, investors should diversify their real estate portfolios across geography to avoid the risk of excessive concentration in a particular local or regional market.

Tip # 3: Avoid High Risk Asset Types

There is risk in all real estate investments, but certain types of assets have been shown to be particularly risky and therefore best avoided by those looking to reduce downside potential. These include hotels and housing, residences for the elderly in all their forms and real estate used in the production of oil and gas.

The hospitality industry, for example, has been hit hard by all three recessions since 2000, including the 2001 recession, the 2008-2009 Great Recession, and the current COVID-19 recession. In all three cases, the industry standard measure of hotel performance (RevPAR, or revenue per available hotel room), fell sharply. More recently, Marriott posted its biggest loss on record for the June 2020 quarter, reported The Wall Street Journal in August.

Another sore point is the care of the elderly, which the pandemic has once again demonstrated. First, the population itself is often at risk, literally. Second, operators of facilities for the elderly, whether residential housing, long-term care facilities or retirement homes, are subject to all kinds of regulations that increase the risk associated with performance. operational property.

Finally, the properties of the oil and gas industry have proven to be as prone to volatility over the years as the industry they support. Think about it: an oil well may or may not produce as expected; thus, the underlying real estate asset is particularly vulnerable to speculative risk. Stay clear if you can!

Tip # 4: consider the range of investment options

Unless you want to actively manage your investment properties and embrace the Three T’s, passive real estate investing may be the way to go. There are a range of options to choose from, including Delaware Statutory Trusts (DST), Tenants-in-Common (TIC) properties, and private equity funds, such as Qualified Opportunity Zone funds.

A Delaware statutory trust is an entity used to hold title to investments, such as income-producing real estate. Most types of real estate can be held in a DST, including industrial, multi-family, office and retail properties. Often, properties are of similar institutional quality to those owned by an insurance company or pension fund, such as a 500-unit Class A multi-family apartment community or a 50,000 square foot industrial distribution facility subject to pressure. a 10 to 20 year lease with a Fortune 500 logistics and transport companies. The asset manager takes care of the property on a day-to-day basis and manages all investor reports and monthly distributions.

An ICT structure is another way to co-invest in real estate. With an TIC, you own a fraction of the interest in the property and receive a pro rata portion of the potential income and real estate appreciation. As an ICT investor, you will usually have the opportunity to vote on major property issues, such as signing a new lease, refinancing the mortgage, and selling the property.

Although ICT investments and DST have their nuances and differences, they often hold the same types of ownership. Although DST is generally considered to be the most passive investment vehicle, there are certain circumstances in which an TIC is desirable, including if investors wish to use cash refinancing after holding the TIC investment for a few years in order to to get some of their own funds, which can be invested in other assets.

Qualified opportunity zone funds, another option, offers benefits, including tax deferral and elimination, which many investors nationwide have used. A fund of this type may invest in real estate or businesses operating within an area of ​​opportunity, typically a geographic area of ​​the United States that has been so designated because it may be underserved or overlooked. As such, there may be a higher level of investment risk. In addition, the fund’s time horizon can be up to 10 years, which means locking up your capital for that time in an illiquid fund.

Tip # 5: Don’t Forget the Tax Benefits of Real Estate Investing

Real estate is arguably one of the most tax-efficient investment categories for U.S. investors. Capital cost allowances are available to all investors, and any loss from real estate investment may be deductible from other income, which could potentially lower your tax bill. Additionally, direct real estate investments – including Delaware statutory trusts and tenants in common – are eligible for a similar exchange treatment, also known as a 1031 exchange, which can save money for investors. investors around 40% on their tax bills when there are net gains. on real estate sales.

An example of a basket of diversified real estate investments

What might a diversified basket of real estate investments look like? Here is an example :

Mary Smith decides to invest $ 500,000 in commercial and multi-family real estate with potential for income and appreciation. She makes five investments, dividing her funds equally among these assets:

  • $ 100,000 in an industrial distribution facility with a long-term net lease to a company like Amazon, FedEx, or Frito Lay
  • $ 100,000 in a medical dialysis center with a long-term net lease to a company, such as Fresenius or DaVita
  • $ 100,000 in a multi-family apartment community with 300 units in the South East
  • $ 100,000 at a self-storage facility in the Midwest
  • $ 100,000 in a debt free multifamily property with 50 units in Texas

Net-net, Ms. Smith has diversified her portfolio both by asset type and geographic area. She avoided more cyclical and highly volatile asset classes, including senior housing and long-term care, hotels, and oil and gas. She made passive investments, leaving the day-to-day management of properties to professionals in the sector. And she consulted her accountant and attorney on the tax benefits of real estate investing, including 1,031 trades.

She is well positioned for the uncertain future and realizes that all real estate investments involve risk, and income and appreciation are never guaranteed. Even diversification, while desirable, does not guarantee profit or protect against loss, but it can potentially reduce risk and create various potential income streams and opportunities for appreciation.

Founder and CEO, Kay Properties and Investments, LLC

Dwight Kay is the Founder and CEO of Kay Properties and Investments LLC. Kay Properties is a 1031 national exchange investment company. Www.kpi1031.com platform provides market access to 1031 exchange properties, 1031 custom exchange properties only available to Kay clients, independent advice on sponsor companies, due diligence and verification of each 1031 exchange offer (typically 20 to 40 offers) and a secondary market of 1031.

https://brokercheck.finra.org/firm/summary/124658


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