Diversifying Commercial Real Estate Investments
admin / October 22, 2020
How and Why Should I Diversify My Commercial Real Estate Investments?
Diversification is an investment strategy that owes its underpinnings to the adage, “Don’t put all of your eggs in just one basket.” It’s a strategy that spreads investments across different types of asset classes to manage risk. Commercial real estate portfolios can be diversified by adding different properties and asset classes. But, what is the benefit of doing this?
What is Portfolio Diversification and Why Is It Important?
Portfolio diversification means that you invest across assets or asset classes that vary in risk and reward. Diversifying your portfolio is a great way to reduce your reliance on one asset class. If all of your resources are tied up in one single investment, the consequences can be catastrophic. A diverse portfolio has legs in different asset classes or property types, thereby building a stronger shield against market forces and future uncertainties.
Your commercial real estate portfolio is no exception and can benefit from this by adding different types of properties and asset classes, such as multi-family housing or apartments, industrial and retail spaces, and office buildings. All of these property types have their own risks and rewards. By having different property types in your investment portfolio, the detriment of a poorly performing investment could be met by another that’s performing well.
As the Modern Portfolio Theory (MPT) suggests, an individual investment’s risk and return should not be viewed singularly. It should be assessed according to the investment’s impact on the entire portfolio’s risk and return. We can see that when an investor diversifies away from individual investment risk, they can elevate their risk and thus earn higher returns. To simplify, lowering the risk profile may increase ROI.
How to Diversify Your CRE Portfolio
Diversifying your commercial real estate investments involves acquiring different property types. Within retail, investment opportunities include strip malls, shopping centers, or malls. Tenants are typically big box stores or smaller local tenants.
Industrial properties include warehouses, distribution centers, and manufacturing plants. These properties come with the added benefit that they tend to come with long-term leases, typically around ten years, which offers a high degree of stability. However, in today’s market, it could be riskier as rents can fall behind, and is the first property type to take the brunt of an economic downturn.
Office properties include towering skyscrapers to small business buildings, with just a tenant or two. These properties are distinguished as either A, B, or C. Properties that receive the A designation are new constructions of the highest quality with the newest amenities. Class B properties are still slightly updated, albeit older in age. And lastly, Class C properties are buildings that are older with significantly dated technology.
Geographic Portfolio Diversification
In addition to diversifying property types, consider choosing various locations for your investments to bolster the spread of the risk. A commercial real estate property portfolio should primarily incorporate investments that fall in three large classifications: core properties, core-plus, and value-added.
Core properties are those of the highest quality and with the most demand. Simply put, these are desired properties in coveted locations at premium rents. Core properties bring in stable and strong cash flow and frequently under the ownership of wealthy institutional investors.
Core-plus properties are just a margin below the best-of-the-best. The building may have aged or be outdated, or it may be in an undesirable location. They typically have short-term leases, which makes them more vulnerable to the forces of an economic downturn.
Value-added properties have problems that require renovations or repairs. Usually, new investors see value-added properties as opportunities. These properties can earn a more substantial return than possible within other classifications, though they typically require larger upfront investments for renovations.
How Can Laverty Chacón Assist You?
A well-diversified CRE portfolio will protect an investor from overexposure to a specific property type when economic and demographic cycles change. Laverty Chacón has 30 years of experience assisting commercial real estate investors with their investments and expanding their commercial real estate portfolio. If you are looking for trusted assistance in diversifying your portfolio, you can reach the Laverty Chacón team by calling 916-722-0333.
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