How a Balanced Real Estate Portfolio Can Save You Millions!
Financial planners generally advise that we maintain a balanced portfolio of assets, spreading our risk over different types of investments.
- Maintain 3 to 6 months worth of liquid funds in a money market account in case of emergency.
- If you’re 40 or older, take a conservative approach and maintain a portfolio that is 25% real estate, 33% bonds, and 42% stock mutual funds.
- If you’re younger than 40, take a more aggressive approach because you have longer to live. Develop a portfolio that is 35% real estate, 17% bonds and other fixed-income vehicles, and 48% stock mutual funds.
- Maximize your 401(k), IRA, and SEP plans.
- Develop a focus with your financial planner and stick with the plan.
This is terrific advice. So why don’t most real estate investors apply the same philosophy of balance and diversification to the real estate portion of their holdings? If you own solely condos or all warehouse space, over the long-term you can get burnt.
I have clients who purchased real estate nationwide, particularly in Texas and New York, during the early 1980s. The market appreciated quickly, and their net worth was phenomenal.
Many of their purchases were leveraged, and when the real estate crash occurred in the late 80s, they lost millions of dollars.
However, the folks who had balanced portfolios, with rental agreements in place that guaranteed their overall debt repayment, rode out the crash and regained their high net worth during the following years.
What does balance and diversification mean to real estate investors?
Real estate is different than cash, bonds, or stocks in that it is real property – you can physically see the home or business or lot that you purchased. Intense emotions are often involved with real estate purchases for this reason, and investors struggle to diversify.
Individual investors lean towards buying property to flip, to renovate, to build new construction on, to rent out, to run a business with, or to take residency at.
Many investors specialize because of the different temperaments, pocketbooks, and skills that we have.
Specialization can be very useful, but consistent success depends on balance.
Here are a handful of principles that I encourage my clients to use:
- Escrow for roof and other unforeseen maintenance on all your properties along with at least 3 months worth of rent for every leveraged property you hold. Keep these funds in a liquid bank account, like a money market fund, set up for this purpose alone. Go ahead and factor these funds into every purchase, and your holdings will remain safe during catastrophes like hurricanes or soft rental markets.
- If you’re a real estate professional and have special knowledge of your market, take a more aggressive approach and maintain a portfolio that is 45% flipping and/or light renovation projects, 15% long-term residential or commercial rental properties and vacant land, and 40% condo conversions and/ or new construction.
- If you’re not a real estate professional, take a more conservative, long-term approach. Develop a portfolio that is 25% flipping and/or light renovation projects, 45% long-term residential or commercial rental properties and vacant land, and 30% condo conversions and/ or new construction.
- If you own five or more properties, purchase in different geographic regions, both urban and rural. This will make it easier to ride out economic trends over the long haul. However, be very savvy about rural purchases – these are best made in areas where the principles of supply and demand work in your favor. For example, mountain resort property that is surrounded by national forestry land has built-in appreciation.
- Discuss 1031 tax exchange advantages with an expert intermediary and maximize the tax savings available through your properties.
- Develop a focus with your business planner and stick with the plan.
The above percentages are of course general suggestions.
Your investment strategy could be wildly different if you are a carpenter or lay tile for a living.
If you have physical limitations, you won’t want any renovation work in your plan.
So utilize the principles of diversification, but customize these basics to best fit your particular situation.