Diversification, diversification, diversification. Anyone looking to reduce risk in their investment portfolio will hear this term repeated time and time again. Investors who are aiming to diversify do so by spreading their money across a variety of assets and asset classes with the expectation that these various investments will rise and fall at different times. This allows for higher overall blended returns over time as investments that are doing well balance out those that are not.
The Importance of Diversification in Real Estate
Real estate is well-known as a portfolio diversification option because it has had low historical correlation with the stock market. Modern Portfolio Theory, one of the core investment theories of the past 60 years, recommends an allocation of 10–20% of a portfolio to real estate for this reason.
Major institutional investors have long included real estate in their asset allocations. David Swensen, Chief Investment Officer at the famed Yale Endowment Fund, puts at least 15% of Yale’s investments toward real estate. Swensen has the best track record of any institutional investor over the past two decades. Mark J.P. Anson, the former Chief Investment Officer of the massive California Public Employees Retirement System, is quoted on financial advisor blog ThinkAdvisor saying, “Real estate is not an alternative to stocks and bonds — it is a fundamental asset class that should be included within every diversified portfolio.”
Diversification Within Diversification
There are more opportunities for individual investors to both access real estate opportunities and diversify their real estate holdings than ever before, largely thanks to new online platforms. In the past, investors generally had to choose between investing directly in a property or putting their money into a Real Estate Investment Trust (REIT). Direct investing requires a high level of management and knowledge, so many real estate investors were only able to put money into a single region or individual property. So if the market was affected by regional economic conditions — like the falling oil prices that hit Texas housing recently — local real estate investors were unable to balance out their holdings in unaffected geographic areas.
The only other option was to put money into a Real Estate Investment Trust (REIT). A REIT invests in income-producing properties and makes its shares available to purchase on the stock market. REITs offer up the diversification benefits and potential high returns of real estate investment but are professionally managed, removing the need for the intense personal involvement that direct investing requires. However, most REITs charge high management fees, offer low levels of transparency into the actual investments being made, and — since they are traded as stocks — are actually exposed to overall fluctuations in the stock market on a day to day basis.
Online real estate investing platforms allow investors to allocate the portion of their portfolio dedicated to real estate to numerous investments instead of one single property or a REIT. For example, LendingHome offers short-term loans to real estate professionals who are fixing up and flipping homes. It then divides up those loans into fractional notes, and individual investors are able to purchase a portion of each note for amounts starting as low as $5,000. This lets investors spread out their investment across different geographies and properties, making their real estate portfolios more resilient to local or property-specific risks and reducing the hassle associated with a direct real estate investment.
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