One Apartment Building is Not Real Estate Diversification

real estate diversificationAt MHP Listings we preach the idea of real estate diversification. As a general idea, it’s a good idea to be diversified no matter what your asset of choice is: stocks, bonds, mutual funds (provide a modicum of built in diversification), gold, or currency. Most financial advisers will babble to you in mind-numbing detail about the proper ratio of stocks to bonds to cash. But what about when an investor wises up, sees the writing on the wall, and switches his investment strategy to real estate?

To put it more succinctly, how does one properly diversify real estate holdings? In the past, we’ve discussed the idea that, when focusing on single family residential (SFR) dwellings, it makes sense to buy in groups of three, with each far removed from the other geographically. That is to say that buying three income property houses in the Los Angeles area does not qualify as diversification, however, buying one each in Cleveland, OH, Phoenix, AZ, and St. Roberts, MO, is diversification. The trick is not to get overloaded in one area because, if the local economy goes in the toilet, your portfolio is going to get slammed hard, and nobody wants that.

The question then becomes does a single apartment building investment qualify as real estate diversification? Taken by itself, of course not! If that apartment building constitutes the sum of your property holdings, the rug could get yanked out from under you by (pick your favorite catastrophe):

  • economic slowdown
  • building or health code violation
  • neighborhood deterioration

Despite the fact that you may appear to be diversified by the fact that you own a multi-unit complex and don’t relay on a single tenant for cash flow, the unit itself is still a single entity and, as a whole, can fall subject to some of the forces we just mentioned. Does this mean that you shouldn’t invest in apartment buildings unless you can afford to buy three at once in different areas, a total outlay of cash that might run into several million dollars? For the beginning investor, we don’t suggest apartment investing at all. Get your feet wet in SFR’s first. For the mid-level investor, it’s not a necessity that you buy three apartment buildings at once, though we would suggest to maintain your investment diversity by a cross-sectional geographic/financial balance. For example, if you own eight SFR units around the country, which would add up to the approximate value of an apartment building you’re interested in, go for it and consider yourself adhering to our real estate diversification principles.

If you don’t have enough value in your other holdings to survive a blunder in your first apartment deal, maybe it would be better to wait a while.

The MHP Listings Team