Investment Specialist, Team Denver Homes – RE/MAX Professionals.
There are two main schools of thought when it comes to real estate investment: diversification and specialization.
Investors who diversify don’t want to put all their eggs in one basket. They try to balance risk and reward by spreading out their investments across multiple property types or locations. Investors who specialize, on the other hand, focus on buying the same property type repeatedly. They attempt to replicate what is successful, without spreading themselves too thin.
Which is the best approach for you? Should you diversify or specialize your real estate portfolio? There isn’t a simple, one-size-fits-all answer. As you build your real estate portfolio, you have to weigh the advantages and disadvantages to determine which plan is the best fit for your personal investment goals. I work with both types of real estate investors, and I’ve seen many success stories on each side.
Let’s take a look at some of the most important questions to ask and factors to consider before you decide which direction is right for you.
Start by reflecting on the following questions;
• What is your biggest investment goal—appreciation or income? Are you hoping to invest in a property that will appreciate over many years and result in a large profit when you sell? If so, you may want to diversify for long-term gains. Are you more interested in generating consistent ongoing income? Specialization might be a better option because it allows you to more accurately estimate your future income. If you decide to diversity, you need to have a clear reason why.
• Do you have real estate investment experience? If you’re new to real estate, you should specialize until you are comfortable with one model and consistently repeating successes. If you have solid real estate experience, you may be ready for the challenge of managing different types of properties.
• What market do you want to invest in? It makes more sense to diversify in an urban market. In a suburban area, it’s more difficult to invest in multiple property types, such as single-family homes, multi-unit properties and condos, that will all generate steady income.
• How established is the area you want to invest in? Up-and-coming areas often offer good opportunities for diversification, as you can experiment with property types to gauge interest before specializing.
Pros And Cons Of Specialization
The main benefit of specialization is that once you find a strategy that works, you can simply keep doing the same thing over and over. If you buy a condo in a downtown neighborhood and it generates good rental income for you, it’s a safe bet that a similar property in the same area will be just as profitable.
You can double down on your previous successes, building efficient systems to manage comparable condos and taking advantage of economies of scale. If you choose to work with a property management company, you will also find it much easier when you own one property type in one geographic area, rather than multiple property types in multiple locations.
One drawback with specialization is that it leaves you more vulnerable to changes in the market. If you only own short-term vacation rentals during a time when few people are traveling, for instance, you will have to deal with financial losses and weather the storm until the market recovers.
If you are interested in specializing, decide what property type and location you want to focus on, and go all in on both. Once you have one property that is generating income, try to mirror it as closely as possible. If you are renting a townhouse to students in Boulder, look for another townhouse in the same neighborhood that would appeal to the same audience. Don’t buy a townhouse in Denver and assume you’ll have the same results. Stick with your exact location and property type while you build your specialized portfolio.
Pros And Cons Of Diversification
When you diversify your portfolio, by property type or location, you have access to more investment options and opportunities for monetary gain. But you also need to be able to deal with more complexity and hands-on management.
The biggest advantage of diversification is that you can create a portfolio that is geared toward both long-term appreciation and monthly income. For example, single-family homes generally have higher appreciation rates but generate less income than multi-unit properties. So you could acquire several multi-unit properties with a good cash-on-cash return and use that income to invest in single-family homes that will increase significantly in value by the time you sell them.
I diversify my own portfolio, which consists of a multi-unit property, two single-family homes, two condos and a commercial building, which gives me a good balance of income and appreciation. But I am also a realtor with years of experience in my industry and market. I only recommend diversification to experienced real estate investors who understand the work it entails.
If you are ready to diversify, make your next property the opposite of what you already have in terms of appreciation or income. If you own multiple properties that are income-only, choose one that will appreciate more over time. Spend less than your budget allows on your first diversified property. You’re trying something new, so accept that you will likely make mistakes as you learn. Depending on your risk tolerance, consider diversifying both property type and location, expanding into a new neighborhood or city.
You can build a lucrative real estate portfolio whether you decide to specialize or diversify. The most important step is figuring out what your investment goals are so you can pick the path that will best support them.
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