Diversification is the act of allocating capital in different types of investments to reduce risks. It is a risk management strategy that helps investors prevent losses.
In real estate financing, diversification can take several forms. An investor can decide to diversify their portfolio of real estate holdings by location, type or class. Diversifying in this way is usually a smart move because this strategy spreads the risks associated with investments. Therefore, if market forces or government policy affect one of the assets, gains can still be recorded from the remaining assets.
By spreading your assets into different places, types or classes, you can protect your real estate investments from unpleasant or unforeseen events. While diversification could require some time and effort, it’s usually worth it in the end.
Owning property in different locations is a diversification strategy that protects an investor from any unforeseen circumstances in one geographical are. While natural disasters, war and real estate market crises happen, they are unlikely to happen in every place at once.
Geographical diversification can also protect against economic problems or political conflicts that may affect the investor’s assets in a particular country.
With geographical diversification, commercial real estate investors protect themselves from the risks associated with having all their property in one place.
Diversification By Type
Diversification by type is when an investor diversifies their assets by the type of property. For example, an investor might decide to own a condo, an office block, a ranch and a hospitality outfit (e.g., a hotel).
The same principle of risk reduction applies. By owning different types of property, the investor can easily adjust to changes in demand or supply across different property types.
Diversification By Class
Sometimes, an investor might decide to diversify their holdings according to class. In this case, they would own different classes of property ranging from premium “core” properties to distressed properties that need major repairs. Different classes of property have different risk-reward prospects, and an investor might decide to spread their investments across classes.
Diversification Helps Protect Your Assets
Diversification can be challenging when an investor is just starting out and has limited funds. It can also be time-consuming monitoring and maintaining assets across different time zones and ranges. However, the benefits of diversification usually outweigh any drawbacks. Every savvy real estate investor will endeavor to diversify their holdings.