Why Diversifying In Real Estate Still Matters

Billionaire Warren Buffett famously stated, "You know, we think diversification is—as practiced generally—makes very little sense for anyone that knows what they're doing...it is a protection against ignorance."

With that backdrop, we'll discuss why diversification is still a good idea, at least in real estate. We cover many asset classes - residential, commercial, industrial, hospitality, and specialty - offering insights on managing risk and maximizing returns. 

We also touch on unique investment strategies like joint ventures and delve into the potential impacts of natural disasters on your experiences. 

In this episode, we explore why companies and investors are making a beeline for regions like Dallas, Phoenix, and how you, too, can benefit from a region's unique mix of politics and favorable regulations. 

Understand why factors like population growth, demographics, and liquidity should be on your radar while investing in a region. And it doesn't stop there! 

Investors achieve diversification by betting on different asset classes, such as multifamily, self-storage, and industrial. 

Whether you're a seasoned investor or just dipping your toes in, this episode will equip you with invaluable insights to chart your course in the dynamic landscape of real estate investing.

Live free. Get Educated. Master Your Money.
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Transcript

Speaker 1: 0:03

Hey, hey everyone. Welcome to the Investing Stuff you should know podcast, where we bring you expert insights into the world of investing and beyond. My name is Johnny Nelson and today guess what? I am the host and I am the guest. This is a little bit of a new format for me. I'll be doing this occasionally just to share some insights of what we have going on in the fun space in our own properties. So it's just high time that we shared some of that knowledge that myself, my team, are doing and experiencing ourselves. So it's going to be fun. It's going to be fun.

Speaker 1: 0:38

Today we're going to be talking about diversification, and that's a fancy word that a lot of us talk about, but what does it mean in terms of the real estate, the real estate space? So we know we're going to get again. We're just going to jump right into this and deliver the value and see where this goes. So we know that we can diversify by asset class and that's a very fancy word just different property types. So what are a few out there that we can discuss and talk about?

Speaker 1: 1:05

Well, we have residential single family home. Most of us live in a home, or many do, many, many rent. We have commercial space, like office spaces, retail outlets and warehouses. We have industrial. We maybe, if you drive out to the edge of your city, perhaps you've seen if you're in a larger area massive block after block or field after field of industrial space being developed. Those are from reshoring, warehousing, just sustaining America. There was kind of a gap, kind of over COVID. There's been a kind of delay in development that really got a lot of investor capital. Hospitality there's another asset class or another kind of building hotels, motels, resorts that those can be an investable asset. And then we have specialty. Specialty could include student housing all the way up to even senior living community. So all these are, they're all real estate, but they have their own unique challenges, their own unique upsides. And every real estate asset class there's a business within a business. I mean it just I saw this online the other day. Essentially it's basically it's a business disguises the building. I just love the way that's phrased. So within, of course, we talked about the different asset classes.

Speaker 1: 2:23

Now let's talk about another way of diversifying. So the whole podcast will focus on what does diversification mean and how can you diversify as a portfolio manager or as a fund manager or maybe a syndicator. There's pros and cons to either side. Some people really really get to know their market. I know operators that just focus in North Carolina or Houston, Texas or Phoenix, arizona, and they leverage that, their intimate knowledge. They maybe they grew up there or they move there and they really know the area. They like the market, they know all the players, they know the contractors, all those things that it gives them an edge from that perspective.

Speaker 1: 3:05

However, there's a downside to that as well, and you have. If there's a an economic downturn, that especially impacts that region. Hopefully the region has a diversification of jobs and, come an economic perspective. Hopefully there's some finance and then maybe there's some manufacturing and there's some hospitality where people want to visit there. So if you have a diverse range of economic activities there, that can help soften the blow. If there's a dip, let's just say, in the financial market, like there is right now, with financing, interest rates being high, so there's going to put the pressure on the financial market. So that's like that.

Speaker 1: 3:44

That's geographical diversification, if you would. So that's maybe I just like I said, maybe I just focus in Phoenix and maybe there was concerns about water supply, but then also it's an amazing market. There's a lot of people moving there, a lot of growth, a lot of it's a very business friendly state, business friendly city. And then there's you could have regional diversification. So that's like local diversification, regional diversification and even, you know, we get I don't know too fancy here, but even international diversification. So if you're a large, large player, maybe you invest some in motels in Hong Kong, hotels in LA, and then maybe even go into Europe as well. So that's like the very broad scale, the scale that I and a lot of my associates play out.

Speaker 1: 4:30

It's focused in the US and it typically it's within an asset class and you know, oftentimes we'll focus within, you know again, one market or there could be multiple markets. You know, maybe you know let's go with Reno, nevada, boise, idaho and Portland. You know, maybe it's kind of a Northwest US type of play or maybe even into Montana. So that can be another way to hedge or to make sure that you're not gonna be too subject to sort of geographical impacts. Let's pick a natural disaster. Let's just say we're invested in Denver and or the Denver area, the Colorado area. There's wildfires. We know that there was some massive wildfires in the region, in the area I forget the city right now, but we know those in fires caused a million dollars of damage. Clearly, subject you know nature has a say in markets, so we can't ignore that. And if we're just invested in Denver or the Denver region, perhaps we're overly exposed to, you know, fire risk, so, but we also know that there's beautiful, beautiful country. Course, clearly, you know plenty of areas were not impacted by the fire, but it's something to consider in from a geographical perspective.

Speaker 1: 5:43

Here we have another area of diversification and that's how are we gonna basically buy into or be part of these assets? You know, how can we? I'm not just gonna show up and, you know, slap down a hundred, I know like a thousand dollars, something like that. I have to go into it with the vehicle. I have to be part of the operating team, which could be a joint venture or JV for short. It could be a fund. I operate a real estate, a 506C fund. That's for accredited investors only. There's other kinds of funds that can take accredited and non-accredited investors. There's a definition for accredited. We're not gonna talk about that today, but just to know that that's also very real and that can also be very handy. There's benefits to going with accredited, non-accredited. Again. That's something else we have again within the idea of diversification of investment vehicle.

Speaker 1: 6:37

We have REITs, real estate investment trusts. These are more or less operated as stocks but they have to distribute. There's other upsides and downsides. They're very liquid but also they have to distribute. I think it's 90% of their revenue or their income every year. So it's really not a long-term play. You're not really part of the. You don't really get the upside of the equity play, of the equity build, as if you went into the deal as an LP, limited partner or as a JV. So there's downsides to that. But they're very liquid. You can come in and out like a stock. And then of course you just have direct ownership. Hey, a lot of us own a house and that's also a way to purchase real estate. So again, just kind of a high level of their diversification of an investment vehicle. You could have direct ownership, real estate, investment trust, real estate funds or joint ventures and there's other ones beyond that where we're just kind of touching the high level.

Speaker 1: 7:35

So what is kind of the guidelines for it? Do we just does one just like come up with some stuff and like I heard that diversification is good and we should do more of that. Well, that sounds rather non-informed. There's certainly some guidelines too that we consider and why we would want to diversify, and the guidelines for what kind of diversification. We don't want to just do it for its sake, because we heard someone say on TV that you should do that.

Speaker 1: 8:06

But some of the things we consider is risk management. Understand, we want to understand the risk profile of each asset. For instance, core assets and prime locations might be less risky than opportunistic investments in emerging markets. We want to do market research, basically continually. So that's something else we can, you know, want to continuously understand where our market is and if there is softening or weakening, or well, that's actually too negative or growth, let's go with the positive side. We want to be able to get ahead of that. Maybe we see an opportunity or an area that's about to receive some major investment at a state or federal level or regionally, and we want to be a part of that. Maybe they're going to put some manufacturing in the Southeast and we are anticipating a car manufacturing plant or, you know, all the data center going somewhere. We want to be getting in on that area if possible.

Speaker 1: 9:02

We have liquidity considerations. That's something else that many people maybe don't think about a lot Are we going to need that capital sooner than later, or what is our time horizon that we might want to consider that getting access? So if you need short, you know your capital rather quickly, or you don't really want to commit a long time, perhaps you know we could step outside the real estate space and say, hey, maybe a stock is better for you, or a, you know, a shorter term bond or, like we just talked about, perhaps a REIT is a good option. So that's where we have liquidity. But that's also the upside of the longer hold where you lock their money in as an investor, whether it's, you know, like you don't just like buy and sell. You could, but typically it's.

Speaker 1: 9:43

The transactional costs are high. You don't buy a personal residence and sell it within a year. You don't buy a large, you know commercial property as a JV and typically flip it in a year. Nor, if you come in as in a fund or a syndication, are you in and out in a year. These things are typically not exclusively, but typically a three to five year horizon and you're oftentimes not necessarily in control of either a joint agreement with your partners or, if you're a limited partner, you are basically forgo the right to make those decisions, trust the GP or the general partners, the lead team, and say, yes, you guys are are. Have your best, everyone's best interest in mind to make those decisions when to sell. When to sell is dependent on a lot of things, but I guess we'll set that aside for another time.

Speaker 1: 10:32

So, again circling back to what are we talking about here the guidelines for the kinds of diversification that we might want to consider. Again, that's risk management, market research, liquidity considerations and then, of course, just general, just kind of knowledge of what the market is doing. There's a lot of factors that complain to this and the seasoned, the old, wise owls out there that have been doing this a long time can, they will and can, and have a list of criteria that they use themselves to not get caught with not having considered these things in their own portfolio. So I just want to share my own approach of late, as my fund grows and again I started out the conversation with so we are in the Phoenix market. I mentioned the Phoenix market. I think the Phoenix market is tremendously strong.

Speaker 1: 11:28

We can see from a geopolitical perspective. Here is my own, some of my own analysis. I'm not going to go through the full thing, but just some of the considerations that I consider that I bring. We see, obviously, just like the growth of the region very, very robust as far as people moving there, homes being built, multifamily being built, manufacturing, and something that's been exciting but less, I mean, it's also kind of concerning at a geopolitical level.

Speaker 1: 11:55

Let's talk about China and like whoa, what are we talking about China for? So at the world stage, there's been a lot of tension between the US and China and within the part of that crossfire, if you would, that diplomatic and political crossfire that tension is the manufacturing of silicon chips. It's a huge industry across the world and some of the best ships are made in Taiwan. And, of course, we know that Taiwan has been disputed the territory with China for a long time. The US sees it as a real risk to our national security, so they have been investing or pushing investments and allowing federal money to be available to manufacturers. Some of them are Taiwanese based, like TSMC is a giant Taiwanese semiconductor manufacturing corporation. They are actually building some massive plants or additional plants in the Phoenix region and the Intel is there, obviously. They make chips and they have been for a long time. But there's other companies are also investing in the region.

Speaker 1: 12:57

So we see that kind of focus and growth in money being invested in a region. You know there's going to be a long term stability, relatively long term, you know, five to 10 years to ability, at least in a region. And how can we be, how can, as investors, we partake of that, that federal money, the technical talent that's going to come with that, and it's certainly these, these, these the commitments that they're making these companies in the government are not like commitments. We're not talking like a tent town, talking like multiple hundred billion dollar plants. These things are massive, highly specialized, highly technical, and they will. The people that are making these investments are committed for a very long term. So if you can be part of that wave, then that's something out, that's something you definitely want to consider in your investment strategy. And there's other areas of the country that seem you know other, like manufacturing automobiles or electric vehicles that these things are happening as well. So I'm not saying this is the only way, but it's simply a big consideration. So that's one of all the different things we've talked about. You know, asset class, liquidity, population growth, demographics this is just like an additional thing that I consider myself.

Speaker 1: 14:07

Another area that we've invested in is the Dallas region. Dallas is a giant, a giant area growing. There's many, many reasons why. You know why the Texas market more broadly, but then also the Dallas market, is very, very robust. Nearly 400 people move there every day. That's just astonishing and those mainly that growth has been coming from California, and mainly from California, but also some people from the East Coast as well. Florida gets more of the New York people, but a lot of people are moving down there. My family myself and my family are considered to moving or actually will be moving down there ourselves in a very short timeframe. So you know we have, if you just wanna like, take a few metrics all of our tuna businesses have relocated down there.

Speaker 1: 15:00

The giant caterpillar, you know, heavy equipment manufacturer caterpillar was in Chicago. This is, I think. I think this happened last year and then they relocated to Dallas and we've had other large, large corporations uproot from their long-term area that they have worked on or been part of and move to Dallas because it's a fairly business-friendly area. However, there's a kind of a mix in there which is attractive to some people where but oftentimes now we're gonna talk politics for just a bit here. Basically you have the state being red, more or less Republican, very business-friendly, but then also you have the city. Some of at least the city core is being more aligned with Democrats, more blue, but then they provide a lot of services that people enjoy they like. So how could you kind of get the best of both of those worlds? You have a red state with like big blue dots in there.

Speaker 1: 15:57

These companies from around the country have seen that Like, hey, this is incredible, we can be part of the rather you know the tax benefits and the less strict labor regulations and some other things, but go to these giant cities or these large cities where people wanna live. So they have seen that advantage and, like I said, many, many companies have moved there. Why are we talking about companies? Because companies bring jobs people wanna be part of, want good jobs, they wanna be on the economic upswing and when they have jobs then they can pay for housing, they can pay for good housing and again, tying this back to investors again, we go through all those other things. But this is kind of like the foundation. We need people. We need people that are getting employed, people that have good job prospects and they wanna live in an area. So all those things kind of taken together and there's others, but that's just kind of give you a sample of some of the things that I look at when we invest in a region or in an area, whether it's a development which we're working on, whether within the fund or other elements of investing as well.

Speaker 1: 17:01

Yeah, so I think that's probably a good wrap for this conversation about diversification and I encourage you to consider, if you're maybe a limited partner, maybe a passive investor, to consider that within your own portfolio, are you part of a team that believes in that as well? Are they diversified in area, in region, in asset class, and also, maybe, if you are savvy, you can spread your own money around the country where you have maybe an opportunity to invest with a few sponsors, a few areas, and if you are for the motorboat or the boulder, you could even go into maybe a few alternative asset classes. You could be in multifamily, self-sourced and maybe industrial, and they're again kind of tying back to our when we started off the conversation. The reasons you would try to diversify in those other asset classes is that they are somewhat not completely, somewhat decoupled from each other. So self-storage did pretty well or has done pretty well, for example, throughout most economic cycles. It's not the highest return, it's not wildly, it doesn't swing up wildly like multifamily can.

Speaker 1: 18:15

Multifamily did really fairly well pre-COVID. It took a hit kind of during COVID with all the rental distress, if you would, and now we have the high interest rate. So there's a little bit of decoupling there. They're not exactly correlated. And industrial is also tied back to the Americans just wanting a lot of things and also reshoring kind of talking about China again reshoring some manufacturing, warehousing and some other production back from the state, from overseas to the US. So again kind of a decoupling from exactly what one from the other. So that's going to be very strong, maybe very powerful, and can ensure that overall your portfolio has consistent returns.

Speaker 1: 19:01

So that's what we're trying to do is not be overly exposed to one type of economic event. We want to have a expose. We're going to be exposed to a lot of risks. We want to be all exposed to the same kind of risk. So the best funds and portfolio managers consider these things, take them into account when they where they invest, how they invest and I'd just like to share that word with you. So until next time. This has been a fun episode. This is my first solo episode. Thank you for listening and watching, and hopefully we can mix in a few of these as time goes on and just kind of share some of the things that we consider we've learned and what we're doing. So until next time, thank you.