I’m often asked by investors about diversity in Real Estate Investing. “Should I buy in multiple cities to spread out my risk or should I stick to one or two markets?” they ask. Diversifying into multiple cities seems like sound investing logic- after all, you’d do this if you were investing in stocks, bonds, or mutual funds. By diversifying, you are not “putting all your eggs into one basket” and protecting yourself from the possibility of your entire portfolio collapsing if one of your holdings (stock, bond, mutual fund) tanks. However, in the world of Real Estate Investing, diversity can work both ways- the more you diversify, the more you have to manage and the greater your risk.
Buying a property is not like buying a piece of paper. When you purchase a stock, bond or a mutual fund, you’re essentially getting a certificate that gives you an equitable interest in that security. And this can be managed from anywhere in the world at anytime. If you no longer wish to hold that security, you simply phone your broker or log in to your account and push the “sell” button. Real Estate, however, is different. You can’t liquidate a piece of property as easily as you can liquidate a stock. Once you close on a piece of property, you should plan on owing it for at least 5 years (if not longer) before considering liquidating it.
Real estate is an active investment that needs to be managed in order to make it perform (i.e. cash flow). This involves collecting rents, fixing maintenance issues when they arise, managing tenants, etc. In that sense, Real Estate is not truly a “passive” investment vehicle- it does require some work. Of course, the experts who have owned and managed several properties will tell you that it doesn’t require much time and it certainly beats working for a living! However, for a lot of people who are not full-time real estate investors or who are investing in markets outside of their home market, self-managing a portfolio of properties is NOT realistic or efficient. Instead, they employ the services of professional property management companies.
Each property management company is different- they have different philosophies, different business models, different personnel, different policies, and different cultures! Each time you buy a piece of property and employ the services of a property manager, you’re essentially investing in a BUSINESS and not just a piece of property. If you buy multiple properties in multiple cities and employ multiple property management companies, then essentially you are managing multiple businesses. For example, let’s suppose you purchase 10 properties in 6 different cities and have a different property manager in each city. Now you have 6 different businesses that you are keeping track of- 6 different online web portals, 6 different property management statements, 6 different points of contact, 6 different companies! And all these companies may use different property management software, or have different fees, or different philosophies, etc. Now, imagine that same portfolio of 10 properties in 1 city. You could have 1 property management company overseeing all 10- 1 company, 1 point of contact, 1 online portal with login, 1 property management statement! Wouldn’t your life be a lot easier?
Now, I understand the argument that investing in 1 city means taking more risk of losing your portfolio if something catastrophic happens in that particular city. I live and invest in Memphis, TN (voted the #1 city in the U.S. for buying investment property by the Wall Street Journal, see- http://www.memphisturnkey.com/memphis-ranked-1-buying-investment-property). Memphis is a great market for cash flow because the prices are affordable, over 50% of the population rents, and it’s the distribution HUB of the United States and home to FedEx Worldwide. However, Memphis is also located not far from the New Madrid Fault, where 4 intense earthquakes hit in the early 19th century (seismologist estimate 7.0 – 8.0 magnitude). Even though it’s been 200 years, if another earthquake of this magnitude were to hit again it would be potentially catastrophic for Memphis! But the reality is an event like this is rare and likely not to occur again for another 50-100 years (if not longer).
Investing is risky and diversity is still the best way to mitigate away risk. It is certainly wise to seek out multiple markets for buying investment property. But a word of caution, don’t get carried away! More diversity is not necessarily better. If you’re worried about “the big one” hitting in Memphis, then seek out other markets like Atlanta, Dallas, or Indianapolis. But don’t diversify so much that you have a management nightmare on your hands! You can envision a scenario where you have 20 properties in 14 different cities and half of them are vacant and you’ve lost contact with the property managers. Suddenly, you’re buying plane tickets to have a dozen or a dozen cities to play “damage control” with your portfolio. Not a good time!
To truly win in the game of Real Estate Investing- keep it simple. Find the best TEAM to work with, in the city of your choice. Then plug in to their system and grab as many quality properties as you can. To modify the statement of “don’t put all your eggs in one basket”, in the world of Real Estate Investing the best strategy is still to “put all your eggs into one basket, and then watch the basket!”
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