Diversification combined with long-term investing is taught by many in the financial world as the way to retire safely. Diversification is supposed to protect our money from risk and help us achieve decent returns. Many people claim diversification should be applied to your rental properties as well. They say if you own too many houses in one area, then you run the risk of something devastating happening to your investments.
I personally do not believe in diversifying, because while it may decrease risks, it also decreases returns on my rental properties. I don’t want decent returns on my investments, I want great returns on my investments. For more information on my rental property investing strategy, check out my complete guide to purchasing long-term rental properties.
Also for more information on how to buy the best rentals which will make the most money, check out my book: Build a Rental Property Empire: The no-nonsense book on finding deals, financing the right way, and managing wisely. The book is 374 pages long, comes in paperback or as an eBook and is an Amazon best seller.
What are the risks if you do not diversify the location your rental properties?
It is possible under extreme circumstances to have your rental properties wiped out if all of your properties are located in the same area. If you have multiple properties located in one area, that area could have a natural or economic disaster. I have a plan to buy 100 rental properties and right now I plan on buying all of those properties in one geographic location; Northern Colorado.
One reason I am not too worried about my rental properties being wiped out is we rarely have any natural disasters here. We had a massive flood (1,000 year) this summer, but none of my properties were affected. We had a huge hail storm that did damage some properties, but my insurance covered those repairs. We have occasional tornadoes, but nothing like the massive tornadoes that the Midwest gets.
Our area is also very stable as far as the economy. We have many industries and employers; we are not dependent on one industry like Detroit. I don’t see any economic disasters coming soon and even Detroit is coming back now. I figure most economic issues are going to affect most of the country and diversification won’t help avoid those losses. My area also has relatively stable growth and does not see the drastic up and downs that some areas see like California. I guess it is possible that a new event that has never happened before could destroy the town or area, but the chances are so small that I am not going to worry about it. In my opinion, decreasing my returns by diversifying is not worth the minimal risk.
What are the advantages of not diversifying my rental properties?
There are many reasons I get great returns on my rental properties. Most of those reasons have to do with me being a real estate agent and investing locally where I am familiar with the market. Here are just a few of the reasons why I get much better returns investing locally than I would investing in another area.
I could not use my real estate license if I diversified
I buy most of my houses through MLS and I get paid a commission on each house I buy. That commission savings usually saves me 3 percent of the purchase price on every house. I am only licensed in Colorado and that savings would not transfer to other states.
I would have to learn a new market if I diversified
I know my market, the trends, values, and rental rates. I know this because I work in the real estate industry every day. If I invested in another market, I would have to learn that market from scratch. There is no way I could learn a new market as well as my own, even if I moved there. If I did move to another location I would have to immerse myself in the market to gain a fraction of the knowledge I have now. I’m not moving because my business, family and home is in Colorado. There is no way I could buy properties below market value like I do now in another market.
I would have to find a new lender if I diversified my renal properties
My portfolio lender only loans in Colorado and parts of two other states. If I were to invest in another location I would have to find a new lender. That means I would have to put more money down, establish a new relationship and possibly pay a higher interest rate. My portfolio lender will loan on as many properties as I want and that would be very tough to find in another location.
I have to pay for a property manager if I diversified my real estate holdings
Right now my team manages my properties. It takes them very little time and saves me a lot of money and time. If I were to invest in another location I would have to hire a property manager which would reduce my returns.
I could not keep an eye on my properties if I invested in another location
I am able to drive by my properties anytime I want. If I were to diversify into another location I could not do that. I would have to rely on a property manager to keep an eye on everything.
I invest in real estate for cash flow and not appreciation
Unlike stocks where the primary way to increase your investment is through appreciation, I invest in real estate for cash flow. Because I invest for cash flow and not appreciation, I am not as concerned with a downturn in market prices. Rents could decrease as well with a market downturn, but even a 20 percent decrease in rental rates would still leave me with cash flowing properties.
When does diversification may make sense in real estate?
I just listed all of the reasons it does not make sense for me to diversify my real estate investments. That does not mean it does not make sense for others to diversify their real estate investments. I just wrote an article on buying long-distance, turn-key rentals here. I wrote that article to help people who can’t invest in their own locations because prices are too high or rents are too low. If the average price of a home in your area is $500,000 it is going to be very hard to cash flow on an investment property. It may make more sense to invest in other areas of the country where you can get higher returns. If you are already investing in other parts of the country then it may make sense to diversify what areas you are investing in.
I estimate I save at least 20 percent of the purchase price of a rental property by investing locally. That is a huge amount of savings and that is the primary reason I do not diversify. If you are not a real estate agent, if you don’t know your local market well or are planning on using a property manager, then most of the reasons I don’t diversify will not apply to you. For me it doesn’t make sense to diversify, but that doesn’t mean it doesn’t make sense for others to diversify their rental properties.