Diversification is a hot topic in this changing real estate market. How do passive investors get access to diversification in their real estate investments? Your Castle Real Estate and Ironton Capital founder Lon Welsh is back to talk about the three dimensions of diversification in passive investing.
- Listen to the podcast “#402: Boost Returns and Lower Risk by Diversifying Real Estate Investments” Denver Real Estate Investing Podcast
- Watch the YouTube video (at the bottom).
- Read the blog post. Note, the blog is an executive summary. Get the in-depth breakdown from the podcast or video.
Three Ways Passive Investing Offers Diversification
There are three main dimensions for diversification in passive investing:
- Asset class of investments
- Strategy being pursued
Active investors who only own real estate in Denver don’t have exposure to other geographic areas. This means that returns are likely to be similar on their investments because they’re all in one market. Passive investing offers a wider geographic spread of properties; Ironton Capital has projects in Florida, Texas, and California, among other areas.
Asset classes are another way to achieve diversification. Most active investors own condos, houses, or apartment buildings, all residential properties. They don’t have exposure to office, retail, or student housing.
Having a blend of geography, asset types, and strategies creates diversification and lowers risk. If you just have residential real estate, getting an office or industrial property can smooth out earnings and appreciation. Or, say you have three houses in Highlands Ranch. That’s one asset class, but if you invest in a new build development, you’ll get exposure to higher returns.
How Do Different Investing Strategies Create Diversification?
Real estate investing strategies are analogous to stock market investing: picking five stocks in tech companies will have a different performance than the S&P 500 Index.
Lon went over several different real estate investing strategies from lowest risk to highest risk:
Core investing is kind of like investing in a public service or utility. It doesn’t bounce around much, but provides reliable returns.
In real estate, core investing is buying a blue chip apartment or office building in a fantastic neighborhood. People pay top dollar for the building, and the main focus for investors is income.
While there is very little appreciation in this type of property, there’s plenty of cash flow with lots of stability and certainty.
Core plus is similar to core, except there’s a focus on some growth and appreciation over time. The property isn’t located in quite as premier a neighborhood, but the rough edges allow for improvement and appreciation along the way.
This would be like investing in a growth stock. It will have more ups and downs but generates more appreciation over a long time. There won’t be as many dividends because it’s in growth mode.
For this strategy, we buy a rougher property in a rougher area, ideally with a finite definition of the work that needs to be done.
This could be a 1960s apartment building in central Aurora with no updates: original kitchens and bathrooms with worn out common areas. The property is bought at a discount that reflects its condition, and then money is put into renovating the building and raising rents. The returns are higher, but there’s a little more risk.
A slightly more extreme type of value-add strategy is opportunistic investing. If value-add is renovating a kitchen with new counters and appliances, opportunistic is completely gutting the space and fully redoing it.
Value-add investments are likely to bring a steady stream of cash flow and appreciation over the long haul.
Development is the highest risk and highest reward strategy. It’s akin to investing in a young company with a lot of growth ahead.
This strategy entails buying land or maybe razing an existing building. The returns are double what you’d find in a Core investment.
There won’t be cash flow in this type of investment for quite a long period because of the time it takes to develop. However, there tends to be a huge spike of cash at the end.
Why Investing in Diverse Funds Is a Good Move in the Current Market
After 20 years of investing in Colorado residential and office spaces, Lon didn’t have the desire to learn new geographies and asset classes as an active investor. It’s much easier to partner with someone who does know all of those things, plus it’s a lot less responsibility and stress. Thanks to Lon’s vast investing experience, he knows how to evaluate and underwrite these investments.
We’re currently seeing multi decade high inflation, which makes Lon more eager to invest in real estate. Inflation is real estate’s best friend. If you own properties in the Denver area, you’re likely sitting on your personal ATM machine because they probably have low fixed mortgages from four years ago. Rents go up because of inflation, which means the increased money goes straight to your bottom line.
Real estate and the stock market are not highly correlated. When the stock market is in a bear market, like it is now, that means real estate does pretty well. Blending your portfolio smooths out earnings and decreases stress.
Learn More about Passive Investing
To learn more about passive investing and get more in-depth information on Ironton Capital’s funds, check out this webinar.