Investing a large portion of your portfolio in real estate can provide excellent returns. However, a lack of diversification also increases risk. If you have invested heavily in real estate, it is prudent to balance your portfolio by adding other assets. This provides stability and reduces exposure to the volatility of real estate markets. In this article, we will discuss various ways to offset an overweight real estate allocation.
Evaluate Your Current Investments
Begin by analyzing your existing real estate investments – their types, locations, performance, etc. See if they are concentrated in one geography or sector like residential or commercial. Examine associated risks like vacancy rates, local market conditions, interest rate fluctuations, etc. This will identify weak spots and help plan diversification. Also review fundamentals like cash flow, debt levels, and holding periods. Calculate real estate’s share of your overall portfolio and net worth. A correction may be needed if it exceeds 50-60% of total assets.
Expand Into Different Property Types
The first step is to diversify across different real estate categories – residential, retail, industrial, and specialized assets like hospitals hotels, etc. Investing in a mix of property types spreads risk and offers returns not correlated to housing markets alone. For instance, add commercial buildings, shopping centers, or warehouses to your portfolio of rental homes. Or vice versa. Also consider investing outside your current geographic zone – different cities, states, or even countries. This reduces localization risk events like natural disasters or regional recessions.
Real Estate Investment Trusts (REITs) allow investing in commercial properties without direct ownership. REITs own real estate assets and are traded on stock exchanges like equities. Investing in REITs thus adds liquidity compared to physical property. They provide exposure to a professionally managed, diversified portfolio spanning various real estate classes and geographies. REIT dividends also deliver relatively stable income. Having a portion of your real estate allocation in REITs balanced direct property holdings.
Increase Equities And Bonds
Adding equities like stocks brings growth potential and reduces real estate concentration. Blue chip stocks deliver steady returns over time despite short-term volatility. Bonds lower portfolio risk and provide income stability to offset real estate cycles. Include a mix of government and corporate bonds. Increase overall equity and bond allocation to 30-40% each to balance a heavy real estate portfolio. Maintain some liquid cash reserves too for contingencies. Periodically rebalance the asset mix to maintain target allocation.
Consider Real Estate Development Sponsors
Investing as a silent partner with real estate development sponsors provides diversification within the real estate itself. It allows participation in larger projects without full ownership commitment. The pros are leveraging experienced developers’ expertise, co-investment by multiple parties, and the potential for higher returns from development profits. Cons could be higher risk compared to finished properties and less control over decision-making. Overall, sponsors provide access to a broad scope of real estate activities but make sure to know all the pros and cons of real estate development sponsors.
Add Alternative Assets
Allocations to alternative assets like precious metals, cryptocurrencies, private equity, etc. can offset real estate risks. Gold provides a hedge as a safe haven asset uncorrelated to financial markets. Cryptocurrencies have gained recognition for upside potential despite volatility. Private equity opportunities in sectors like technology, healthcare, and energy can deliver high returns to balance real estate’s lack of growth. Such assets bring much-needed diversification to concentrated real estate holdings.
Maintain Prudent Debt Levels
Since real estate is a leveraged asset class, monitor debt levels closely. Limit loan amounts to 50-60% of property value and debt to 50% of gross assets. Excess leverage increases risk given real estate’s inherent volatility. Manage debt prudently across projects – avoid cross-collateralization and stagger maturities. Keep some assets free of debt as a reserve. Using debt judiciously together with portfolio diversification provides the right balance.
A heavy concentration in real estate poses risks from a lack of diversification. Balancing the portfolio by adding assets like stocks, bonds, REITs and alternatives overcomes this limitation. Maintaining prudent debt levels also helps manage risk. The ideal real estate allocation is 50-60% of total assets, with the rest in liquid securities, cash, and alternatives. Rebalancing periodically aligns the portfolio to target asset allocation. This balanced approach allows for optimally benefiting from real estate’s returns while mitigating associated risks.