DIVERSIFICATION?

Question

Hello BP community!

I have eight rentals, seven of which are in the Kansas City area.  I'm looking at my next purchase, but I'm not sure if it's better to focus on Kansas City, which I'm just starting to learn, or diversify into another area (Memphis?  Milwaukee?  Detroit?  NO!!!).  I understand the concept for stocks, but I'm not sure it's as applicable in real estate.

Thank you for your insightful thoughts.

David

Dave Ketcham · Answer

This is a great topic.  We have a couple of properties in SoCal, but just bought a property in the KC area for the specific purpose of diversification.  We are buy-and-hold investors and there simply aren't many good opportunities for positive cash flow in our area of SoCal right now.  So, we see the KC area as a separate economic region that will be profitable, but separate from the crazy ups and downs in CA.  I will say though that it has taken many, many hours of time and travel to learn a new market, identify a property manager, and look for properties!

Emma S. · Answer

I think geographical diversification is very prudent for the very reasons stated by @Marco Santarelli .

Another reason: natural disasters (which seem to be more frequent nowadays). An entire region could be hit really hard. Makes perfect sense to me to diversify to other regions as long as the numbers make sense.

I suspect that quote from Buffett is less applicable to this specific issue of geographical diversification because REI is not a liquid investment like the stock market. An investor may know his local market really well today but if next year new state regulations drive businesses to leave the city/state; leading to increased unemployment & a depressed real estate market, then that investor cannot easily get out of his market to get into another more profitable market. So what good did knowledge of his market do for him in this situation? Not that much.

On the other hand, the same quote can be applicable to REI investing in different niches. So if an investors specializes in SFR's, or Mobile homes and is doing great, well in that case diversifying into apartments etc. may be unnecessary and superfluous.

Just my 2 cents.

Matt Devincenzo · Answer

“Diversification is protection against ignorance, it makes little sense for those who know what they’re doing.”-Warren Buffet

That is a quote I really liked when I heard it. I think when I first read it there was some more discussion and he explained more. It's not that diversification is wrong, his point being if you know the market drivers and cycles then focus on ensuring you're the most knowledgeable and you will come out further ahead than if you diversify.

Jeremiah B. · Answer

Diversify?   Yes!

Most of investing is deciding what fits your situation, suggesting that investing rules apply differently for different people.  But, I feel very strongly that one rule, that is relevant to all investors, is the importance of diversification.

I say a lot of things that are not correct; this is not one of them.

Dave Carpenter · Answer

I would be one of those ignorant people Buffet is referring to. If you are so knowledgeable in a certain area that you would be losing money by diversifying, then he is absolutely correct. I think those people are very few and far between.

In my opinion you have to weigh the risks of expanding into a lesser known area vs expanding to spread around risk. To me, buying in different parts of the same city will protect you from one community that might be impacted by local politics. This is somewhat rare, but certainly does happen (read: everyone's favorite city Detroit). On the other hand, diversifying all over the country will hedge you against a whole region being impacted by an downturn. The next level beyond that would be to invest internationally.

For me I would value more highly having a brand in a specific city and be able to exercise economies of scale with contractors, materials, etc. over ensuring that I am hedged against any type of economic changes.

At some point I think it becomes a "chicken little" type situation. 6 units in 1 city does not seem excessive to me.

Another simple way to diversify would be to invest in different types of units. Have some larger apartment buildings as well as duplexes or even single families.

Marco Santarelli · Answer

@Dave Ketcham:  Very well said Dave!

Matt Lavinder · Answer

It's a bit of a trade off,  isn't it?  To get the really great deals,  I think you've got to focus your marketing and build your team in a focused area.   It's hard enough for me to manage construction crews working on the other side of town.  I just don't see working with a contactor from afar.  But,  if you are just building long term wealth via turn key rentals,  I can see the value of diversifying geographically.  But,  you aren't going to get the really good deals that way,  which creates another kind of risk, doesn't it?

David Jayne · Answer

thanks to all for your insights.  i think the demise of detriot really got me thinking, but kansas city is a fairly diverse economy.  the natural disaster concern is a consideration, though.  two of my properties are practically right next to each other, which isn't the best idea i guess.

@Cameron Ellis i have heard memphis is a solid area, but i've never seen that breakdown.  thanks for sharing.  i don't know the economics of the city or any of the neighborhoods there, but it would definitely be worth some investigation.

Dell Schlabach · Answer

A couple interesting quotes that seem to line up with Buffet, thatI have had hanging in my office since the crash, after five years of "diversified" real estate strategies.

Concentrate your energies, your thoughts and your capital. The wise man puts all his eggs in one basket and watches the basket. 
	 Andrew Carnegie

"Put all your eggs in one basket, then guard that basket!"
	Mark Twain

For me a single minded focus, committing to excellence and becoming the best with a single strategy the past four years has made all the difference.

I believe there is a point to diversify, but to diversify, before you become very competent and capable in one area I think is a recipe for failure.

I see this a lot with new "investors" who are so "open minded" to all options in order not to miss out on anything, that they miss out on the massive amounts of chickens that can be hatched out of one basket, when energies, thoughts, ideas, and time are put into creating a highly productive basket being supplied with a constant stream of eggs to be hatched.

My thoughts

Marco Santarelli · Answer

@Daren H.:

The main reason for diversification across different geographic areas (i.e. states) is to have your assets spread around different  economic regions.   Every real estate market is "local" and each housing  market moves independently of one another.   Diversifying across  multiple states helps spread your "risk" around should one market  decline for any reason (increased unemployment, increased taxes, new regulations affecting your investments, loss of major employers, etc.)

I believe it's prudent and wise to manage your portfolio this way.

Continued success!

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