Should You Go Big in One Market or Diversify Across Many?

I recently closed on an apartment community, which increased my company’s portfolio to over $190,000,000 worth of apartment communities under our control. We have 11 apartment communities and… 11 out of 11 are in Texas. In fact, 9 out 11 are in Dallas Fort Worth (DFW). I’ll get to the relevance of this in a second.

But first, after every closing, I document a lesson learned with the purpose of helping others who want to pursue apartment syndication or multifamily investing. You can read about the 16 lessons from those deals here: 16 Lessons from Over $175,000,000 in Multifamily Syndications

Now, let’s look at my company’s portfolio a little closer and dig into this lesson learned – or really, an observation I had. We have 2,613 apartment doors in total with 85% (2,208 doors) in DFW. So clearly, we are going deep in one market and are not currently diversifying across multiple markets. But, I frequently hear about how real estate investors should diversify.

I don’t agree.

As apartment owners and operators, if we diversify across other cities/states just for the sake of diversification, then I believe we would actually incur more risk, not less. Here’s why: all real estate deals have risks, which can be separated into three categories:

• Risk in Market and Submarket
• Risk in Deal
• Risk in Team

By sticking to one market that we know very well and have a proven management team in place with economies of scale, it allows us to mitigate risk factors 2 and 3 – not eliminate, but mitigate. Conversely, if we were to branch outside of one market, we’d have to find the following:

• Property management – one of the biggest keys to success. Yes, we have a plan, but it must be properly executed
• Vendor contacts – not as big of a deal if you hire a 3rd party management company since they can provide these contacts, but it is a big deal if you don’t
• Local legal experts for contracts – a bad one can burn you
• Knowledge of tax assessments – fairly easy to figure out, but still a learning curve
• Build a reputation among the brokers – intangible and is vital to finding the best deals

Additionally, we’d have to evaluate and qualify the market and submarket. Basically, we’re opening ourselves up to all three risk factors by branching out. So, when we decide to go deep into one market, the key is to make sure that market is solid.

Here are the primary things I look for in a market:

• Job diversity – no one industry makes up more than 20% of the jobs
• Population – growth over the last five years and current projections show a continued growth
• Supply and demand – look at vacancy trends and absorption rate

Of course, as with all generalizations, there will be exceptions. Here is a couple I can think of:

• This is only in reference to being an owner/operator (i.e. active investor). If you are a passive investor and can passively invest with multiple owner-operators (i.e. syndication or turnkey companies) who have the systems in place in different markets, then that seems like a good strategy to me. In this scenario, the deal and the team (risk factors 2 and 3) are already given to you. Knowing if they’re good and reputable is something you’d obviously still need to qualify, but it makes conceptual sense to diversify if you’re a passive investor
• While we are going deep in DFW, that doesn’t mean we’ll always only be in DFW. In fact, we actively get sent deals across the country every week – lots of them. However, in order for us to branch outside of DFW, it’s going to take an extraordinary deal combined with a local expect partner to compel us to pull the trigger.

To summarize, I believe you lower your risk when you go deep in a market. It’s better not to diversify across multiple markets unless the opportunity is significantly better than what you can get in the market in which you are already investing.

What do you think? Should you go big in one market like us, or are you finding success by diversifying across multiple markets?