# is real estate investment diversified?



## rookie (Mar 19, 2010)

when i look at an investment in real estate, i think its already kind of diversified in itself. because the value of a property depends on so many factors - govt, policies, infrastructure, job prospects, local and global economy etc. so just putting investable money in real estate, should suffice. am i missing something here?

what happened in the US when the RE crashed? so did the entire stock, bond and money markets right? so what is the point in learning, studying, tracking and buying so many different investments? 

diversification in terms of region is the only missing thing.

i want to see how different people thrash this opinion or train of thought...


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## Four Pillars (Apr 5, 2009)

rookie said:


> when i look at an investment in real estate, i think its already kind of diversified in itself. because the value of a property depends on so many factors - govt, policies, infrastructure, job prospects, local and global economy etc. so just putting investable money in real estate, should suffice. am i missing something here?
> 
> what happened in the US when the RE crashed? so did the entire stock, bond and money markets right? so what is the point in learning, studying, tracking and buying so many different investments?
> 
> ...


I disagree. I think that a real estate investment in terms of a condo or house is extremely undiversified. You've listed a number of risk factors - not diversifiers.

Lack of diversification is one of the many reasons I'll never get into real estate investing.


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## MoneyGal (Apr 24, 2009)

Diversification in investing terms is understood to mean spreading risk. 

"Diversifiable risk" (the risk that can be reduced by diversification) is the risk that your intended investment (whether a house or a stock or anything you intend to sell later at a profit) will not produce the desired level of profit. 

The chances of ONE property (or one stock) failing is MUCH greater than the chances of MANY properties/stocks failing all at the same time, at least if they are a properly diversified set of properties/stocks. 

So, ideally, when you are constructing a portfolio you will not only include many properties or stocks - you will also ideally look for investments whose value will move in different ways in response to the same underlying conditions. 

This is in contrast to non-diversifiable risk, which is the risk that the entire market (housing market, stock market) will decrease in value. You can't diversify this risk away, hence the name "non-diversifiable risk." 

In your post, you've listed some factors that influence the housing market, and you've also touched on non-diversifiable risk as a category. 

Between interruptions this post has taken me about an hour to write; hope it makes sense. TL,DR edition is: you've described non-diversifiable risk in your post; this isn't what diversification protects against.


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## Cal (Jun 17, 2009)

Agree with the two FP and MG.

RE is one asset class or sector. Having lots of RE is not being diversified. And yes it is best to have a balanced portfolio, which I am guessing is what you are trying to accomplish.

I think you misunderstand why the RE and stock markets in the US collapsed.

In short (and pardon the pun on that), the RE market ran out of steam, the rates on the low rate mortgages were resetting, and securities related to RE tumbled, some financial institutions didn't even understand the securities that they owned related to the RE market. This caught alot of institutions by surprise and they had to pay out on the debt obligations. Some couldn't.

Had the financial institutions had enough on their balance sheets to account for the potential loss of RE income (mortgage payments) and valuations, as well as calculating in case they had to pay out on mortgage backed securities, and collateralized debt obligations, the stock market would not have taken such a hit by any stretch.

Sorry for the readers digest version, best to read for full details:

http://en.wikipedia.org/wiki/Financial_crisis_of_2007–2010

as well as 'The Big Short' by Michael Lewis to really get a feel for how some of this really played out.


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## Four Pillars (Apr 5, 2009)

The other problem with real estate is that you can't buy it in small chunks. If I could buy real estate units of say $5000 then I wouldn't care if it was diversified - because it would be part of my larger portfolio and would just be another asset class.

As it is - if I buy a $450k rental house then that will comprise a rather large portion of my portfolio which would mean my portfolio is not diversified.

It would be like having 50% (or more) of your portfolio invested in one stock.


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## Sherlock (Apr 18, 2010)

I suppose if you owned real estate in many different parts of the world, that would be diversified. Of course that's not realistic for the average investor.


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## OhGreatGuru (May 24, 2009)

Four Pillars said:


> The other problem with real estate is that you can't buy it in small chunks. If I could buy real estate units of say $5000 then I wouldn't care if it was diversified - because it would be part of my larger portfolio and would just be another asset class.
> 
> ...


That's why people buy REITs.


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## OhGreatGuru (May 24, 2009)

Sherlock said:


> I suppose if you owned real estate in many different parts of the world, that would be diversified. Of course that's not realistic for the average investor.


It would be gegraphically diversified, and perhaps currency diversified. But not "Sector" diversified.


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## kcowan (Jul 1, 2010)

Real estate represents a huge and highly leveraged investment in one property. Unless the asset value is a small portion of your overall holdings, it is highly risky as an investment.

Having said that, many people have made out very well holding large and highly leveraged properties. However, that was in the past, and is no guarantee that such performance is representative of the prospects today. YMMV


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## HaroldCrump (Jun 10, 2009)

Diversification is a double edged sword.
It can protect your portfolio from complete meltdown when "bad things" happen.
However, at the same time, it can limit your upside.
Therefore, there is an opportunity cost to diversification.

In this example, if the property that you sink all your capital into does singularly well due to any number of reasons, then this could be turn out to be your ticket to financial freedom.
Conversely, there's the risk of deeply denting your portfolio during a RE meltdown.

There's a point at which widespread diversification become counter productive and yields meagre returns.
Similar to buying all kinds of sector funds and all kinds of geographical funds.
Returns would likely be pretty slim compared to focusing on a core geographical location or core sectors.
Too much of a good thing can be bad, too.


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## Ethan (Aug 8, 2010)

rookie said:


> when i look at an investment in real estate, i think its already kind of diversified in itself. because the value of a property depends on so many factors - govt, policies, infrastructure, job prospects, local and global economy etc. so just putting investable money in real estate, should suffice. am i missing something here?
> 
> what happened in the US when the RE crashed? so did the entire stock, bond and money markets right? so what is the point in learning, studying, tracking and buying so many different investments?
> 
> ...


Bonds and money market investments did not crash, their prices increased significantly.

Another problem I see is geographical allocation. I live in Saskatchewan, if the housing market were to collapse here it would likely be due to a slowdown in agriculture. This would affect Saskatchewan's two biggest companies (PCS and Viterra), however if I hold stocks from other regions (ie banks in Ontario, gas companies in Alberta) they would not be susceptible to the same risks and likely wouldn't follow a similar pattern. While I can buy stocks from all over the world, my real estate investment is limited to Regina, as I want to be close to my properties.

It would be interesting if someone could run a covariance calculation between Canadian housing prices and the TSX.


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## MoneyGal (Apr 24, 2009)

"Someone" has. Try this article for starters. 

http://www.advisor.ca/images/other/ae/ae_1004b_riskforsale.pdf


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## Scottlandlord (May 27, 2010)

I've diversified into 2nd mortgages as well as none residential rentals.

I'm now heavily into the wonderfully romantic and exciting world of: parking spaces.

Yet, my core business is still my portfolio of residential rental properties.


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## GeniusBoy27 (Jun 11, 2010)

There's this old German couple at a place we have downtown who owns 25 parking spaces, at $200/month. That's their retirement fund = $5,000/month.

No hassle. No effort. 

It's a brilliant idea.


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## kcowan (Jul 1, 2010)

GeniusBoy27 said:


> No hassle. No effort.
> 
> It's a brilliant idea.


Yes just ask Impark here is Vancouver. They can turn an empty lot onto a parking lot by signing a lease with the owner. They do profit-sharing so all the costs are written off and then it is pure profit.

There is a gravel lot at W Georgia and Cardero that we use when biking around Stanley Park/Coal Harbour. $13 for three hours. It has been a parking lot for many years. $$$


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## Ethan (Aug 8, 2010)

MoneyGal said:


> "Someone" has. Try this article for starters.
> 
> http://www.advisor.ca/images/other/ae/ae_1004b_riskforsale.pdf


Interesting. Thanks for posting!


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## Scottlandlord (May 27, 2010)

GeniusBoy27 said:


> There's this old German couple at a place we have downtown who owns 25 parking spaces, at $200/month. That's their retirement fund = $5,000/month.
> 
> No hassle. No effort.
> 
> It's a brilliant idea.


Yes


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