The journey of investing can be very fruitful, however, as in everything in life, things change, hopefully for the better, and sometimes toward the unexpected. The generation of income is one of those factors that is likely to be effected by change. It can go up, it can go down, and it can virtually disappear depending on your investment position. Even the wisest investors get blindsided by events. This is why diversification is key in growing your investments.
As an investor, you will be faced with unsystematic risk, or the risk associated with the inherent uncertainty in business. Unsystematic risk, also known as specific risk, is made up of the risks that are unique to a specific market ie; the internet changing retail patterns, co-working changing office building construction. One of the best ways to manage these risks and keep the uncertainty to a manageable level is to diversify your portfolio. In the first half of this article, I will outline the potential threats to each asset class. In part two, I will provide a brief overview on how an investor can diversify a portfolio to better prepare for and balance out risks.
There are five main asset types, or property types, discussed herein that a person can invest in. These include retail, multi-family, office, industrial, and residential. Each property type faces a different set of threats that have to be accounted for.
Retail: Retail properties are haunted by the rise of e-commerce business and frequent changes in consumer behaviors. These factors can alter the success of a business, good or bad, depending on the tenant’s relevance to its customers. What’s more is that the retail leases are usually for longer terms and may not have the flexibly that the tenant needs. With retail evolving, a retail property income and value may be at fluctuate.
Multi-Family: Multi-family real estate investments, however, face a different risks; one being rent control. Rent control refers to the ordinances and laws that set price controls for residential housing. This also includes restrictions on how to manage the property. Restrictions on rent mean that investors face limits on the rate at which they can raise their tenants’ rents, which can make it difficult for an investor to achieve their desired return on an investment and more importantly in turn will also effect the ability of a property to increase in value.
Office: Similar to the challenges faced by retail spaces are those of office investment properties, which face a new kind of competition as well. Today’s market is seeing an influx in coworking spaces, which has ultimately created a decline in demand for traditional office space. More companies are transitioning to remote working as well, a trend which drives office buildings to shift their business models to adapt.
Industrial: This sector has experienced major changes in recent years. As e-commerce transactions have increased, more demand for industrial space has been required. However, anticipated changes in income, supply chain trends, and trade policies can negatively impact the demand.
Residential: There are numerous risks to residential homes. The most prevalent in today’s market include changes in construction regulations and lending terms. Unfavorable policies and terms can make it difficult for investors to experience positive cash flow on their residential units.
This is just a glimpse at the risks associated with the individual sectors; however, there are many more since all markets are constantly shifting.
There are various ways an investor can diversify their portfolio of investments, which will strengthen their ability to withstand the weaknesses of any one investment type — some of which I outlined above. Here are some options:
Diversification is an invisible shield. It offers you flexibility in the constantly changing market and can assist in minimizing the risk of loss. For example, if one investment is performing poorly, you have another thriving investment that offsets your losses. One day, the tables will probably turn, and the once-struggling investment will anchor your portfolio while another asset takes a less favorable turn. In addition, you can participate in different strategies, including those that require no management on your end. A well-diversified portfolio can improve the chance of ongoing growth.
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