A Balanced Portfolio (Own it ALL!)

by FI Fighter on October 17, 2013

in Real Estate Thoughts

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strat

My first “real” guitar was a Fender Stratocaster. I bought it because I loved the look of it — gunmetal blue! I actually knew nothing about guitars, but as luck would have it, it turned out to be a pretty versatile ax!

However, the one thing I couldn’t get over was the fact that the guitar used single coils throughout, and had no humbuckers! This was in college, when I was just starting to really get into heavy metal and neoclassical shred guitar. Obviously, a standard Strat would not suffice! Since the guitar had no slot for a traditional humbucker, I reasoned I could create a more complete guitar by keeping the neck pickup a traditional blues singe coil, and matching it with a heavily distorted Hot Rails bridge pickup.

By mixing it up in this manner, I was able to go from playing cool blues licks to heavy thrash chuggin’. It was the perfect compromise, which allowed me the capability of playing multiple genres of music without having to switch guitars. You could say I was pretty pleased with the end results. 🙂

Dividend Stocks

When it comes to investing, I’ve always tried to copy this approach to help build a blended portfolio. It all started off with dividend stocks. At first, I didn’t know what I wanted:

-High yield?
-Dividend growth?
-Appreciation?
-Low beta?

So, I picked a few stocks and just went at it. Also, most everyone has been told not to put all your eggs in one basket. Diversifying is a must since it will limit your downside in a case a company goes belly up.

Over time, you start to learn what type of investor you are, and you reshuffle the deck to get your asset allocation to better fit your investment style. For instance, The Southern Company (SO) has a juicy yield, at 4.92%. Ooh, I’ll take some of that! But the share price doesn’t move the needle much. Maybe I also need to mix in some Union Pacific (UNP)? I love UNP for the appreciation and dividend growth, but the yield is too low! How about adding some Johnson and Johnson (JNJ) to balance the two? It’s also difficult for me to stomach the constant market fluctuations… maybe I need some General Mills (GIS) to help filter out all this noise?

This all makes sense right? And most dividend investors I follow maintain about 20 to 40 stocks or so. Pretty standard stuff.

Real Estate

With all that said, I find it rather funny when I speak to other people about real estate investing and they are shocked when I tell them I’m diversifying into different markets. That is, I want to own a few properties here, and a few more over there, and maybe even one or two in my own backyard.

What’s the big deal, anyway? My guitar was versatile, and my stock portfolio diversified. Shouldn’t my real estate holdings also be?

One common cry you always hear is, “but out of state investing is so risky!”

Why is it risky? How is it any more risky than owning real estate in your own back yard? In fact, I would argue that owning too many properties in one’s own neck of the woods is even more of a gamble. Let’s say Silicon Valley falls apart (it could happen), and all the local jobs are outsourced. What good will it do me to own 10 properties here? What if there’s another major earthquake? It’s more a question of when than if…

To be real, I approach my real estate holdings with the exact same mindset I used when I invested in stocks. Let’s see if I can breakdown my logic (example uses allocation of 15 properties and assumes all out-of-state purchases are made through turnkey companies):

Silicon Valley Properties
Stock Equivalent: Apple (AAPL); Mostly a growth stock, like AAPL up to 2012, that pays a small dividend.

Desired Allocation: 2 properties

Reasons to own:

  • Exceptional price appreciation potential.
  • Very strong rental demand (single Craigslist ad can often get you 10 qualified tenants in just 1 day).
  • Lots of jobs; stable employment base.

Reasons to worry:

  • Poor cash flow (2013).
  • Cash on cash returns higher in other markets.
  • Need a large downpayment.
  • Lots of competition creates bidding wars that drive up purchase price.

Chicago Properties
Stock Equivalent: Seadrill (SDRL); Ridiculous yield, but the party could stop at any time (major oil spill).

Desired Allocation: 3 properties

Reasons to own:

  • Extremely good cash flow.
  • Rehab is more like complete redevelopment; brand new properties.
  • Rent to purchase price ratio among best in nation.
  • Multi-unit 2-4 flats help diversify income; economies of scale.

Reasons to worry:

  • City has high unemployment rate.
  • Evictions are difficult; tenant friendly.
  • High crime; need to perform extra due diligence to insure buying into the right neighborhoods.
  • Heavy reliance on Section 8 subsidies.

Indianapolis Properties
Stock Equivalent: The Southern Company (SO); slow and steady wins the race; low beta and stable.

Desired Allocation: 4 properties

Reasons to own:

  • Good cash flow.
  • Evictions are potentially easier; landlord friendly.
  • Cheap properties (sub $100k built in 2000 or newer).
  • Low barrier to entry (all cash purchase or with financing).

Reasons to worry:

  • Job growth not amongst strongest in country (people are flocking to the Sun Belt).
  • Little to no appreciation (stable, however).
  • Thin margins for seller (rehabs completed aren’t on par with Chicago so need to allocate more funds towards maintenance/repairs).

Houston/DFW Properties
Stock Equivalent: Coca Cola (KO); lower yield than a utility company, but a shining star (solid all around) in most everyone’s book. A dividend growth stock, or dividend aristocrat.

Desired Allocation: 6 properties

Reasons to own:

  • Strong job growth.
  • Decent appreciation.
  • Population boon expected over next 10+ years.
  • Evictions are easy; landlord friendly state.

Reasons to worry:

  • Extremely high property taxes; Texas is among highest in nation.
  • Cash flow is decent, but lower than the Midwest.

Conclusion

There’s my strategy laid out for you. I think if you look at my real estate philosophy through the lens of a dividend investor, it starts to make a lot more sense. I know a lot of people still think I’m crazy for planning to scatter my holdings throughout the country, but I really do feel like the strategy makes sense. This way, I get to tap into different markets, and reap all the benefits associated with each one. Like stocks, I’ll have a few holdings that will appreciate fabulously (Silicon Valley), a few that provide high yield but are more risky (Chicago), some defensive, solid yielders (Indianapolis) and the bread and butter (Houston/DFW) that always provides consistent, reliable, and solid returns.

Why not have the best of everything? Have your cake and eat it too!

P.S. In case you were wondering, I now own 6 guitars (for even more versatility). What can I say, I’m a fan of diversification! 🙂

{ 4 comments… read them below or add one }

1 writing2realityNo Gravatar October 17, 2013 at 7:25 am

Nice comparison FI! I think too often people get so focused on control (proximity to their property) that that lose sight of the importance for diversification in all aspects of investing. Of course it is easy, and reassuring, to be able to drive by your properties, but that isn’t the be all, end all, of investing. And yes, it does take a bite out of your income to pay a management company, but it is unlikely that San Fran, Chicago, Indy, and Houston/DFW will all experience the same ups and downs, so that “cost” of diversification really is negligible should something bad happen in your local economy.

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2 FI FighterNo Gravatar October 22, 2013 at 6:02 pm

writing2reality,

Yeah, out of state helps diversify, and in some cases it’s almost necessary since not all local markets will cash flow the same. In California, the returns have all but dried up, so I’m actually forced to go hunting elsewhere.

Something impacting the local economy severely was also another fear I always had. True, I can’t go and visit my properties on a whim, but I do get reassurance that if something bad happens locally, I’ll be hedged by investing in multiple markets.

I find that as long as I approach real estate investing with the same mindset as dividend investing, I’m on the right track. It’s all about balance, and no single stock/market will have everything you are looking for.

Take care!

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3 refinerrNo Gravatar February 15, 2014 at 11:15 am

FIF just read your first part about guitars to my husband because I had no idea what any of those words meant. He’s confirmed those are all real things so you’ve checked out! Also thanks a lot – he wants 6 guitars now. He’s at http://www.eatsleepworkmusic.com if you’re curious!

Reply

4 FI FighterNo Gravatar February 17, 2014 at 4:39 pm

refinerr,

LOL! Oops, my bad 😉

Cool, I’m going to go check out the site now!

Take care!

Reply

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