Asset diversification is key to maximizing your returns and minimizing risk—and makes your portfolio much more attractive in the current real estate environment.

Real Estate Investment Trusts (REITs) have become a popular option for investors. As a fund manager, it’s important to ensure your REIT fund is properly balanced between different asset classes such as single-family rentals (SFRs), multifamily properties, and general use commercial (GUC) properties. Balancing your portfolio is key to maximizing returns and minimizing risk. It also makes the marketing of it much more attractive in the current real estate environment.

Pros and Cons of Each Class

Single-family rentals. The growing demand for rental properties has made SFRs an increasingly popular option for many investors. With more people choosing to rent rather than to buy, rental payments can offer investors a stable source of income. These properties are also attractive because they tend to require less upkeep, management, and maintenance than multifamily properties. They are also quicker to underwrite and assess for risk, not to mention sell to the secondary market if that is part of your focus.

Multifamily properties. On the other hand, multifamily properties offer the potential for higher returns, because you can generate multiple rental incomes from a single property. With more units to rent out, there is potentially a lower risk of vacancy, meaning a more stable income stream for investors.

With that said, multifamily properties are generally more expensive to acquire and maintain, which means they require a larger investment upfront. They still are a smart focus of your fund if they are placed in the correct concentration limits, they aren’t massively massive outdated, or they don’t require improvements that have been delayed. If multifamily is going to be a vertical for your fund, make sure you have a solid team member with experience in this asset class who can drive this program. There’s nothing worse than having a large property with underperforming rental income and needing maintenance that has been deferred. This class of investment needs smart eyes and wise underwriting, but it can pay off well if added to your fund correctly.

General Use Commercial. GUC properties offer a different set of benefits, including retail spaces with long leases, mixed-use residential/retail, offices, and multifaceted warehouse types, which are leased out to businesses rather than individuals (or a combination of both). The combination of people moving to newer areas and a lack of inventory provides an opportunity to back a builder with solid, repeat loans and fast exit turnarounds. These properties can generate higher rental incomes if held. Being newer and more attractive, they require little to no rehab or maintenance.

Focusing on spec home builders and those looking to do smaller tract sizes with staged phase releases can offer a solid, longer-term repeat system for your fund and make it easy for investors to understand. However, tenants may be more likely to default on their leases during times of economic volatility. In that case, GUC properties can require more maintenance or redesign to keep tenants satisfied or newly leasing. The question to always ask is: “If the nail shop closes down, what else can we do with this spot?”

Balancing your REIT fund among these various asset classes can help you achieve a diversified portfolio that offers stable returns and lower risk. Achieving this balance can be challenging, especially for new fund managers. A great rule to follow is: “Too much of any one thing isn’t good for you.” So, embrace diversification and be mindful of concentration limits you set with your team and your counsel.

Guidelines for Diversifying Your Portfolio

Here are some general considerations for diversifying a fund among different asset classes.

Ratio goals. As a best policy, consider following the rule of  70% residential, 20% multifamily, and 10% GUC. Obviously,  this formula can be adjusted and should reflect your individual expertise. That said, this is a common and solid baseline.

Your experience. If you don’t have experience with an asset class, is it better to avoid it, hire someone who does, or start small with one or two properties? If you don’t have a solid level of experience  with a certain asset class, it is sometimes best practice to involve a third-party expert to back your underwriting and asset valuation.

Asset location. Consider the markets in which these asset classes are doing particularly well. Also consider which asset classes are better suited to a certain market.  Further, to get a more granular feel for a particular property, some lenders actually walk a property, street, or local area when considering a loan. If you can’t walk the actual property, enlist a local agent or expert to send video of the general area to help you evaluate the overall “picture of risk.”

Investor interest (and/or secondary market interest, if selling the paper). The best way to evaluate investor interest in the market is to stay current on market trends, job corridors, school zones, and what the local real estate groups are moving easily. Local markets are local. Those who work in those markets every day are usually your best source of what is hot and what is not.

Don’t Work in Isolation

The industry abounds with resources to assist you as you make decisions about your portfolio. Here are a few considerations for continuing your education and building your knowledge of the industry.

Get a mentor. Mentorship can be invaluable. Experienced fund managers can offer insights into the industry, provide guidance on investing strategies, and help identify potential pitfalls and opportunities. Never stop learning! Smart and experienced fund managers pursue knowledge and trends as hard as they pursue investors.

Mentorship can also help fund managers stay up to date with changes in the market and emerging trends. For example, with the rise of remote work, some investors may be turning away from multifamily properties in urban areas and looking for properties in suburban or rural areas. A mentor can help a fund manager identify these emerging trends and adjust their investment strategy accordingly. Keeping your eye on these properties in real time and in person is also best practice. It helps to forecast issues with the location and property that may be missed by phoning it in. Your investors will thank you!

The first place to start looking for real talk, real education, and real advice is with AAPL. Beyond that, there are many very strong organizations in our space that hold events and conferences with educational programs. A few examples are the National Lending Experts, Think Realty, and the Family Office Club.

Look into events at your local level, too, to find out who is doing what you want to do in the areas you want to specialize in. Take time to talk to those people. You will know quickly whether a company or individual aligns with your focus and outlook. “Never stop learning” as my old mentor would say.

Seek out other professionals in the industry. Fund managers should also consider working with real estate professionals like brokers and property managers. These professionals can provide valuable insights into the local real estate market, help identify potential investment opportunities, and offer advice on property management.

One key challenge for fund managers is identifying the right properties to invest in as they underwrite. This requires a deep understanding of the local real estate market as well as an understanding of the specific needs and preferences of potential renters or lessees. Real estate professionals can help fund managers navigate these complexities and make informed investment decisions. A good policy to follow is that you “never want to be a mile wide and an inch deep.” Know your market and your asset class—this will save the day more than once.

Another important consideration is the management of the properties themselves. Property management can be complex and time-consuming, especially for multifamily properties or GUC properties (inspections, maintenance, rental payment collection, etc.). Working with experienced property managers can help fund managers ensure their properties are well-maintained, tenants are happy, and rental income is maximized. One person cannot do it all, and your investors will feel more confident knowing you are paying attention to every detail.

Stay Balanced

It’s also important to regularly assess and rebalance your portfolio to ensure it remains aligned with your investment goals and objectives. Every 30, 60, 90 days is a good review timeline for new funds; every 120 days to six months for older funds. As the market changes and new opportunities emerge, you may need to adjust your investment strategy accordingly. This can be challenging, but it’s crucial for ensuring your fund remains profitable long term. Communicate monthly with your investors, informing them about market trends, your thoughts, and any potential new focus. Doing so speaks volumes to your professionalism and dedication to operate the best fund or REIT you can.

Finally, as a fund manager, it’s important to have a clear understanding of your investors’ goals and objectives. This will help you identify investment opportunities that align with their needs and ensure that your fund remains attractive to potential investors.

Balance is always best when it is done from the front and the back. Look at all sides as well as long-term results as you march forward in today’s ever-changing investment world.