Investing is a journey of balancing risk and reward, and diversification is one of the most effective strategies to achieve this balance.
But what exactly is diversification in investing, and how can it benefit your investment portfolio?
Understanding Diversification
Diversification is the practice of spreading your investments across various asset classes to reduce exposure to any single risk. By not putting all your eggs in one basket, you lower the potential impact of any one investment's poor performance on your overall portfolio. The fundamental idea is that different assets often react differently to economic events, so stability or gains in another might offset a downturn in one area.
When we talk about diversification, real estate often emerges as a valuable asset class to consider. Investing in real estate offers several potential benefits that can enhance your portfolio's stability and potential for growth.
Stability in Volatile Times
“Public markets are quite volatile. Stock prices can fluctuate wildly due to economic events, geopolitical tension, and pent-up pressure from the massive derivatives market. This volatility can be particularly pronounced during times of economic upheaval. For instance, since the onset of the COVID-19 pandemic, we’ve witnessed dramatic swings in the stock market, influenced by pandemic-related disruptions, supply chain issues, and shifting consumer behavior. This real-time example illustrates how susceptible stock prices can be to rapid changes and uncertainties,” says Cameron Wu, Vice President of Investments.
In contrast, real estate typically experiences less volatility than stocks. While real estate markets aren't immune to economic shifts, they tend to be more stable. Thanks to their tangible asset base, real estate investments have historically delivered strong risk-adjusted returns, frequently outperforming the S&P 500.
Demand vs. Supply
One of the main reasons real estate is such a strong diversification tool is its consistent demand. In the U.S., there's a significant housing shortage — estimates suggest we need between 4 to 7 million more homes to meet current needs. Factors like population growth, increased urbanization, and a rise in single-person households drive this shortage.
Even during economic downturns, the basic need for housing remains unchanged. People will always need a place to live, which provides a steady foundation for real estate investments. Unlike stocks or bonds, which can be highly sensitive to economic shifts and market sentiment, real estate is less affected by short-term market volatility because its demand is rooted in fundamental human needs rather than market trends.
Additionally, real estate markets are shaped by local supply and demand dynamics. In areas with booming job markets or growing populations, the need for housing often outstrips the supply, driving up property values and rental income. While some markets might face oversupply issues, these are usually more localized and easier to navigate than broader economic fluctuations.
Diversification Within Real Estate
Diversifying within real estate can enhance your investment strategy by spreading risk across various property types. Here’s a quick look at how different real estate investments can complement each other:
- Residential Properties: These include single-family homes and apartments, which can offer stable demand and reliable rental income. They’re generally less volatile and more predictable.
- Vacation Properties: Hotels and short-term rentals can yield high returns, especially in tourist areas, but they often come with seasonal fluctuations and require active management.
- Real Estate Funds: Real estate funds like the Arrived Single Family Residential Fund and the Arrived Private Credit Fund let you instantly diversify into several properties or real estate projects nationwide.
By tapping into multiple types of real estate investments, you can take advantage of different market opportunities and potentially cushion the impact of any single market trend.
The Importance of Long-Term Investing
Investing in real estate is not typically a get-rich-quick scheme. It requires a long-term perspective. Real estate investments often involve holding properties for extended periods to realize their full potential in terms of appreciation and rental income. Focusing on long-term investments can help you ride out short-term market fluctuations and benefit from the compounded growth of property values and income streams.
Diversifying across different asset classes can help mitigate the impact of volatility from any single investment. With its lower volatility and reduced sensitivity to market fluctuations, real estate can offer a more stable investment option. Arrived further enhances this stability by providing a range of diversified real estate investments through our Private Credit Fund, Single Family Residential Fund, and tailored property portfolios.
