I've always been a strong believer in diversification, or in other words, not putting all of your eggs in one basket. Typically, when we want to learn about how to diversify our assets, the information provided through general research is on how to diversify your overall portfolio that includes public investments, such as stocks and bonds, as well as private investments, such as private equity funds and real estate.
The problem with public markets, however, is that they're shrinking. The number of IPOs has dropped by half over the last 20 years; industries such as airlines, banking and social media are dominated by just a few major players. Although I still invest in the public market, I prefer to keep my overall allocation to a minimum.
As the CEO of Stablegold Hospitality (SGH), a real estate investment firm, I've learned that, in the long term, we get a bigger bang for our buck in the private market. So, I'd like to focus solely on how to diversify within it or, more specifically, within one's real estate portfolio.
My allocation approach is as simple as pie. I call it the 60/20/20 rule.
1. 60% For Multifamily Residential Properties
The ideal scenario for any real estate investor is, at a minimum, doubling your cash flow from the same square footage you receive with a single-family property. The security and consistency of such an investment also make up for the volatility of our investments in other markets or asset classes, which is why I park the majority of our firm's funds in this piece of the pie.
During times like these, when inflation is rising and fewer people can afford luxury homes, there will always be a growing demand for affordable living space.
When purchasing a multifamily property, remember that the initial cost must be low enough to ensure the property has a positive cash flow very soon after the purchase. However, this doesn't mean investors should focus solely on turnkey investments. Older buildings in low-income areas, for example, may initially require additional investment to bring their living standards up to code. The revenue gained from steady, long-term renters, however, will likely reward that investment with sizable dividends shortly thereafter.
2. 20% For Vacation Rentals
Although holiday planning is not top of mind for everyone right now due to the spread of Covid-19, it's important to remember we're in a situation that will not last forever. Just as crude oil prices have dropped, the resurgence of vacation planning is as inevitable as us driving our cars to and from work again. In a similar vein, whether it's for family, business or personal reasons, we'll all need to travel abroad and find accommodations again.
Vacation rentals are another great way to gain more income from the same square footage you would receive after purchasing a single-family property.
While managing our firm's portfolio of vacation rentals, I've seen how easily hosts can make three times more on short-term rentals compared to what they would make with long-term rentals in the same space. When this rental is located near a popular event space, such as an arena for hockey games or an outdoor space that hosts annual festivals, profits can soar even higher — up to 10 times as much.
3. 20% For Private Equity Real Estate Funds
Private equity or real estate firms often take on the roles of fund and property managers. After finding contributors for a blind pool fund (i.e., blank check offering), investors could be rewarded with a significant amount of passive income.
When funds include investments on multifamily properties, it's a huge benefit to contributors because much of the legwork is done for them. In our case, for example, all of the staffing, security, insurance, ongoing maintenance, marketing, accounting and legal services, to name a few, are outsourced.
The 60/20/20 rule works best for seasoned real estate investors who enjoy taking an active role in the management of their properties because it gives them a balance between earning active and passive income. Those who prefer earning more passive income and have found a private equity firm with a great track record they can trust should consider increasing this piece of the pie.
If you're an avid investor in the public markets, I still recommend increasing your investments in private equity funds, in addition to multifamily residential properties. Vacation rentals, on the other hand, can be subject to volatility during times like these, and you may be getting enough instability in the public markets.
Although it's hard to predict where public markets will be in the next 20 to 30 years, it's never a waste of time to invest in stocks and bonds, especially for those who study this market on a regular basis. However, consider keeping the majority of your funds planted in real estate. As long as the world's supply of land is diminishing and people need homes to live in, it's bound to be stable.