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Practical guide to Diversification: what it is and how to do it

28. September, 2022

When evaluating how to invest today, the concept of diversification is often part of the macro-issues discussed with our clients. When dealing with real estate investments overseas, we at OPISAS often have to deal with the concept of diversification, as this is one of the main reasons why an investor decides to act in a different country rather than his own.

The concept of diversification can be easily explained by resorting to the quote of “don’t put all your money under the same mattress” or, better still to convey the idea of the fragility of some assets: “all the eggs in the same basket”.

Although these quotes date back to the dawn of personal finance, we can say that even today the concept of diversification plays a key role in planning a good investment portfolio.

In order to understand how to invest today in the best way, more and more people show a certain curiosity in foreign dynamics and in what they can really offer. In fact, it is not surprising that many investors who contact us from all over the world are already active on the local market in their home country and are worried about the possibility of falls in the market in which all of their capital is invested.

It is not difficult to meet investors who, in addition to their personal residence, own a second home that can be used as income, perhaps a few kilometers from their home. Although having a property near your home creates the idea of greater control in the investor’s mind, in the event of unwanted market fluctuations, there is a risk of not having an alternative resource that creates assets.

The concept of diversification becomes fundamental in a specific phase, that is, in investment planning. In other words, it becomes appropriate to talk about it when deciding where to allocate your capital in order to balance and limit risks.

Let’s see in practice what are the different ways to implement a good diversification of your portfolio and how to invest today in the best way.

 

Diversify by asset 

Diversification by asset is the most adopted by investors, as it just means avoiding concentrating all the capital in a single type of investment (real estate, stock exchange, securities, currencies) and therefore investing in several different assets. The concept underlying this choice is to act on different assets for incomes which undergo more or less reduced fluctuations or which can be resold at different times. The investor thus has a certain autonomy in managing his portfolio and significantly reduces the risk of a total loss of his assets.

We can say that the foundation on which diversification is based is simply the high improbability that all the assets in which one has invested will collapse simultaneously, thus leading to a total loss of one’s income.
 

Diversify by currency

Another pillar of good investment planning is currency diversification. Also in this case, acting on currencies other than that of your own country, you can reduce the risks deriving from out-of-control exchange rate fluctuations. In this case, the choice of the foreign country in which to invest part of one’s capital is strictly linked to the currency that represents it and is a fact to consider when planning how to invest today. In fact, it is preferable to act on currencies that are an international reference point, as well as that have shown a certain flexibility over the years. A practical example is certainly represented by the US dollar.

Diversify in real estate

But let’s focus now on the asset that, if held directly, favors greater autonomy of action and which by its very nature is considered more concrete and stable: the real estate asset.

In our previous article we analyzed the reasons that lead an investor to choose real estate investments overseas for the future of their family. Now let’s see how to invest today and why it is appropriate to implement good diversification, or to act on real estate properties located overseas.

1) Diversify by location

In the act of understanding how to invest today in the best way, diversification by location is undoubtedly one of the most appreciated and used by investors. Indeed, it is certainly recommended to act on multiple properties located in different locations, rather than on multiple properties in the same residential market. Acting on different countries, each with its own laws, its internal market and its international attractiveness, it is in fact possible to dilute the risk deriving from any losses in the local real estate evaluation.

Furthermore, from a more general perspective, it is very important to remember that, in the case of income properties, with the same overall investment, it is preferable to own several properties of limited value rather than just one of the entire amount invested, since this strategy allows to ensure continuity in rental income even in the event of unforeseen events. To understand this concept, just think of the possibility of a change of tenant: if one of the tenants settled in one of our properties decides not to renew the lease, it will in fact be necessary to find a replacement tenant. The fact of owning other leased properties at the same time would in any case guarantee the continuity of income. The basic rule is therefore to ensure continuity in income, even if one of the investments made is unable, for a short period, to provide the usual income. This is the rule that best of all explains how to invest today.

2) Diversify by use of the property

Another key factor of good diversification, often underestimated, concerns the different types of properties in which to invest. A real estate property that generates an income, can in fact be rentable in the short term (for example per night), or long term (generally with annual or multi-year leases). There are also properties with intermediate solutions, such as monthly rent, but beyond the opportunities offered by the market in this sense, what is important to know is that paying attention to this factor can allow you to diversify successfully and meet the needs of those who are considering how to invest today in a best way.

A practical example is represented by investors who purchase properties with different types of rent: properties with short-term rental, such as Vacation Homes that allow you to combine personal use for your holidays and returns by renting the unit when not it is used, and pure investment properties rented on a long-term basis or with tenants already settled inside who pay the rent monthly.

3) Diversify by exit strategy from the investment

Speaking of property revaluation, a method through which it is possible to diversify in the best possible way is based on the careful analysis of the residential market in which you are going to invest.

As mentioned above, each location has its peculiarities and its demand for housing. Generally, based on the timing of the exit strategy from the investment, we can distinguish two major types of properties: properties that accrue a capital gain in the short-medium term and those that accrue a capital gain in the medium-long term.

In the making of a well-diversified package of real estate investments, it is good practice to invest in properties in markets that present different behaviors in terms of capital gains (i.e. the difference between the price at which the property is resold and the one at which it was purchased). In simple terms, in building your real estate investment, you can combine properties located in markets with an international appeal in which the revaluation normally takes place earlier in time and properties to be held in the portfolio for longer, for example in a market that offers good rents and immediate stability, but which sees a progressive growth in real estate values in the long term.

All clear, but how can I start diversifying today?

A good solution for those who are approaching real estate investments overseas for the first time and are inquiring about how to invest today, is to plan an investment in a location with accessible values ​​and stable returns, such as those proposed by OPISAS.

Focusing on accessible values ​​for each property, it is possible to decide to diversify from the beginning by acting on different properties located in different markets and with different characteristics. If you opt instead to start with a first test investment, the advice is to start with markets that have a short-medium term exit window.

 

For more information

For your U.S. real estate investments, you can write to contact@opisas.com to schedule an appointment with an advisor who is an expert of the U.S. real estate market.

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