How to Diversify Your Investments in Real Estate

EDITOR’S NOTE: This article is part of our Money254 Partner Series produced in partnership with Vuka, an investment club that allows Kenyans to invest in the Acorn Student Accommodation I-REIT.

Investing in real estate is a powerful way to build wealth and earn passive income. However, it also involves certain risks and challenges. While the returns from real estate can be substantial, the initial capital required is often high, which may compel people to concentrate their portfolio on a single type of asset. 

However, this lack of diversification can expose investors to significant risks, particularly when their portfolio is heavily invested in physical assets such as land or buildings. 

Investing in real estate without diversifying your portfolio can expose you to several challenges and risks, including:

• Market Risk: A concentrated investment in a single type of real estate, such as land or rental properties, can be highly susceptible to market fluctuations. Economic downturns can reduce property values and rental incomes. 
• Liquidity Risk: Real estate is generally less liquid compared to other investments. If you need to convert your assets into cash quickly, you might face difficulties, especially in a down market or with properties that are harder to sell, like specialised or rural land parcels.
• Concentration Risk: Relying solely on one or two types of real estate investments means that your entire portfolio is vulnerable to issues specific to those types. For instance, if your entire portfolio is located in an area affected by insecurity, then you may suffer losses or low returns. 
• Income Volatility: Solely relying on rental properties for income means your cash flow is directly tied to occupancy rates. High vacancy rates or non-paying tenants can cause significant income fluctuations.
• Dead Capital: Investing primarily in land can be risky since undeveloped land doesn't generate regular income, and its future value can be highly speculative. 
• Regulatory Risk: Real estate investments are subject to various county and national government regulations. Changes in zoning laws or tax codes (affect the annual land rates you pay) can significantly affect the profitability of your investments.  

One effective strategy to manage these risks and overcome those challenges is through diversification. 

What is Diversification in Real Estate 

Diversification is a risk management strategy that helps prevent "putting all your eggs in one basket," which can cause significant losses when things go south. 

In real estate, diversification can be understood in terms of asset type, investment structure, and strategy. The idea is that your investments are not all prone to the same market dynamics. 

Benefits of Diversifying Your Investments in Real Estate

Diversification can stabilise your income by balancing underperforming investments with those doing well. For instance, if rental income from one property decreases, income from other properties can help offset the loss.

Secondly, spreading investments across different types of properties and geographical locations and using various investment vehicles like direct property ownership and Real Estate Investment Trusts (REITs) can help mitigate market risks and reduce reliance on any single investment. 

Finally, diversification allows investors to balance liquid real estate investments, like I-REITs, with illiquid investments, such as a plot of land. 

How to Diversify Your Investments in Real Estate

Invest in REITs 

An income real estate investment trust (I-REIT) is a regulated collective investment vehicle that owns, operates, and invests in income-generating properties or properties by pooling funds from a group of investors. 

These properties can include commercial buildings, residential apartments, industrial facilities, and other real estate assets, offering a great opportunity to diversify your investment. 

Investors can buy shares in an I- REIT, gaining exposure to a diversified portfolio of real estate assets without the need to purchase or manage properties directly. I-REITs pay out rental income as dividends to shareholders.

Unlike other real estate investments, I-REITs have low starting capital. For example, with the Vuka Investments Club, you can start buying units from as low as Ksh5,000 per month. Liquidity is further preserved as it is possible to buy and sell units from platforms such as the Vuka Investment Club - all in real-time. 

Invest in Residential and Commercial Properties 

Residential properties include bungalows, apartments, maisonettes, and other structures where people and families reside. Commercial properties encompass office buildings, retail spaces, and industrial properties.

Investing in residential and commercial properties can balance and diversify income streams, as these sectors often respond differently to economic conditions. 

Invest in Land 

Adding a physical piece of land to your portfolio can provide balance since it has different market dynamics from the performance of developed real estate. Additionally, you can lease your land for agricultural, commercial, or other projects to generate income while you wait for its value to appreciate. 

Land investments often have lower maintenance and management costs than rental properties, and they can, therefore, maximise returns. This may favour people with long-term investment horizons. However, investing in land should not come at the cost of preserving your liquidity since a piece of land may take months or even years to liquidate. 

Diversify in Different Geographical Locations 

Geographic diversification helps spread risk across various locations. When you invest in properties across different cities and regions, you can mitigate the impact of local economic downturns, regulatory changes, or natural disasters. 

Different areas may also experience growth rates. Diversifying geographically allows you to take advantage of varying market conditions and opportunities. 

A Case Study of the Vuka Investment Club

The Vuka Investment Club lets you invest in one of Kenya's top I-REITs, the Acorn Student Accommodation I-REIT (ASA I-REIT).

Investing in the ASA I-REIT gives you indirect ownership in over ten student housing properties under the Qwetu and Qejani brands. These properties are located near major universities in Nairobi, including Hurlingham, Karen, Roysambu (near USIU), Ruaraka (near KCA University), Parklands, and Wilson View. 

ASA I-REITs can be an excellent diversification tool in real estate because:

1. Low Entry Point: Unlike traditional real estate, which requires significant capital, Vuka allows you to start investing with as little as Ksh 5,000 per month. This means you can gradually build your investment without needing large sums of money upfront. Additionally, you’ll earn rental income, which is paid as dividends.

2. Low Operational Costs: Managing rental properties involves significant effort, including finding tenants, maintaining them, and complying with legal requirements. Investing in I-REITs allows you to enjoy the benefits of rental income without the management hassles. The ASA I-REIT is managed by a Capital Markets Authority (CMA)-licensed fund manager. 

3. Liquidity: Traditional real estate investments can be time-consuming and difficult to sell. With Vuka, you can easily buy and sell your ASA I-REIT shares through their online platform. This flexibility helps you adapt your investment strategy to changing market conditions and personal goals, potentially increasing your returns.

If you are interested in the I-REITs option, you can contact the Vuka team here to see if it's a good fit for your investment needs.

Wrapping Up

Traditional real estate investments have gained popularity on account of passive returns and capital appreciation. 

However, they can be highly illiquid. Having too much of your money committed to any one investment is a financial risk. Having it all committed to physical assets such as a house or land is an even greater risk as they can be hard to turn into cash at your point of need. Thus, as you invest in real estate, remember to have a healthy balance between the physical assets and the financial investments, such as I-REITs.