Capital Allocation
Investing your hard earned savings
“I’m thinking of putting my life savings into GameStop.” — probably said.
…All year I have been discussing capital allocation strategies. I’ve needed new and differing perspectives because we are overdue for a big shake up. Including my own shake up — we have been selling assets that are fully depreciated and conducting 1031-exchanges. Handling this transition correctly is one of the most important moves I’ve made in my career thus far. A future newsletter will discuss the takeaways from this process.
Working full time in real estate, pretty much my entire net worth is tied up in real estate. For most, this would be mind boggling risk. However, not to me because this is my business; I’m not an investor per se, but an owner-operator. With that said, set aside stocks, bonds, commodities, cryptocurrencies for a moment, I’m speaking specifically on your real estate allocation.
When it comes to diversifying ones’ real estate portfolio, think not only geographically, but temporally. The best advice I’ve received so far is allocating capital towards specific tranches of the capital stack and spacing them out over a period of time, say 24 months to deploy $500,000.
Geographical is pretty simple to wrap our heads around: you don’t want to have all of your eggs in one [market] basket and see that market have a tectonic shift for the worse.1 Temporally is a whole new consideration — spacing out your capital allocations over time can reduce your risk as you can see your markets evolving and adjust accordingly.
Next, consider operational risks. Don’t invest all of your capital into one person or one management company, one property type, or one value-add process, or, again, one market. This is perhaps most true with yourself. Why put all of the execution risk on your own shoulders? I am a full time real estate investor but I invest passively with sponsors as well.
Lastly, your portfolio’s mainstay could be buying your own real estate as an equity investor but maybe balance that out by placing your hard earned capital in other positions in the capital stack. You could seek out preferred equity where your higher position in the capital stack gets a higher preferred return but forgoes the appreciation. Or you could get into the lienholder side of the capital stack and be a note investor in some form such as a mezzanine lender or a senior lienholder. These decisions are really deal specific but allow you to spread out your risk in several different ways. Again, we don’t want all of our eggs in one basket.
I may have some temporary decisions laid out on how to invest for the foreseeable future but capital allocation is an on-going discussion. I encourage you to start having capital allocation discussions with your advisors. Maybe you already have. Please comment or tweet at me with some of your own opinions on how to best invest in real estate!
— Jon
Let me point out that having a real estate portfolio all in one market has its risks, yes, but also has its rewards. One key consideration is how you can drive down operational costs with economies of scale by having a large presence in one market.