Investors regularly reassess their portfolios and rebalance in order to achieve diversification. And many view this process as a way to tweak their portfolios, making small changes. But the last year has shown us how quickly macro-sized changes can occur. These events should encourage us to broaden our concept of diversification and look beyond niches to understand the large forces at work.
Look at the huge impacts that the massive government interventions have had on different sectors of real estate. Government-imposed lockdowns attacked small businesses in favor of large businesses. Large businesses like Wal-Mart and Amazon were kept open – deemed essential – while small businesses that sold the same goods were forced to close. This meant that very large companies had a banner year and huge numbers of small businesses closed, many permanently. The real estate occupied by those business that couldn’t pay their rent has also suffered.
Apartments have been the darling of real estate investors. They are the most easily understandable type of commercial real estate investment, and the sector has been extremely hot even during the pandemic. But what will be the result of continued eviction moratoria? Anecdotally we hear that good operators have generally maintained rents. But as inflation runs rampant and workers continue to refuse to go back to work, how long will rents be maintained? Will the moratorium continue? If not, will there be a huge class of people who decided not to pay rent and will no longer be able to obtain housing once they are kicked out of their existing apartments? Will apartment owners be bailed out by the government? There are very large forces at work here and it is not at all clear what the fallout will be for apartment owners.
On the other hand, the trend for online retail has only been accelerated. Many of us have gotten used to ordering from Amazon and having everything brought right to us. This trend requires additional warehouse space for staging ‘last mile’ deliveries. It looks like large warehouse and flex warehouse demand will continue to rise.
Hospitality and entertainment properties have also been very hard hit. While this obviously hits hotels, it also affects convention centers, concert venues, theaters, restaurants, bars, and all types of entertainment. Some restaurants were able to pivot to carry-out service and transformed their business (now no longer needing a large dining room). Others went out of business.
In addition to the massive shifts in industries and real estate classes, the effects on particular geographies and locations have been profound. America has been grossly divided into ‘lockdown states’ and ‘open states,’ grouped by their responses to the virus. One can disagree about wisdom and effectiveness of lockdowns. But what is important for real estate is the mass migration away from lockdown states as well as the shift in doing business. Conferences, for example, have moved locations to open states so that they can have confidence they will be able to have their meetings.
A more pervasive shift in demographics is away from large cities and into less urban environments. As more people began to work from home, many realized that living in large cities was no longer necessary to be close to their work. And with the lockdowns the advantages of cities (lots of restaurants, the arts, etc.) were no longer available. Many have fled the high cost areas to live in a less expensive and freer environment. They are enabled to do this by the work-from-home movement. While there does seem to be some boomerang movement back to the cities, this shift of the workers who can work remotely out of the cities appears to be a trend that may continue. Obviously, such a shift will impact real estate values both in the cities and in the places these people move into.
Taking this trend to the extreme, the so-called ‘digital nomads’ may be moving not only out of the cities but out of the country. An increasing number of people, realizing they can work from anywhere they have an internet connection are finding they can be in paradise spots with no impact on their professional lives. Property in such attractive expat locations as Costa Rica, Panama, and Belize is in high demand. And other countries (particularly those that have reasonable travel restrictions) may be benefiting from this trend as well.
What does all this mean for diversification? The attractiveness of secondary and tertiary markets has dramatically increased and the risk of tier one markets has increased. Foreign real estate has never been more attractive. Perhaps more important is the realization that government can get away with far more intrusive and drastic actions. Prior to the pandemic no one would have thought the government could exercise authority to choose which businesses are ‘essential,’ to indefinitely mandate closure of businesses, or to require sensitive disclosure of health information just to shop. These actions change the investment calculus and turn tried and true rules of thumb on their heads. And they should strongly encourage all investors to rethink diversification in light of these potential massive changes to standard operations. Given these massive changes is your portfolio still diversified? Or is there one of these forces that affects all of your holdings at once? Worth a new look.
Steve Streetman is a real estate consultant specializing in deal structuring and the use of cryptocurrency. Look for his book, “Cryptocurrency and Real Estate: how to profit as Bitcoin and Blockchain transform real estate investing” available now on Amazon in paperback and ebook formats. You can also find out more at https://CryptoREBook.com.
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