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Portfolio diversification is a cornerstone of any successful portfolio construction strategy. Traditionally, when long-term investors think about a diversified portfolio, they often consider real estate as one of the diversification pillars – along with other alternate assets such as gold and commodities. However, there are multiple options to achieve diversification in a real estate-focused portfolio (though “true” diversification requires a broader focus than just real estate). Understanding what that entails may help you make more informed portfolio construction decisions.  

What Diversification entails

Investors (and sometimes, professional investment advisors too!), have their own unique approach to getting real estate exposure in their investment portfolios. Some might look at investing in Real Estate Income Trusts (REITs) to get that exposure. Others may choose real estate-focused stocks and Exchange Traded Funds (ETFs) to do so.  Some investors, especially retirees, may opt to buy a family cottage, while others might consider investing in a timeshare to achieve hard asset-based portfolio diversification. 

Diversification helps reduce various types of risks in portfolios, including concentration risk – which occurs when you have one (or too few) types of assets or themes in a portfolio. While each of the approaches, highlighted in the prior paragraph, might offer incremental forms of diversification, not all of them might be appropriate as a diversification risk mitigation tool. 

Looking Under the Hood

To understand how diversification works, and why it matters, let’s take a closer look at three of the diversification ideas discussed above.

TIME SHARE

Technically-speaking, when you invest in a timeshare, you own real estate – albeit fractionally, nonetheless, as a timeshare owner you add real buildings and facilities to your investment portfolio. Let’s look at how Timesharing fares as a diversification tool:   

• Of the three approaches, Timeshare investments might be the least favorable

• They’re not a full ownership investment. You get fractional ownership, which gets you a non-controlling interest in the real estate. And that’s typically not something you wish for in your portfolio
• Over time, their resale value depreciates. Investors often can’t sell their timeslots at the original or higher prices, so they offer their partial ownership at lower-than-purchase price. This phenomenon, known as “offloading”, then drives down pricing of the asset 
• Because others also have a stake in that same real estate, you can only enjoy your share for a limited time during your ownership (a couple of weeks a year)
• “Enjoyment” isn’t typically spontaneous – you must book months in advance. If plans change, you might have to forego living in it for that year
• You still pay maintenance throughout your holding period, which can add-up over a 10 to 15-year holding period  

OUTRIGHT PURCHASE OF PROPERTY

Buying property (cottage, condo, rental home) outright might be the best option, since you’ll typically (hopefully) earn significant price appreciation in the long run. However, this form of portfolio diversification usually comes at a higher price point. A cottage, condo or freehold home is likely to be more expensive than a Timeshare ownership:

• You could get stuck in a price bidding war, which drives up the cost of your initial purchase
• You must arrange a down payment – unless you’re flush with cash, which might mean selling other parts of your portfolio (perhaps stocks that have appreciated) to fund your initial deposit
• You’ll need to consider taking on debt (mortgage), which can be a risky proposition if you’re approaching retirement and can’t pay it off before then
• You’ll also be responsible for paying taxes, maintenance, cost of upgrades, and periodic renovations and regular upkeep – it all adds up  

STOCKS AND EXCHANGE-TRADED FUNDS (ETFs)

There’s a middle-of-the road approach, which entails building a well-selected portfolio of real estate-related stocks/ETFs. More appropriately, from a diversification standpoint, you’re not limited to just a single property – vacation resort, freehold home, cottage – but gain exposure to a wider range of real estate, including industrial, commercial, residential, leisure, and professional. 

• Over the long-term, if you choose them right, your choice of stocks and ETFs are likely to appreciate and avoid volatility in price action when compared to other investments
• Most blue-chip stocks and real estate investment trusts (REITs) pay a healthy dividend – so you also earn income while you own these investment vehicles
• If you need cash, you can sell portions of the portfolio and earn capital gains 
• It’s relatively simple to buy/sell them – buying/selling won’t be as expensive as buying/selling property
• Though you do need to pay taxes and fees, those won’t be as high as what you pay if you sold your cottage or investment property

The best approach to achieving real estate diversification is by selecting the types of assets with minimal risk. While Timeshares are marketed as great investments for vacationers, they don’t offer true portfolio construction value. This is partly why many consumers have sought timeshare cancellation services to help them get rid of their unwanted contracts. Owning a home or other property outright, on the other hand, entails significant cost and maintenance responsibilities. 

Stock portfolios might therefore be a good way to not only add diversification to an investment portfolio, but might also be a novel way to earn passive income (through dividends and capital gains).

Creating Diversified Stock Portfolios

To better evaluate how diversification might play out in a real estate-based portfolio, we’ll construct two such hypothetical portfolios. Our first portfolio is meant to simulate a play on timesharing and short and longer-term rental. We’ve used stocks of companies in that space as a proxy for just such a portfolio.  

Over the course of the last 4-months or so, this portfolio has lost almost -6.5% of its value. 

On a medium-term analysis (200-days), the portfolio has performed well, netting investors a nearly 10.5% ROI. Because jurisdictions all over the world have only more recently (within the last 3 to 4-months) started easing travel restrictions, the 4-month view might be a more relevant reflection of this portfolio’s current performance.

Now, let's look at Portfolio B, a collection of REITs and industrial, residential and commercial property businesses.

In the shorter-term horizon, this portfolio of diversified real estate-related businesses, from multiple industry sectors, handily outperforms its Timeshare/vacation rental peers. But let’s review how this portfolio performs on the medium-term horizon.

In this extended view, Portfolio B delivers an unbelievable 42.5% ROI. One point of note is that both portfolio returns do not include dividends or distributions. Bottomline: Over the course of both, 120-days, and 200-days, the timeshare portfolio underperformed the REIT portfolio significantly, making the latter a better diversification strategy than the former.