How To Build The Perfect Portfolio

How do you define “being wealthy”?

An offshore attorney I met years ago defined being wealthy as having enough passive income to cover all your monthly expenses.

That’s an easy answer, but not as easy a goal to achieve…

Rental income can be the perfect passive income… but unfortunately, most U.S. investment professionals don’t know much about investing in real estate.

And overseas real estate? Forget about it!

Investment professionals in the United States are all trained in financial products. As a result, the investment and retirement portfolios that most of them recommend include paper investments only, in three categories: stocks, bonds, and cash.

Depending on your age and your risk tolerance, most financial advisors will tell you to put some percentage of your investment portfolio into stocks (riskier and longer-term), another percentage into bonds (lower risk and medium-term), and the balance into cash (zero risk and short-term).

Some advisors focus on specific industries or domestic versus international offerings. Some throw metals into the mix.

Real estate is rarely, if ever, seen in an investment portfolio pie chart.

It’s not because investment advisors, as a rule, think that real estate is a bad investment. They just aren’t in the business of selling real estate. They have financial investments to sell you… so that’s what they’re going to recommend you use to build your portfolio. If you want some real estate exposure, they’ll suggest a real estate investment trust (REIT).

That approach has never made sense to me, including when I was studying it in graduate school.

Historically, many of the world’s richest people have had real estate to thank for their wealth. That fact alone should be enough to make the case that it’s counter-intuitive to exclude real estate from your investment portfolio.

Real estate has always been my preferred investment class, and my investment portfolio has the reverse problem of the portfolios most financial advisors create—it’s heavy real estate.

More than ninety percent of my investment portfolio is invested in property in some form. The few stocks that I have owned over the years haven’t done well, and mutual funds are simply fee-generation mechanisms for the managers, in my view. Few beat the market over any period of time.

I’m not recommending that you put all your investment eggs in real estate.

What I am saying is that real estate is key to any diversified investment portfolio. Further, whatever real estate assets you invest in should be diversified as well, including and especially by country.

Real estate diversification comes in three parts: the location of the property (I’m referring to the market, not the street address), the currency the property is valued in, and the property type.

By asset diversification, I don’t mean investing in a two-bedroom rental and a three-bedroom rental in different neighborhoods of the same city. You need to look at different types of real estate.

Broadly speaking, your options break down as follows:

• Rental property, short- or long-term, residential or commercial
• Land… for land banking or development
• Agriculture
• Indirect investment

While you should see some appreciation on a rental investment to help boost your overall returns, your main expectation for return on investment in this case is the net yield from rental cash flow.

Non-agricultural land, on the other hand, doesn’t generate a rental yield. In this case, you’re looking for all of your return from the appreciation of the property.

Land banking (buying land and holding it) can have tremendous upside if you buy right. But also, one big benefit of owning land is that it has little downside if you buy right.

It is a store of wealth with minimal carrying costs (usually nothing more than property taxes). You may want to keep the land cleared, and you might have an HOA fee if the land is part of a development. Otherwise, little is required out of pocket to hold a piece of land, as long as you want to hold it.

The point of an agricultural investment is a cash return, annually from crops or productive trees (fruit or nut) or every twelve to twenty-five years in the case of a timber plantation.

You don’t have to be a farmer to make money from agricultural land today. This is a breakthrough reality of our times for us global property investors… and turn-key agricultural offerings are a constant focus for me.

The final asset category on my list—“indirect investment”—refers to any property investment where you don’t own the real estate directly. This could be the REIT that your financial investment advisor suggested, or it could be an investment in a company that develops real estate or a hard money loan.

A hard money loan is when an investor lends cash to a real estate entrepreneur (a developer or someone who does renovation projects, for example). You lend the money for a short term at an interest rate that is much higher than would be typical for a bank loan.

The developer is willing to pay the higher rate of interest because getting a bank loan would be too complicated or simply not an option. You, as the investor, get the property (or a piece of the property, in the case of a big development) as collateral.

The risk with these options is that you don’t directly own or control the asset (the property).

Some types of real estate can cross category lines. Pre-construction refers to an investment in a piece of real estate that is under construction or planned for construction. It could be a short- or long-term rental, residential or commercial, or maybe a condo-hotel.

The advantage of buying pre-construction is a reduced price, meaning you should expect good appreciation during the construction period. A pre-construction investment can be flipped to an end buyer when the building is close to completion, or you can take possession of the unit and turn it into a rental yourself.

Renovation projects (fixer-uppers) offer the same choices in the end—to flip or to rent.

The upside appreciation potential of a renovation should translate to enough return to make the project worthwhile. Sometimes, though, even in a case of great appreciation, you find that you could get a great ongoing return on your investment by renting the property out.

The downside to renovations is the hard work and direct effort required on the investor’s part to make the project successful.

As you set out to build the portfolio that is ideal for you, pin down the following:

• Your budget. How much money do you have available to put into your real estate portfolio?;
• Your level of risk tolerance;
• Your diversification objectives (currency, country, category). You may want or be able to invest in only one or two properties to get started. That’s OK. That’s the idea.

And remember, it will take time to create a broadly diversified international real estate portfolio.

I’ve been at it for thirty years… and my portfolio remains a work in process.

Stay diversified,

Lief Simon

Editor, Offshore Living Letter