DIVERSIFICATION AND RISK IN REAL ESTATE INVESTMENT

James Lynch
3 min readAug 2, 2018

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The fact that higher‐return investment portfolios have higher risk must always be remembered. The relationship between risk and return is one that always has to be allowed for and this is the case in real estate as much as it is in any other markets such as shares, commodities or even cryptocurrency.

It is, however, possible to reduce risk for a given return by diversifying the investments held within an investment portfolio. Diversification can be achieved within an asset class; and between asset classes. CastleCoin focusing on the real estate sector, via its tokenised fractionalisation of real estate allows for diversification by giving potential investors specific exposure to multiple individual investments and properties within a single market which maintain lower capital requirements than conventional real estate investment. To emphasise the scale of existing capital requirements for conventional real estate investment in Australia you only need to look at the median house prices in Melbourne and Sydney which are around AUD$1M. Leveraging and investing in a single asset such as this depending on the size of your purse really becomes the definition of putting all your eggs in one basket and greatly increases your exposure to risk.

Economists have been analysing how diversification affects risk for some time, beginning with simple illustrations and then statistical illustrations. The early theoretical work on the subject was carried out by a Nobel prize‐winning economist, Harry Markowitz, who published his first paper on the subject in 1952. The understanding of the relationship between risk and return introduced by Markowitz was an important contribution, but it was not until another ground‐ breaking study was carried out by Meir Statman in 1987 that the benefit of diversification could be measured in any way. Statman used historical return data from companies listed on the New York Stock Exchange, and calculated standard deviations for 1,000 shares. He then constructed portfolios beginning with a portfolio consisting of one, then a portfolio of two stocks and so on, all the way to a portfolio consisting of 1,000 stocks. He then measured the standard deviations for each separate portfolio and found that the portfolio standard deviations declined.

The benefit of risk reduction occurs quite rapidly as more stocks are added, with specific risk being almost entirely eliminated with a portfolio of between thirty and forty stocks. Statman used this observation to suggest that the optimal equity portfolio was one consisting of between thirty and forty shares because the costs associated with further diversification, such as administration costs, would outweigh the benefits of diversification beyond that point. That said it should be noted that market risk — that is the risk attached the entire market where investments lie still remains and the only way to reduce market risk is to diversify into other asset classes entirely, or not participate in the particular market. Statman’s findings have been applied almost exclusively to shares, but they work for other asset classes as well, such as real estate facilitated via the CastleCoin platform.

CastleCoin is a blockchain based Australian Real Estate investment platform that establishes a community empowering buyers, vendors and market participants to engage in an ecosystem supporting a more efficient investment sector. Capital requirements, liquidity, viable asset selection and document management all represent barriers to entry and complications that currently exist in the conventional real estate investment framework. In recognising these limitations, by tokenising real world assets, whole and fractionalised, CastleCoin, employing the use of Ethereum network, smart contracts and tokens, offers a blockchain based property investment platform for the buying and selling of Australian real estate which is fast, immutable, fluid, intuitive and accessible for vendors and investors alike.

www.castlecoin.io

https://t.me/CastleCoin

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