How many deals is enough before the diversification actually does something

Question

Underwriting is what I spend my days on, so I want to sanity check the portfolio construction side rather than the deal side.

If a typical equity offering has some real probability of returning less than capital, then a book of 5 positions is mostly a bet on 5 sponsors and a book of 40 is closer to an average. Everyone says diversify, nobody says the number. At a $10k minimum, 40 positions is $400k, which isn't nothing.

Does the marginal deal stop helping somewhere, and does it matter that most of these deals share the same rate environment and the same exit assumption?

stephen_ok9 · Answer

Correlation caps it. Once your positions all depend on cap rates at exit and on rent growth holding up, adding the 30th deal removes sponsor-specific risk and does nothing about the shared risk, which is the bigger term. I'd rather have 12 positions spread across property type, geography, vintage year and debt versus equity than 40 multifamily value-adds all bought in the same window. Vintage spreading is the one people skip, and it's the cheapest to do since you just deploy over time instead of all at once.

laurenkim53 · Answer

Also the $10k minimum isn't universal. Plenty of the debt offerings go down to $1k or less, which is how you get position count without $400k. Lower returns, but it's a different risk to hold alongside the equity.

raj_mehta14 · Answer

I don't have the number either, but the thing I got stuck on reading about this is that a debt position and an equity position in the same building aren't really two positions. The property either performs or it doesn't. Diversifying by capital stack inside one deal seems like it counts less than it looks like it does.

How many deals is enough before the diversification actually does something

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