Building an Antifragile Portfolio
Teacups and human bones. These are two of the simplest examples Nassim Nicholas Taleb (of Black Swan fame) uses to illustrate the Antifragile concept in his book of the same name.
Both teacups and bones can be broken. But teacups are fragile and especially susceptible to shocks. Gently shaking the box they are stored in will not make them less prone to break when dropped. And once broken, they’ll never be the same again.
Bones on the other hand, are antifragile. They can heal themselves when broken, and unlike teacups benefit from outside shocks like resistance training, becoming stronger over time.
The fragile/antifragile concept can be applied across any number of disciplines, from health and fitness to finance and politics. In general, the antifragile system is one where stress, shocks, or volatility are sources of strength instead of weakness, and the benefits are not only downside protection but also upside optionality.
Clint Myers does an excellent job in this post applying the antifragile concept to individual properties in a way that makes immediate and intuitive sense.
Taking it a step furhter and thinking about this from a real estate portfolio management perspective:
If the ultimate goal is to build a long-term compounding machine, with durable and growing cash flows that drive appreciation, then we want to avoid being overly exposed to likely risk factors in any one year, while maintaining the ability to take advantage of unexpected opportunities.
What does that look like?
Staggered debt maturities – This allows the investor to avoid concentrated refinancing risks, and ensures the average interest rate across the portfolio will be less volatile than market rates from year to year. When financing markets are favorable, the investor can take advantage at assets with maturing debt.
Lower loan-to-value – Provides a margin of safety to absorb a down year in property operations and reduces the likelihood of a forced or distressed sale situation. It also allows flexibility in uses of cash flow and the investor can always increase the loan amount at refinance if terms are favorable.
Staggered lease rollover – Paying attention to lease rollover across the portfolio, not just at the property level, translates to more consistent income, spreads out lumpy leasing costs, and reduces the risk of overexposure to a recessionary leasing environment in any one year. It also means that there are regular opportunities to mark a portion of the portfolio to market in times of rising rents.
Time diversification in acquisitions and dispositions – This reduces the risk of buying or selling the entire portfolio at the top or bottom of the market. The investor is always able to upgrade the portfolio without trying to time the market to perfection.
Ample Liquidity – To be able to weather unexpected vacancies, repairs, or lower refinance proceeds, or to have ready capital to snap up compelling acquisition opportunities.
An antifragile portfolio mindset offers not only downside protection but also upside optionality.