[Editor's Note: This is a guest post by Phil Ayres, the Chief Technology Officer for REPSE, a real estate platform not dissimilar from blog sponsor Realty Mogul. This site “helps investors understand their preferences for real estate investment opportunities and match them with project sponsors and developers who have private investment opportunities corresponding to their criteria.” While I certainly consider private investments an optional part of your portfolio, there is no doubt that real estate has a long track record of solid returns, and investing in it in a syndicated manner eliminates most of the downsides of REITs and the downsides of landlording directly, although at a cost. It is often difficult to learn about private investments, so I hope to provide some insight into how to learn about them by including posts like this. In this post, Phil makes the case for private real estate deals such as those available on REPSE. We have no financial relationship at this time.]
A financially successful medical professional ranks highly as a target for wealth managers, and for good reason. You appeared on their radar by having assets that need managing more actively than the free time your profession allows. After a while though, a bunch of mutual funds and ETFs with a major brokerage does not feel like an active or exclusive way to grow your wealth. This is the point when professionals who would consider themselves experienced investors start to see the attractiveness in real estate investing. [Editor's Note: Introductory paragraphs are notoriously tough to write, but successful investing isn't about your emotions, feeling “exclusive,” or necessarily “being active.” The attraction of branching out into private real estate investments should be solid returns and diversification for the portfolio in my view.]
Rather than buying and leasing properties, there is another more hands-off approach. Investing in the equity of companies that run real estate projects carries many of the benefits of owning income generating properties, without the need to collect rents and fix toilets. This form of investment in real estate projects, often termed equity or passive investing, more closely fits the time pressures of your profession.
Is being “alternative” bad?
Passive real estate investment is pushed into the category of alternative investments by most investment advisors. If it doesn't fall into the traditional asset classes of stocks, bonds, and cash, then it is “alternative”. This may be fine when viewed through the same lens as private equity, commodities, hedge funds and financial derivatives, but alternatives can also include collectibles such as rare wines, artworks and vintage cars. [There is no doubt that most asset managers working for an AUM fee will recommend against this type of investment due to lack of familiarity and a financial conflict of interest- they make less money if you invest in something they aren't managing.-ed]
For successful professionals, who are experienced, accredited investors there are some major appeals to looking at mainstream alternatives such as investment in real estate projects. Escaping the clutches of Wall Street for every penny you own may be one. Gaining a few more back from the IRS for certain real estate tax advantages may be another. But a wealth manager tied to a major brokerage is unlikely to ever suggest moving funds they have under management to these alternative investments. So it is worthwhile understanding yourself what the motivations are for alternative investment opportunities.
Diversify within diversification
A major investment aim for alternatives like real estate is that they have a low correlation with the regular stock market. Stocks, bonds and foreign exchange can circle around mass investor sentiment, politics and central bank policies. Real estate on the other hand is tied closely to more local trends and needs.
With real estate, investors are able to more broadly spread risk through diversification. Real estate has a whole set of asset types, classes and risk profiles all of its own. For example, an investor can make multiple investments across multi-family, office and retail properties, in several geographic locations across the country, with a mix of new construction, rehab and income generating rental properties. With such a mix, real estate investments can help to smooth out much of the traditional market volatility from the stock market.
Deal by deal
A common reason for experienced investors to allocate capital to alternative investments is in the hope of earning higher returns than a mix of stocks, bonds and mutual funds. With this potential for higher return of course comes risk.
Every deal is different with alternative investments and private placements, so significant investment analysis and due diligence on individual opportunities is the only way to mitigate some of this risk. You don't get the benefit of an investment advisor's team of analysts when looking at this space. But you can take a bet that if a bank is willing to give a real estate project a commercial loan at a good rate, somebody with experience has assessed the project to have a reasonably low risk of utter failure. [Massive bank failures, bank bailouts, and real estate foreclosures in 2008 provides a good counterpoint to this argument.-ed]
Unlike more obscure alternatives that require a true passion for the asset being acquired, real estate has the advantage of being easier to assess current market value and potential to earn income. Although by no means perfect, comparable properties in the local area provide a strong guide to the worth of a property. Coupled with existing income and conservative projections for the future, potential investment returns can be examined, dissected and understood.
Nobody can guess where a real estate market might go in the future, but local market forces can be easier to divine than the global sentiment that drags Wall Street along for the ride. With research, speculation and no small amount of luck, returns can be greater than you might achieve with even a risky ETF suggested by an investment advisor.
Passive, but not ignorant
Investment in real estate projects is only passive from the point of view that an investor owns a share of a company, rather than directly owning the real property and participating in management and construction responsibilities. The passive part is about providing experienced project sponsors the capital required, so they can get on and do the jobs they do best, whether that is working with a general contractor, collecting rents or fixing bathrooms.
A good developer will keep investors apprised of the progress of the project, milestones and financials. This helps you remain attached to the investment over the years. Sometimes, the investors in a project may be asked to make decisions about changing management structure, taking on more debt, or exiting the investment early. On top of the initial research effort into an investment opportunity, this interaction provides investors a feeling of ownership that just doesn't come from owning a few millionths of a Google or an Apple.
Less regulation, more lawyers
Alternative investments offered privately to high net worth accredited investors gain some efficiency from having a lower regulatory burden than public companies. And with this lighter regulation comes some risk for investors too. Essentially, any real estate project needs to explicitly offer transparency in terms of feedback, financial reports and updates given to investors where the regulators do not necessarily demand them.
Without the comfort of an investment advisor's analysts, investors need to look out for themselves when examining any deal. A private real estate investment offering is really just a glorified legal agreement wrapped up with certain securities regulators' requirements. Like any serious contract, getting a lawyer involved is essential.
Private investments like these rely not just on legal and financial analysis, but on trust in the sponsor of a real estate project and the ethics that they display. These must play a role where regulators and independent auditors do not. Getting to know who you are investing in becomes an important part of your due diligence.
Is it for you?
Are you comfortable committing time to research projects, and risking some capital to an alternative investment that your investment advisor may not be able to discuss? Are you able to have money tied into a project for years? Do you like the idea of taking a risk for the potential of a greater reward than you might get from your regular investments? Answering negatively to any of these questions may well rule you out.
A serious understanding of the types of real estate projects and how to participate in them can help if you are interested in this type of alternative investment. Learn more about investing in real estate here.
Do you already own investment real estate properties? Have you invested in private real estate projects? How do they compare? What would persuade you to add real estate equity investments to your portfolio? Comment below!