By Dr. James M. Dahle, WCI Founder
How should you invest in real estate? Well, there are a lot of different ways. As those who have taken the Fire Your Financial Advisor online course know, there is basically a real estate investing continuum with maximum control on one side and maximal diversification on the other as shown in this slide from the course. The idea is to match the investment structure to the investor.
However, a lot of people are still a bit confused about the various methods to invest. Bear in mind I'm not talking about the different types of real estate (mortgages, hard money loans, mezzanine debt, preferred equity, equity, single-family homes, self-storage, trailer parks, multi-family, commercial, retail, industrial, etc.) I'm talking about the structure of the investment. Just like the relationship between investing accounts (think different types of luggage) and investments (think different types of clothing), pretty much any type of real estate can go into any type of investment structure.
In an effort to make this even easier and straightforward, I have put together a flow chart that should help. If you work your way through the questions, you should end up knowing how you should best invest in real estate. If the following information doesn't answer all your questions I would recommend checking out our No Hype Real Estate Investing course. It is the best course on the market and is the perfect place to start your real estate journey.
If that is too hard to read increase the magnification of your screen or Download Chart.
How Should You Invest in Real Estate?
Keep Things as Simple as Possible
If you start at the top, you'll see the first question deals with whether you should invest in real estate at all! I view real estate as a completely optional asset class. Technically you own at least a little bit if you own a stock market index fund. REITs make up about 2% of the US stock market. If you are the type to keep things as simple as possible, just skip a separate real estate allocation in your portfolio altogether. But if you, like me, see the high returns and low correlation with both stocks and bonds that real estate offers and think that's worth a little more complexity, then move on to the next step.
REITs
The next two questions will help you decide whether or not to just do what I did for years — a slice of your portfolio dedicated to publicly traded REITS, usually via a low-cost index mutual fund or ETF like the one offered by Vanguard. For just 12 basis points, you get all the publicly-traded REITs you want in a very liquid, very cheap, very diversified investment. These tend to be large companies that own large real estate assets and they tend to have moderate correlation with the overall stock market. But you can't beat the ease of investing in them. For this reason, I've held this particular investing structure since I started getting serious about investing 15 years ago.
If you've decided that you're willing to pay a little more in fees (to be fair, the expenses of the companies and the properties they own are not included in the expense ratio of the mutual fund), be a little less diversified, and deal with a little more hassle, we'll keep moving through the flowchart.
Direct Real Estate Ownership
The next question deals with hassle. If you don't want any hassle, again, that mutual fund is pretty attractive. If you are willing to deal with a lot of hassle in order to be able to drive your friends and family past your property and have the greatest control over your investment and taxes, then direct real estate is for you.
You can reduce some of the hassles by hiring them out, but every time you pay someone else to do something, you lose some control over how it is done and your return is reduced by the fees. This is one reason that many real estate investors think they're getting outsized returns — because they're not counting in the value of their time buying the property, managing the property, and selling the property.
For Accredited Investors: Private REITs, Crowdfunded Syndications & Direct Syndications
If you're willing to deal with some hassle, but still don't want a second job, the rest of the chart is for you. It basically comes down to your accreditation status (accredited investors either have $1M in investments or make > $200K/year), how much you have available per investment (while still maintaining a reasonable level of diversification), and whether or not you like picking your own properties.
Most funds and syndications aren't available to unaccredited investors, so their only options are the private REITs available from online crowdfunding companies. The properties in these REITs are much smaller than those in the big publicly-traded REITs and there are usually fewer of them. You may not have the economies of scale either and so fees may add up too. But in reality, you're investing in different assets. Instead of huge malls and massive apartment complexes, you might have a collection of single-family homes, triplexes, and tiny strip malls.
If you are accredited and like picking your own properties, you are likely looking for syndicated deals, where a large number of investors pool their money to buy a property. Going directly to syndicators generally requires a higher investment than going through crowdfunding companies. If you do not wish to pick your own properties or think you just aren't any good at it, then you're probably more interested in a real estate fund. Minimums on these tend to be high, so if you can't meet them and maintain diversification, your only options are access funds which will lower your minimum investment in exchange for an additional layer of fees, and the private REITs.
Examples of Real Estate Investment Structures
What are some examples of each of these structures? Well, at some point or other, I've invested in most of these structures and I currently have affiliate deals with providers of many of them.
- REIT Mutual Fund: Vanguard Real Estate Index Fund Admiral Shares
- Individual Properties/Managers: RoofStock
- Turnkey Real Estate Providers: Jax Wealth Investments
- Private REITs: Fundrise, RealtyMogul
- Crowdfunded Syndications: Crowdstreet, RealCrowd, Equity Multiple, PeerStreet, Fund that Flip
- Direct Syndications: 37th Parallel
- Access Funds: CityVest
- Private Funds: Origin, Broadmark, Arixa
You can check out other real estate investing companies from our list, but be aware that due to the long term nature of real estate investments and the difficulty in truly vetting these companies, this list is much more of an “introduction list” than most of our “recommended lists”. You can also subscribe to receive my Real Estate Opportunities email giving you information about specific deals, special discounts, and invitations to webinars. You'll receive a couple of emails a month, you can unsubscribe at any time, and it's FREE.
Do you feel ready to learn more about real estate? WCI's No Hype Real Estate Investing course is the best on the planet. Taught by Dr. Jim Dahle and more than a dozen other experts, this course is packed with more than 27 hours of content, and it gives potential investors the foundation they need to learn about all the different methods of real estate investing. If you’re interested in real estate investing, you can’t afford to miss the No Hype Real Estate Investing course.
What do you think? How do you invest in real estate and why? Argue your case for your favored method! Comment below!
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As a long-time investor in real estate, I think this is an important topic.
A lot of younger doctors ask me about this topic so I think this post will be helpful to them.
PIMD has promoted HomeUnion for turnkey and MLG as a fund. Have there been changes with those companies and the are no longer recommended or are they just not sponsors of WCI?
I think HomeUnion came to me years ago but I wasn’t super comfortable recommending a turnkey company at all at the time. I’d probably take them now. MLG is a long-time PIMD sponsor, but not one here. I don’t invest with them. That list is a list of examples, not a list of recommendations.
Would be nice to get some differentiation between different Individual Syndicators and Asset Classes as well as Different RE Funds. Are there tax implication differences between the two for a W2 employees or are they pretty equivalent? I realize you are investing in the sponsor only and trusting them to pick good properties when investing in a fund, whereas a syndicator you can vet the deal itself. Also may be interesting to discuss (even though timing is a taboo topic) the timing of investing in these deals in this current market cycle for someone looking to get in now. Or to wait 6-12 months and see where the market goes, as I am curious how a recession would affect the numbers in these deals? What would make these deals more attractive at the time of a recession (better IRR, lower Minimums, lower sponsor fees)?
Most funds/syndications are 5-10 year deals. You’ve got to have a pretty good crystal ball to time that time period effectively. Tax implications between syndications and funds are basically the same and differ more by asset class than the structure.
I initially started out with REITS to get real estate exposure and classified it under my Alternative Asset class even though there is a really high correlation with equities (I tend to think of them as real estate flavored stocks).
I like the IRS mandate that 90% of the profits has to be distributed back to the investor and it has been an income type asset with yields better than bonds (a bit unconventional but I decreased my bond % in my portfolio and increased my REIT % because of it).
As my net worth and discretionary fund grew, I dipped my toes into crowd funding. Was still nervous so only did debt deals and got paid accordingly with no loss of capital.
Hitting accredited investor status opened up a ton of doors and it is where I have been putting all my non-retirement money into since May 2017. Syndicated real estate is for me because I do not want to actively manage my holdings but of course lose some return because of that convenience.
There is some concern with real estate, which like everything cycles, and there has been talks we are approaching the end of one now. But again who knows what the future holds.
Good article.
I might suggest you expand comment on option of individual, publicly traded REITS (e.g. timber and farmland).
I own those and REIT index funds; timber and farmland has gotten clobbered recently–time will tell if it is worth the slant in the portfolio.
I invested with CityVest and so far that has been snake eyes.
I hate being a landlord; trying without and with a property manager and I still hate it. I can see how folks that have a ton of properties with a full rolodex could have an easier time of it. Analogy is probably like medicine and working at a place only a couple times a year (don’t know the formulary, the nurses, staff, local standard of care, EMR, etc).
So…I am jealous of folks who like it and do well at it, but I just need to face up to the fact that RE just isn’t for me!
Very helpful resource! Thanks for putting it together.
Investing in real estate is at first glance easier and more accessible than ever, but still has a high psychological barrier to entry.
This should help lower that a bit.
— TDD
I love that flow chart, thank you. I don’t think you need to own real estate to be a successful investor. Personally, I like the simplicity, clarity and liquidity of stock and bond index funds. If you do invest in real estate, the devil’s in the details. Typically the more due diligence and sweat equity you put into it, the better the returns.
Isn’t the biggest advantage of real estate over stocks the fact that you can invest with leverage in a way much more beneficial than in stocks? If you aren’t using leverage, does investing in real estate really outperform stocks in a way that makes up for its risk?
While leverage is more common with real estate than stocks, there’s no reason you can’t lever up your stocks too if you wish. Most people actually are doing this by carrying a mortgage on their home while investing.
At any rate, I expect stock like returns out of unleveraged real estate. An income of 4-6% plus appreciation of 3% or so. Obviously those are long-term numbers, the short term is a crap shoot. Also ignoring any tax benefits.
I have invested in several crowdfunding deals. I have had very good luck with Broadmark, around 10% return consistently. They are going public later this year so we’ll see what happens with them.
Xebec Realty has been terrible. I invested in a complex at O’hare airport and began with around a 7% return but that went to zero. I haven’t gotten a distribution in about a year. They are trying to sell the property but no luck so far. They tell me that regulations in IL is making business very tough. They seem to have a lot of excuses for their poor performance. I won’t be repeating with them.
I have money in Trion and that has been pretty good, just starting to get distributions over the past year that are inconsistent, but are related to the selling of large apartments after remodeling. They seem very good.
I don’t know if it was you, but I’ve heard about that second investment from somebody else as well. I was also kind of disappointed to see Broadmark going public, although I think there might be a significant capital gain there for us since most of their peers that are already publicly traded aren’t paying a yield like Broadmark has been.
This “going public” event has also made me rethink my approach to this asset class (which I love.) There are a fair number of these that are already publicly traded. The iShares ETF for the asset class has a 0.48% ER and an 8.84% yield in the last year.
We are very interested and have been learning lots in the last few months. Thanks for this article. It pretty much confirms the direction we’ve been thinking about which is private real estate funds. Something we’ve been trying to figure out with a fund is given they often invest in properties in multiple states and you would be required to file multiple state tax returns, what’s the hassle or potential cost associated with that? What would an average accountant charge for that sort of thing?
It’s an issue for sure. It would be nice to find a fund that only invests in tax-free states, states that take composite returns, and states I’m already filing in. The cost and hassle varies by state/fund obviously.
Real Estate (REITs) are reported to be among the sectors with the highest P/E and CAPE P/E. At this time they seem very expensive.
https://www.gurufocus.com/sector_shiller_pe.php
P/E ratios are not the proper measurement to apply to REITs.
Hi, WCI,
I’m considering syndications, private funds, or access funds options. I am concerned about whether these might make federal tax filing more complex though. Put a few $k into Prosper a few years back and have been annoyed at all the extra math required to file taxes. Can you give a sense of whether such real estate investments add significant complexity to a DIY TurboTax guy like myself?
Yes they will and do. If you want ultrasimple taxes, max out your retirement accounts and stick to index funds from one broker for your taxable account.
But I don’t find a K-1, much less a 1099, to be a major annoyance. Now having to file another state tax return on the other hand…
This is a terrific reference article! While I have always found direct investing in properties to be relatively straight-forward, I agree with the commenters who observed that a lack of insight into the various ownership structures is a genuine impediment.
This is an interesting way to look at the various options to invest in real estate. One group of companies that you have not included are NNN REITs (both public & private). These firms have outperformed the REIT index by about 5% per year over the past 10 years (including 2008). The reason why these firms have outperformed is they have long-term contractual cash flows (leases) that have rent bumps in them. In addition, they have lower costs than other REITs because the tenant is responsible for maintenance and build-outs. They also have lower maintenance cap-ex versus other REITs. This can be seen in these firms EBITDA margins in the 80s% to 90%. This lower cost model has created less operational leverage on the downside which can be seen in the 2008-9 recession where the NNN lease firms recovered to their pre-crash levels by early 2010. Another way to look at these firms are portfolios of tenants bonds.
Packer
As near as I can tell, I included both public and private REITs on that spectrum. Whether you like equity REITs, mortgage REITS, NNN REITS or whatever, doesn’t change the structure.
They’re not bonds though, don’t fool yourself. If they only outperformed the REIT index by 5% in 2008, they lost 3/4 of their value. That’s not bond-like.
Sorry for not being clear, I was referring to you flow chart your spectrum was comprehensive. NNN REITs did not loose 3/4 of their value, they lost about half of the real estate index and the total 2008/2009 loss was gone in one year. They recovered their full pre-2008 value by early 2010 and have been rising ever since. Just look at the chart of O versus the REIT index and you can clearly see the difference. It is not stable as BND but is somewhere between bonds, REITs and stocks with higher than REIT and stock returns.
At the core NNN lease firms have first-lien claims (bonds) on real estate. They also outperformed the REIT index due to their lower costs (a sustainable advantage) versus the REIT index. If you look at the Vanguard REIT index, the “look through” fees (index fees plus expenses associated with the REITs it holds) you are over 5%. NNN REITS have expense ratios of 1.2% to 2.4%, more than 50% cheaper than the Vanguard REIT index. This can be seen in the margins of NNN lease firms in the 80 to 90% versus 40% to 70% for the typical REIT. Despite this advantage NNN REITs trade below the average Equity/AFFO of REITs and some trade at a discount.
Packer
They sound wonderful. I agree an NNN property is generally less risky than one that is not, with less volatility (which usually means lower returns). But I don’t agree that it is some unique structure that deserves its own place on the spectrum. Glad you’re happy with your investment.
Thanks for the tip that direct real estate ownership would be a lot stabler but more of a hassle to pull off because of all the paperwork. I’m thinking about investing in single family homes since my dad used to always teach me when I was younger that putting my money in real estate makes my money grow without too many risks. Moreover, he mentioned that single family homes are easier to liquidate because it’s easier to find a buyer.