By Dr. James M. Dahle, WCI Founder
A couple of weeks back I wrote about the New WCI Asset Allocation. If you read it, you may have noticed that we are now dedicating 20% of our portfolio to “alternative” types of investments, chiefly real estate, but also including other interesting asset classes–basically anything other than the stock and bond index funds that make up 80% of our portfolio. In reality, the “change” was really an acknowledgement that we had some investments that weren't being formally included in our asset allocation/written investing plan rather than any significant change in asset allocation. In this post (and subsequent updates) I'll be discussing the nuts and bolts of these investments so you can follow along at home.
Update on Real Estate Investments
First, let's do an update on the real estate investments we have owned for a while. You can compare to this prior post about our Real Estate Empire. The main theme you will note here is that we have very little interest in buying (and especially managing) an entire property. Not only are we not really any good at it, but we really disliked being landlords. We mostly prefer to invest our time actively and our money passively.
Publicly Traded REITs
Yup, we still own the Vanguard REIT Index Fund. Despite a terrible beginning, we have had excellent long-term returns from this investment since we added it shortly after getting out of residency back in 2006. Our official, annualized, XIRR returns come out to 12.33% per year from 2006 to present. Not bad considering the 78% loss we took in the Global Financial Crisis. Over the years this has been 7.5% of our portfolio, but it will be trending down to 5% and perhaps even lower to make way for other investments. I love the convenience, liquidity, and low costs of this fund, but dislike its moderate correlation with the overall stock market. In my stock-heavy portfolio, that's a big deal.
Our Partnership Office Building
Bonus points if you know where this is
This has been one of our best investments of all time, although a lot of that is just luck in my case. For some reason, the year I made partner they let me buy into the investment at a price that was several years old, giving me an instant boost to my return. Unfortunately they only let me buy two shares. In addition, the old building was recently sold and the LLC bought a new, larger building. We got a great price on the old building, further boosting my return. The shares split and I was able to buy more so this is becoming a bigger and bigger chunk of my portfolio. The income from the property is going toward paying down its debt, but I'm fine with that. My XIRR return on this investment as of the first of the year was 21.55% per year for the last four years. Our investment is currently worth about $33K.
Indianapolis Apartment Complex
This has been a bit of a disappointment so far and may continue to be one. This was my first (and so far only) investment through the crowdfunded platform at RealtyMogul, one of this site's advertisers. I think the minimum on it was $20K, but they let me in for half of that, or $10K. We put the money into the investment in November 2014, a little over 2 years ago. We get a report from time to time, but most of them seem to list problems that have been encountered. For example, HUD apparently disagreed with the management team about how much needed to be held in reserve and so held on to a bunch of cash. That cash, of course, happens to be the same cash that was supposed to come to me. The initial documents on this investment projected a 15.5% IRR and a 9.5% cash on cash return. Meanwhile, my actual XIRR return on this investment (valuing my share of the partnership at the $10K I bought it at) is 3.77% per year. That's obviously a lot less than 9.5%. The management team says:
Most of this cash is withheld by HUD until we complete the remaining 29 rehabs. Our goal is to complete all rehabs as occupied rehabs, enabling all work to be done by the end of April. The choppiness of your investment returns is directly correlated with the timeliness of rehabs and the 60+ day lag on reimbursements; however, this choppiness does not affect our confidence in the long-term performance of the asset.
Let's just say the choppiness IS affecting my confidence in the long-term performance of the asset. But hey, it's a 5-7 year investment (and it's only $10K). Let's give it some more time.
Salt Lake City Apartment Complex
If you'll recall, this is a building being built from scratch with a preferred equity structure that we purchased through Fundrise. Our investment is only $5K. Without fail, they send me $168.75 per quarter. I calculate my return (again valuing my investment at $5K) at 12.50%, not quite the promised 14% return. It's been fun to drive by occasionally and see it going up.
The House Flip
You'll recall we had a $2K investment through RealtyShares. This was a one year debt investment I bought in summer 2015 for a house flip. It made all the payments as promised and I even got my money back, for a 9.14% return, slightly better than promised.
My Grocery Store
I own a little tiny chunk of the strip mall closest to my house, including the grocery store we shop at. This was a $5K investment crowdfunded investment bought through RealtyShares that was supposed to have a 6% cash on cash return for the first three years and an overall IRR of 16.6-19.8%. They basically send us $25 a month (and haven't missed any payments.) That works out to an XIRR of 5.33%, a little less than the promised 6%.
The Hospital
At the time I wrote that last post, I had just committed $30K to buying some of the land on which the new hospital our group staffs is located. The investment ended up falling through due to some legal/structuring issues and they gave us all our money back with a little interest (and I mean little) a few weeks later. I anticipate I'll eventually buy some syndicated shares of our main hospital, but haven't yet done so.
I expected to buy some more crowdfunded real estate investments later in 2016, but ended up putting that money toward our mortgage which is rapidly dwindling. More details on that in a future post. But we expect to invest some more in 2017, particularly the latter part of the year after all the 401(k)s, Roth IRAs, and DBP are funded and the mortgage is paid off.
Our Alternative Investments Portfolio
So what is actually in the 20% of our portfolio currently dedicated to real estate and other alternative investments RIGHT NOW? It's a mess. Here's the list:
- Vanguard REIT Index Fund
- Partnership Office Building
- Indianapolis Apartment Complex
- Salt Lake City Apartment Building
- The Grocery Store Strip Mall
- TSP S Fund (I know, not an alternative, but it takes time to move illiquid investments around and fund them so this will make up the difference for a few more months.)
- Lending Club Roth IRA Account- 70% liquidated and transferred but will probably have a small amount there for years.
- Lending Club Taxable account- 90% liquidated and transferred
- Prosper Taxable Account- Stuck with this tiny account for years as Prosper no longer lets you sell notes
- Physician on FIRE
The Future
So what does the future hold for this section of our portfolio? It holds lots of fun stuff that I'm really excited about.
Less Mutual Funds
The TSP S Fund (an extended market/mid cap fund) should be phased out of the portfolio by the end of the year and the REIT Index Fund will also decrease to around 5%. Long-term readers know I have a portfolio that is almost entirely in tax-protected accounts. While I would love to have tax protection for really tax-inefficient assets like P2P Loans and real estate debt investments, it introduces a fair amount of hassle (although I am considering a checkbook Roth IRA) and additional expenses. So most of these alternatives are just going to be held in taxable. That means I can't move money into this section of the portfolio any faster than I can grow my taxable account, and I'm not going to fund taxable while I have tax-protected space available to me. That money has to come from somewhere. It will come from the (hopefully) ever increasing earnings of WCI, from cash flow freed up by paying off the mortgage, and from our small taxable mutual fund account as its appreciated assets are used for our charitable contributions and replaced by the future earnings earmarked for those charitable contributions. Bottom line, it'll take some time for us to grow our taxable account to 10-15% of our portfolio, especially since we fund all the tax-protected stuff first.
Some Hospital Shares
I expect I'll buy a few syndicated shares of our hospital in the next year or two. The returns have been pretty good for past investors and correlation ought to be low with the rest of the portfolio.
More Crowdfunded Real Estate Debt Investments
As noted in my recent post about liquidating our Lending Club investments, I prefer a 9-10% return backed by an asset I can foreclose on than a 9-10% return backed by someone's word (especially when that someone is dumb enough to borrow money on credit cards.) I'm sure we'll have more of these in the future. I also have some local contacts that do some hard money lending to trusted real estate investors.
One tricky aspect of crowdfunding is that unlike with a mutual fund that owns companies located in many states, you directly own these investments as a partner in an LLC. That may mean filing a state income tax return in those states. My understanding is that the debt deals can be in any state and I just pay taxes on the income in Utah. However, the equity deals may actually require me to file a state tax return. That sucks. Luckily for me, my only out of state equity investment is in Indiana, where they require a composite return to be filed. Otherwise, my entire investment return on that tiny investment would be eaten up by the cost and time of filing an Indiana return. At any rate, I intend to very carefully monitor whether I will need to file an extra state tax return before getting into any more out of state syndicated deals. I'll stick with Utah, the 7 income tax-free states (AK, FL, NV, SD, TX, WA, WY), and states that require a composite return be filed by the LLC.
The Plethora of Crowdfunded WebSites
One of the biggest difficulties I've had with the literally hundreds of crowdfunded real estate websites that have appeared on the scene since the JOBS act of 2012 is separating the wheat from the chaff. Each of these entities is competing both for investors and investments and obviously are incentivized to put together as many deals as possible. Since it takes years to do a round trip through an equity investment and since these are essentially all accredited investor only investments, there is no Morningstar where you can go get detailed information about the investments. The closest thing I have found is some yeahoo's blog reviewing them. He divides them into 6 tiers. The crazy thing is that not a single site meets his requirements to be in the top tier and 80% of the sites are in the bottom tier due to “not enough information available.” That leaves four tiers. The 2nd tier is called “The All Stars.” He considers these companies to be All Stars:
- Peer Street
- Real Crowd
- Realty Mogul
- Realty Shares
- Acquire Real Estate
- LendingHome
- Roofstock
- Patch of Land
That's nice, since two of the three I'm using made the list. Fundrise, the third company I have actually used, apparently used to be in that tier (and in fact was ranked number 1 back when I invested in it), but has dropped to the fifth tier after some legal issues related to the unexplained resignation of their CEO with replacement by his brother and a change in the business model to exclusively using eREITs (which are also offered by other sites but which I'm definitely not sold on. Perhaps more in a future post about those.)
Other crowdfunded websites that advertise with WCI include:
Equity Multiple (in the fourth tier-“Up and Comers”)
I'm really excited about this company. They might be ranked by this random review site as an “up and comer” but I'll be including them in my search when I next look for a crowdfunded real estate investment. They are one of the few sites whose principals co-invest in every investment and publishes their returns quarterly. Kudos to that kind of transparency.
Fund That Flip (in the third tier-“Contenders”)
These guys do all debt investments and unlike most sites, have a number of investments with a LTV of < 65%. I'll include them when I look for my next debt investments later this year as well.
Crowdfunded Equity Investments Versus Private Funds and Syndications
There are some serious benefits to using a crowdfunded site in comparison to finding your own syndicator or fund. These include:
- Lower minimums- It is much easier to diversify with a $2-20,000 minimum than the $50-100,000 minimums you often see with more private deals. This not only allows you to diversify between deals, but also between crowdfunding websites. Diversification protects you from what you don't know.
- Extra set of eyes/due diligence- If you're like me, your experience with real estate investing and the business world in general is limited. Having the experienced eyes of the crowdfunder going through the deals and throwing out the obvious losers has some benefit. There is a cost (i.e. an additional set of fees) you have to weigh against that benefit though.
- Convenience- If you're willing to use a half-dozen different crowdfunding sites, there is essentially always a reasonable deal ready to go when you have the money to invest. It is a lot tougher to do that with private funds or syndicators.
Advocates of using a private fund or a private syndicator would point out that crowdfunding websites attract inexperienced investors–Perhaps the truly experienced and talented managers have investors lined up out the door to invest with them as fast as they can find deals to invest in. Once you have found a talented manager you trust, you can then invest in all of their future deals. While it lacks diversification, it is essentially the Warren Buffett principle of “Put all your eggs in one basket and watch it very closely.”
However, there are significant downsides to going the private route.
- Due diligence- You've got to do all this yourself, and given the amounts you'll be investing, you'd better. That might mean flying out and meeting the management team, going to see the investments, or even doing background checks on the principals.
- High minimums- $50-100,000 is typical. A typical doctor might only invest $50K in an entire year, and much of that will be going into 401(k)s and Roth IRAs. Coming up with $100K all at once is tough for a young accumulator.
As you can see, there are pluses and minuses with each of these models. Some of the current and previous WCI advertisers offer private funds or syndications, all of which I have considered investing in, but haven't (mostly because I don't have the taxable money to do so.) These include:
Origin Investments– I had dinner in Salt Lake with one of their principals last month and I really like their approach to investing. They are just about done raising money for their third fund, but have had exceptional returns so far with their first two funds. The $100K minimum is still a bit of an issue for me, but hopefully in the near future that sort of thing won't be as big of a deterrent for me.
37th Parallel/Nest Egg Rx– Dennis Bethel is an emergency doctor now turned real estate investor who has advertised on the site in the past. He works with 37th Parallel and a few WCI readers have invested with them in the past. I have yet to hear a complaint and I've asked everyone who has invested to send me feedback when they can. The last time I looked into it there was a $50K minimum. It seems to be working out for Dennis as he hung up the stethoscope last year.
Larson Capital Management- This is the arm of Doctor's Only (Larson Financial) that offers real estate funds to their clients. I think they're on their fourth or fifth fund with several properties going into each fund. Initial returns on the first few funds look promising. The last time I looked into it, the minimum was $50K.
There are hundreds of other real estate investing companies out there. There is no way I could ever look at even a small fraction of them. But I expect I'll eventually invest in one of these companies or one of their competitors. Before doing so I will certainly do more due diligence and I recommend you do too.
Life Settlements Fund
Some time ago I wrote about investing in Life Settlements. This is basically buying whole life policies from people who want to get rid of them at a price so good that your return on a diversified portfolio of them provides a solid investment return. The attraction here is solid returns with an asset class that ought to be dramatically uncorrelated with stocks, bonds, and real estate. I'm still interested, but like the private real estate funds, the minimums (typically $50-100K) have been high enough to keep me out in the past. This is on my list of things to invest in “some day.”
Growing the WCI Network/Buying Websites
Most of you noticed I bought a small piece of Physician on FIRE, LLC recently. I'm certainly no expert in real estate investing, but I'm pretty good at running a website, particularly in this niche. As discussed in a post last year, I am interested in buying websites, particularly websites where I can add significant value. I expect I will buy part or all of more sites in the future. Sites in this niche, assuming our “proof of concept” experiment these next few months goes well, will become part of the WCI Network. The best part of this network is that not only can I dramatically increase the return of my investment using my expertise and hard work, but that the investment also increases the value of my own business. I fully expect my investment in POF, LLC to be a “ten-bagger” within a few years, not even including the value the network brings to WCI. At any rate, POF, my “biggest competitor,” now has no bigger cheerleader for his success than me!
Well, there you go. That's what we're doing and what I'm thinking with respect to the alternatives portion of our portfolio. This is certainly the “fun” part of investing for me, but it's not play money. This is just as much “serious business” as the index fund portion. These investments all have the potential for outstanding returns and should have low correlation to the remainder of the portfolio.
If you choose to invest with these crowdfunding sites, I would appreciate you doing so using these affiliate links as it helps support the site at no additional cost (and sometimes significant additional benefit) to you:
Invest with RealtyMogul!
Invest with Fundrise!
Invest with Equity Multiple! Management fee on your first investment waived when using this link.
What do you think? Do you invest in alternatives? What percentage of your portfolio do you use? How do you invest in real estate? What do you think about the crowdfunding websites versus private fund dilemma? Comment below!
WCI’s No Hype Real Estate Investing is the best real estate course on the planet and the best way to get started in this exciting (and profitable) asset class. 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!
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This is your Ten-Bagger speaking. 🙂
My alternatives have been limited to the Vanguard REIT fund and a couple startup craft breweries. I am intrigued by the crowdfunded RE sites, and have joined one or two as an accredited investor, but have not funded any deals yet.
My main concerns are the plethora from which to choose — I wouldn’t want to choose the wrong one with a $10,000 minimum investment. The other is the tax treatment at this stage in my career. These deals might start to look more attractive once I begin working less or not at all.
Best,
-PoF
Wonderful article. I recently tried one of these crowdfunding sites (realty shares) since I too wanted to diversify away from only stocks and bonds with low correlation to the market. Just like the author, I have 0 percent desire to be a landlord (although it seems those folks get the best return!). The one big disadvantage relative to owning your own property is that you are really at the mercy of the management. If the seller is corrupt, you loose your shirt!!! But then again, this is a relatively small percentage of my portfolio and as you said the deals have supposedly been vetted. We will see how they do over time…. Continue to keep us updated. I will follow very closely!!!
By the way, I also like your conclusion regarding peer to peer lending sites. Backing by hard assets is better than reliance upon credit especially if the economy turns south!!!
Only in theory. It sounds great, but in “economy turning south” your hard asset loses value and poof goes your money.
Its good, but not foolproof.
Great article
I enjoy my visits to our Vet as we spend 10 mins on the Dog & 20+ on our recent real estate investments.
One of our new married into to the family members is a pharmacist & he enjoys your site (my recommendation) & he is also about to plunge into some investment properties.
One of my wife’s colleagues admitted to her several years ago that he made more & kept more from real estate than he made in his high o/head practice.
After 30+ years of concentrating on REI our passive income stream continues to be phenomenal.
What are your thoughts on Memphis invest? And other similar management companies that sell the property to you and manage it for you. One of my friend swears by it and has brought several properties with them, taking over hundreds of thousands in mortgages with them.
To me it is too high risk but to him it is a no-brainer…can anyone give me some thoughts about this?
Definitely another alternative- basically turnkey real estate investing. I really don’t like the idea of being the sole owner of an out of state investment property, even if someone else is “taking care of everything.”
Escalante National Monument?
There is no Escalante National Monument. But it isn’t in Escalante, nor in a National MONUMENT.
Parowan Gap Petroglyph Site?
That’s a great guess. I’ve been meaning to get out there and see that. But that’s not it. I’ll bet there are fewer than 200 people alive today who have been where that picture was taken. Chances of one of them reading this site are not high. I know of one book and no websites that mention it and access is problematic to say the least as it is a very remote location.
Shoot, now I’m even more interested!
This is a terrific overview of real estate investing. There is lots to say on this topic so this may motivate me to finish the article I’ve been writing on “Ten questions you should ask about real estate crowdfunding investments”.
For now, there are two points I would like to add to WCIs analysis.
1) my primary concern about most crowdfunding sites is the lack of transparency and the very superficial underwriting. In most deals I have looked at there is not nearly enough information to make an informed decision. There is even less information provided after you have invested.
2) just because you get a check that provides a “current return” does not mean that your investment is performing as promised. In most cases, this return is paid from a reserve that is funded from deal proceeds because the project itself does not produce enouGh cash flow to cover the promised return. This means you are just getting your own money back. This is particularly true in cases where the property is new construction or requires significant improvements.
CAPFUNDR chose to offer real estate funds rather than individual deals because we think it’s too difficult and time consuming for investors to do the necessary homework to differentiate the good deals from the bad.
Of course, your proposed solution leads to an entirely problem- how to choose from among the private real estate funds out there. Diversification is even more of an issue since the minimums are higher.
You have diversification within the fund, so you can focus on a few managers, rather than lots of individual deals. The main point is that it requires a lot less specialized knowledge to evaluate a manager and a strategy, rather than a deal.
I am invested in the same shopping center in SLC via RealtyShares, also in for $5k. (Keep shopping there, bro!). I have also invested a total of just under $60k split between Peer Street and RealtyShares, the latter joined over a year ago via your affiliate link.
I find that Peer Street is easier to use with less paperwork, lower investment minimum ($1000) and a larger deal flow (all straight debt). I have not yet lost any capital, but I own one position at RealtyShares ($3k) that is nonperforming, an apartment complex in Milwaukee, and I am interested to see how this works out.
Other “alternative” investments include an ownership interest in an imaging center joint venture, DFA US and international REIT mutual funds, and a managed futures fund. I am drawing down my Lending Club account, currently under $4500.
Just to respond to something you reference, WCI… one does want to be careful about the extra complexity and cost of getting into “out of state” and especially multistate partnerships.
One thing people easily underestimate is the speed at which one adds nonresident tax returns. More granular detail here…
http://evergreensmallbusiness.com/partnership-tax-consequences-financial-advisor-didnt-tell/
But the general rule to watch out for: Any state in which a partnership operates will require a nonresident tax return.
I’m a big supporter of diversification, so I would not (at least for now) invest in a single house/building.
I prefer options like one that you have mentioned: vanguard REIT.
It gives me exposure do real estate and diversification at the same time.
Great article as always. I’m nearly finishing my pediatrics residency and hoping to have a decent chunk of my investments in real estate (after maxing out retirement plans of course). I rather enjoy the DIY/ fixer-upper hobby and am hoping to work on the local homes myself in my downtime ,of which I’m about to have much more than I know what to do with!
Side note: since listening to your podcast I can’t help but read your articles in your voice. I think I’ve gotten the inflections down and everything (I may throw in a “stupid” or two for good measure. Definitely makes it more entertaining haha. Anyone else find themselves doing the same thing?
I must start a website/blog soon….Must. Join. WCI. Network.
Another category of alternative investment is rural farmland and cattle. This my husbands project. We bought the initial farm at really depressed prices jointly. Currently have 21 registered black angus cows and Bulls. I also have VNQ. As I have mentioned I have had ownership in a hospital and a surgery center in the past. I had back luck with an angel investment.
Well, no one can say you’re all hat and no cattle.
Timber is another interesting alternative with some great past returns. I like the idea that if the market is down a bit, you just wait a year or two and let the trees get bigger. I guess you can do that with cattle to a certain extent too!
“Well, no one can say you’re all hat and no cattle.”
Tip o’ the hat to that!
-PoF
I wanted to plant some timber but my hubby thought it would take to long to see a return. I think it adds value to any property.
I believe I recall your story about the angel investment. “Bad luck” might be an understatement.
I haven’t had the initial capital to go into farmland directly, but have since gradually built up a pretty large position in timber and farmland REITs. Probably not the best solution, but definitely easier. As drama has been unfolding with my rental property tenats, I think I just might sell it off and put it into a REIT. The lack of hassle is worth a fair bit of opportunity cost.
Honored you remember that anecdote. The shooter is serving a life sentence.
Wouldn’t real estate investing in businesses where you work and shop be the same as owning stock in the business where you work? Does that increase your risk? If the market tanks and you lose your job, your decreased income means you would spend less at the businesses where you shop. If your work lets people go, it might downsize to a smaller location thus decreasing your real estate return. I know this scenario includes a lot of ifs, but it seems like you would take a double hit if you lose your job and your real estate investments subsequently tank.
This is a valid point with respect to WCI’s investment in his office building and hospital, which are obviously highly correlated to his career. The counterpoint is that if you are going to invest directly in real estate, it should be in an asset that you have a unique ability to understand and evaluate. On balance, he probably has good reason to believe in the success of both assets, so these are smart investments as long as he doesn’t put all of his eggs in that basket.
Yea, life is risky. Two schools of thought- don’t put all your eggs in one basket or put them all in one basket and watch that basket very closely. We all have to figure out where we’re going to be on that continuum.
I bet you would think having more than half your net worth in some stupid website is really risky too, but I keep a pretty close eye on it!
Great! I’ll take $5 million over a 50 year term at 3% Where do we sign?
I have a couple of alternative investments. I have a rental property that seems to be going okay, and its hard to deny the tax advantages, but I feel like I will tire of being a landlord even through a property managment team. So far, property management has been even more annoying than anything else.
I invest/trade a little with my play money and it falls square into an alternative asset class. Its so far getting to be a fairly good portion of my allocation. I’ll just let that grow to as large as it wants to be and worry about it when it becomes too lopsided.
“Advocates of using a private fund or a private syndicator would point out that crowdfunding websites attract inexperienced investors–Perhaps the truly experienced and talented managers have investors lined up out the door to invest with them as fast as they can find deals to invest in.”
I would think this applies to both crowdsourced and private syndicators. I would think the most talented managers get their capital from banks, REITS and institutional investors, not any old accredited investor.
I prefer direct ownership of real estate and you don’t have to be a landlord. You can hire a property manager and simply consider that as part of your monthly expenses hopefully with good cash flow. As for crowdfunding sites, We’re in a bull market.. and everyone including their mom seems to be investing into these sites… shouldn’t we head in the opposite direction?
WCI,
When you are going through the deals in the RE crowdfunding space how do you filter them out? Are you looking for a certain track record or a certain LTV? I.e. what metrics are you using before committing to a deal?
Gracias,
PD
I do like to see a track record. You’ll notice I made the minimum commitment on the ones I have and haven’t made any in a while. Not sure I have some failproof method. At any rate, I think we’ve had some posts in the past that give some tips, but I can’t seem to find them at the moment. Maybe it’s an upcoming guest post.
CrowdDD is a good resource for evaluating sponsors and platforms. It is currently in beta.
http://www.crowddd.com/
This thread is basically about private real estate.
I don’t know how the return of private real estate compares to public real estate. I have read that the return of private equity is similar to that of public equity, when the comparison is on a risk adjusted basis. I would be surprised if the returns of private and public real estate were significantly different. If they were, then capital would flow from one to the other.
I have read that private and public equity don’t correlate over shorter periods of time, but with a horizon of years, they correlate reasonably well. That makes sense. If they didn’t correlate over longer periods of time, then there would be an arbitrage opportunity available.
WCI, you’re taking on diversifiable risk with your private real estate investments. IOW, you’re taking on risk that you don’t get compensated for.
You’re engaging in the real estate equivalent of stock picking (security selection). This is active management. Active management is a negative sum game after costs.
There are many who have done well doing what you’re doing WCI, and some have done extremely well. They have either had an edge or luck or both.
What is your edge, WCI?
This is an excellent article relating private/public equity by the always great Morgan Housel.
http://www.collaborativefund.com/blog/risk/
The real estate market is quite a bit more inefficient than the equities one, which makes getting good deals a bit easier. His edge was access because he was a physician at the group. Active management is a negative sum game after costs? Maybe so, but there are still opportunites out there, it just would preferably be you positive some other poor schmuck negative.
Not everything can be arbitraged away due to many factors, and some just simply havent been ever. Look at the market, why are stocks given an equity premium over bonds and bonds over cash? By now, it should have been completely arbitraged away but it hasnt.
There are still edges in the market, usually based on structure and a probabilistic assessment of risk/reward setups, but they do exist.
There are reasons for the equity risk premium. A bond holder gets certainty of income and return of principal. A stock owner doesn’t. If the company goes bankrupt, the bondholder will get paid off first; the stock owner will get whatever’s left. The stock owner will be exposed to the risk of bad returns in bad times, the bond holder less so. Financially, bonds can’t grow faster than the economy. But with dividends, it is possible for stocks to grow faster than the economy, and historically they have. Finally, companies borrow money to make money. If they didn’t make money on that money, people wouldn’t invest in companies.
Yet the premium has been large and greatly outperformed bonds, those bad returns pale in comparison the the average ones. The fact the premium is still available and large (though has decreased), suggests not all things are arbitraged away. Even if companies go bankrupt that can largely be diversified away by indexing, and still in that case, equities as a basket outperform and is not a good reason.
There exists a premium one can have by simply choosing equities over stocks, why arent more people choosing it is the question? People have no problem tilting to things such as small cap within the equity universe itself, essentially mitigating that premium, but not across the asset classes. You have to see that it is an interesting conundrum in and of itself.
Don’t apply something that has been shown to be true in publicly traded equities to another asset class where it has not been shown to be true, at least as far as I know.
I’m working on “the edge.” In the meantime, I’m being cautious.
“I have read that private and public equity don’t correlate over shorter periods of time, but with a horizon of years, they correlate reasonably well.”
That should be corrected to “I have read that private and public real estate don’t correlate over shorter periods of time, but with a horizon of years, they correlate reasonably well.”
What ever happened to straight forward, easy to understand, simple investing that was so prominent in your early posts?
Most recently (all within the last month) discussed here: https://www.whitecoatinvestor.com/the-new-wci-asset-allocation/
here: https://www.whitecoatinvestor.com/the-bare-minimum/
here: https://www.whitecoatinvestor.com/the-pros-and-cons-of-income-investing/
here: https://www.whitecoatinvestor.com/steady-plodding-brings-prosperity/
and here: https://www.whitecoatinvestor.com/investing-doesnt-have-to-be-complicated/
As noted in my recent post about my portfolio, 85-90% of my portfolio is invested in a simple, easy to understand way. I can retire today on that 85% of my portfolio, although perhaps not at my desired lifestyle. I think it’s okay to invest in more than index funds. Many roads to Dublin. There are a lot of people interested in these alternative asset classes who are interested in updates on what I’ve been doing with them. But the posts are rare enough that they can be pretty easily skipped.
Good article on real estate investing. However, I find it ironic that you find the real estate investing options attractive, yet you often discourage readers who are into building portfolios of individual stocks. You mention that picking individual stocks is a losing proposition and advocate instead diversified index investing. By this logic, shouldn’t you just support investing in VNQ for real estate exposure? Otherwise, I think buying a basket of blue chip dividend paying stocks would be more transparent, and probably safer than a basket of opaque crowd sourced or even worst, private real estate deals.
The whole point is to diversify away from equity risk, and they idea that they are largely uncorrelated asset classes. VNQ while a REIT is involved in real estate, its constituents are part of the S/P and its overall correlation with equities is rising. So owning a reit doesnt give one the diversification of owning real estate in some other fashion.
Theres not really a performance, correlation, time, or diversificaiton benefit to owning individual stocks vs. funds. Different ball games with different objectives.
Exactly. You cannot apply the methods that are effective in an extremely efficient market to one that isn’t so efficient.
The argument here appears to be diversification to decrease risk. But with this type of investing, you’re taking on idiosyncratic risk that can be diversified away.
Alternative investments don’t correlate with publicly traded stocks/bonds. But part of that is an illusion. Publicly traded stocks/bonds are marked to market daily, whereas alternative investments tend not to be.
I’m not saying that alternative investing is bad. There are many who have done very well from it. But for the average retail investor, who wants to use active management, you’d probably be better off in publicly traded stocks/bonds than alternative investments. With alternative investments, there is less transparency, less liquidity and usually more cost.
The argument is high returns and low correlation with the rest of the portfolio. There is also potential to be paid an illiquidity premium.
I agree there are many who have done very well with it. I disagree that using active management with publicly traded stocks/bonds is a better idea than either doing it with alternatives such as real estate or using index funds for publicly traded stocks/bonds.
I agree that theoretically there should be a liquidity premium with alternative investments. I’d like to see the evidence for it. At least in private equity, the data is that it isn’t there. And it isn’t there in comparing private REITs to public REITs.
About hedge funds, people used to make the argument for high returns. When research showed that it wasn’t there, the new argument was for low correlation. How well did hedge funds protect you in 2008-2009?
I didn’t say that active management with publicly traded stocks/bonds is a better idea than using index funds for publicly traded stocks/bonds. I disagree with that statement, although there is a minority of investors for whom it is a better idea.
I agree the data isn’t there. What are you going to do about the lack of data? You can either not proceed because there is no data, or you can jump in and see what happens. Your choice.
I’ve never owned hedge funds.
I mention hedge funds, private equity and private REITs, because these are alternative investments on which research has been done. That research finds that most retail investors would be better off without them. I’m not aware of research showing that there is a subasset class in alternative investments which I would be better off owning. If there is, please get back to me.
Your questions are excellent and you may very well be right. Yet despite the data you refer to, I keep running into people making excellent (double digit) returns in real estate. What is your explanation for that? Are they lying? Do I just happen to keep running into top quartile folks? Or are there actually investments out there that relatively reliably provide 10-20% returns that aren’t available to non-accredited investors? And if there are, what is the best way to access them?
Now I’m one of those people I kept running into. Despite the fact that the data says I shouldn’t be making double digit returns on private investments, yet here I am doing it. Weird huh? Am I still learning and experimenting etc? Sure. But if you wait until you know everything before you do anything you’re not going to get very far in life.
Is it risky? Sure. Is it more risky than having half your net worth tied up in some stupid website? Probably not. I’ve got a whole new view on equity risk these days.
Anecdotal? Sure. But I do a lot of things in my life I don’t have good evidence for and I bet you do too.
There are many roads to Dublin. Don’t assume the road you are on is necessarily superior to all the others. It might not be.
“I keep running into people making excellent (double digit) returns in real estate. What is your explanation for that? ..,Now I’m one of those people I kept running into.”
Published hedge fund results are commonly excellent. But when you account for biases, such as survivor bias, that changes.
I doubt that’s just true of hedge funds. Anecdotally, I’ve noticed that people (including myself) tend to talk about their successes more than their failures. I suspect other private investments are no different.
As for your returns on your private investments, kudos to you. But I’d rather devote my time to areas where there is evidence to support them.
Like posting on websites? 🙂
WCI, you have 12505 posts on the Bogleheads forum. I’m a minor leaguer compared to you ;).
Eh. Gotta keep engagement. Same old stuff gets boring. I am 50% sure thats the reason.
The problem with hedge funds and alternative investments isnt that they dont perform, its that its nearly impossible to know which ones will and which wont, and all the ones that are known are already closed to new investors or closed up shop.
The “edges” left in the market are leverage, short selling, and volatility. If you dont understand or know how to take advantage of any/all of those you should settle for market returns.
Leverage is a big reason RE returns can be good, works in the market to but people are very averse to it, so its underutilized. Shorting and volatility are different beasts and require a more thorough understanding and complexity that will keep the great majority out.
I’ve done two $5k deals on fund that flip and made about 11% and have had all of my principal returned. I liked the shorter time frame. I’m not sure if I’ll do it again, though, because i did wonder if I’d get my principal back or not. I think I may stick with my taxable account for this money in the future (it’s part of my contingency fund).
Thank you for being a pioneer and showcasing your experiences with these newer types of investments. I was initially very intrigued by peer-to-peer lending, but I didn’t understand it well, so I waited cautiously. I now see that the appeal isn’t quite as strong and I’m happy that I didn’t dive in. Perhaps the same thing will happen with Real Estate Crowdfunding?
Certainly within the realm of possibility.
Currently our alternatives are limited to 2 percent in a Vanguard REIT. I do expect other alternatives will make it into what I consider our five percent of our portfolio for play money. However I don’t ever expect they will be large aspects. I just don’t have the time or desire to go into a specific deal. Still I find it a very interesting read.
You just validated my point. The gist of the blogs has come from straight forward investing advice that anyone can follow with a minimal time commitment to much more complex opportunities that are not easy to understand. They certainly require much more time to research on the front end and probably make one’s taxes much more difficult.
Take what you find useful, leave the rest.
You are correct that they require more research and make taxes more difficult. What would you require in order to justify that? Low correlation with the rest of your portfolio and a solid return, right? Now all you have to figure out if whether or not any given opportunity is going to be worth the additional hassle or not.
In many ways, the “three-fund portfolio guys” are making investing way too complex. They could just follow the example of Mike Piper and just put it all into the Vanguard Life Strategy Moderate Growth mutual fund and be done with it.
“You are correct that they require more research and make taxes more difficult. What would you require in order to justify that? Low correlation with the rest of your portfolio and a solid return, right”
I’ve read similar arguments for hedge funds. IMO, the best way to reach one’s financial goals is evidence based investing. Where is the evidence that your alternative approach works? If alternative investing improved portfolios, why haven’t I read about this? The name most associated with success in alternative investing is David Swensen. He discourages retail investors from alternative investing.
Thanks for letting me know your opinion.
I’m posting my evidence as I make it. You can do what you want with it.