Investing in residential and commercial real estate can be a great way to grow your portfolio. Apart from the revenue, there are a ridiculous amount of tax benefits available to real estate investors. After reading Garret Sutton’s Loopholes of Real Estate, I became eager to invest in real estate.
Commercial and residential real estate investments are very different but both provide opportunities to control risk and maximize your returns. However, this investment class requires a bit of education and hard work up front to research and area, understand the market, find properties and negotiate a below average purchase price. Often times the fate of how much money you will make will depend on how much you pay for the property up
I have been seeking opportunities to do my first real estate investment with a seasoned veteran who knows what they are doing. Unfortunately, my local network of real estate investors focus on flipping multi-million dollar single family mansions. Buy for $1.8 million, renovate for $800k and sell for $5 million. LATHER, RINSE REPEAT! Fix and flips do not get me excited, there are so many investors in my area doing this type of work that the market is highly saturated and investors are willing and able to pay a premium in cash because land is limited and there is huge demand by foreign millionaires to purchase property in California.
There is much money to be made in these types of flips, but I prefer I am more interested in buy, hold and rent strategies, especially those involving multi-tenant properties where it is possible to reduce financial risks and gain tax advantages by depreciating a physical asset on the books that in reality is likely to appreciate in the long run.
There is no right or wrong strategy, it all comes down to personal preferences and risk tolerance. With multi-tenant properties, revenue generation is spread out over move customers, so if a tenant moves out, the revenue from the other tenants will most likely cover the cost for the unutilized unit. In the case of a single-family rental if a tenant moves out, the investor will need to scramble to find a new tenant as soon as possible, otherwise, the mortgage payments will have to come out of pocket. For this reason, purchasing a duplex, triplex, or fourplex, can significantly reduce your out of pocket risk, because of the economies of scale the cost per unit for these multifamily properties is significantly lower than purchasing individual homes. Based on this reasoning the more units you have the more you can spread out the risk related to vacancy rates.
If a property contains five or more units it is classified as a commercial property rather than residential property. The term commercial property also extends to mobile home parks, storage units, hotels, parking lots, office spaces, etc., and they are more likely to be managed like a business, having a property management team and maintenance crew to keep the property in good condition and collect rents, which generates jobs for the local community and enables the investor to utilize the professional expertise and skill sets of others to help grow business revenue year over year.
One of my goals for 2017 was to invest in a piece of commercial property through a crowdfunding platform. After reading through the terms and conditions, evaluating the business models, and attending live webinar events for several real estate crowdfunding sites, I decided upon the RealtyShares platform which hosts debt, preferred equity, and equity offerings from real estate developers, across the nation. I liked Realty Shares because real estate developers submit detailed investment packages ranging from 50 to 100 pages that give the career background of the developers, market research, etc. Most of the other real estate crowdfunded sites were some type of “REIT” and did not provide any information as to what exactly you are investing in, or even what the risks of the investment would be.
Above is a map of all the markets RealtyShares’ developers currently operate.
Debt offerings are straight debt investments through promissory notes with fixed interest rates ranging from 7% to 11%. RealtyShares will hold a first lien on the property, which enables them to foreclose on the property to recoup principal if the debtor stops making payments. These are the least risky deals on the platform and offer an internal rate of return ranging from 7% to 11% over a 6 to 24-month term. Most of the offerings in this category focus on single family flips, but can also include multi-family and retail property to a lesser extent.
Preferred equity offerings are second position debt investments where the real estate developer typically offers up all of their equity interests as collateral. Terms range from 24 to 36 months. The rate of return ranges from 12%-15% and are often split into a current rate and an exit fee. For example, an opportunity offering a 15% return may be split into an 8% current interest rate on the principle paid either monthly or quarterly and a 7% exit fee at the end of the term when the property is sold or refinanced by the real estate developer.
Equity offerings are often the most creative deals which offer the highest potential rate of return, but they are also the most risky. As an investor, it is pertinent that you perform your due diligence and fully understand the structure of the deal and real estate developer ‘s history before contributing to these types of offers. These offerings range from 36 to 60-month terms and with 14% to 18% projected internal rate of returns. RealtyShares will create an LLC on behalf of the investors of which the investors will become members of the LLC alongside the real estate developer. The LLC will then take ownership of the property. Equity deal investors run the risk of the property under performing or not appreciating as fast as projected by the real estate developer in which case it may take longer to execute the intended exit strategy or the property may be sold for a lower profit than was expected. Lastly, there may be possible tax benefits available to equity investors due to real estate depreciation.
The registration process was straightforward, enter your email address and create a password, enter your name, address, etc., self-certify you are an accredited investor, link your bank account, and then patiently wait for the required cooling off period to end. During the cooling off period you can explore the website and view all open investment opportunities, however, you will only be able to invest in opportunities that begin after your cooling off period has ended.
I used the 30 day cooling off period to research the opportunities listed on the site. There is typically a 2 to 3 page overview summarizing the investment deal, describing the property, anticipated risks and financials. There are then four more in-depth sections with more details on the property, financials, market, and real estate developer.
The Property section discusses the property history and current state of affairs. T
The Financials section documents the waterfall of how profits will be distributed, identifies where all sources of funding that will be utilized to acquire the property along with a detailed budget for repairs, operating expenses, and contingency funds, the exit strategy, and the expected cash flow to all parties involved over the anticipated term.
The Market section discusses the geographic location of the property and provides information regarding demographics, major industries and employers, recent sales and revenue estimates of comparable properties in the region, and rental statistics. Most of the data is gathered from ESRI and REIS, two of the largest providers of real estate market data.
The Management section provides resumes and Linkedin profiles for the real estate developers seeking investors, along with a history of their real estate history and current portfolio net worth.
I identified three commercial real estate opportunities that met the rate of return and risk level I determined were acceptable to me at this stage in my life. My first option where a 61 unit apartment complex outside of Seatle, Washington located near Amazon’s and Boeing’s headquarters and several other large tech companies. The second option was a 286 unit apartment complex in Columbus, Ohio that was in need of minor repairs to bring the rents up to current market prices, and my the third option was a new 629 unit self-storage facility in Saint Louis, Missouri.
All three deals offered projected returns in the 16% to 18% range over 36 to 48 months. It was a toss up between the Seattle property and the self-storage units. I decided on the Seatle apartments because I’m a techie and believe it is the younger sister of San Francisco, just coming into its prime but due to the cooling off period restrictions, I was not able to invest in the property since the offering started few days before my cooling off period had ended. So I settled for my second choice, the self-storage units.
The self-storage units were appealing for two reasons, first, the team of real estate developers included three ex-senior executives from the self-storage industry with 20 to 30 years of experience each. If you ever wanted an all-star team to help make your investment less risky you didn’t have to look much further.
In 2012 they formed their own capital management company to invest in self-storage units for themselves. To date, they have acquired 36 self-storage properties and have successfully exited four of those investments. In addition to the 31 properties in their current portfolio, the principals have investments in 25 other properties across the nation. Through some additional research into the self-storage industry, I found out that the real estate developers for this deal were recognized in 2015 as one of the top 8 industry movers and shakers by their peers.
The second reason was because the financials showed that the units could be rented below current market rates for the area and still generate a significant profit. My research using Google Maps also revealed that the property is located in a high traffic area adjacent to a brand new gas station and within a few blocks of high-density residential neighborhoods.
I decided to invest $20,000 from which I expect to receive 16 quarterly payments of $421 over the next four years. This equates to an 8% interest rate on the principal investment for a total of $6,743 worth of interest. Upon the sale of the property, I will receive my $20,00 principal back plus and additional 8.4% return that will equate to $7,903 for a total profit of $14,646. That’s a total profit of 73% over a four year period! Because this is an equity deal, if the property sells for less than estimated the 8.4% rate on my final payout could be significantly less, but if the property sells for higher, I will see my fair share of the additional profits! I can further hedge my risks by redistributing the quarterly payments, into LendingClub or Betterment to simultaneously produce passive income over the four-year period.
Since the passing of the JOBS Act in 2012, the internet has given rise to all sorts of crowdfunding platforms. Prior to the JOBS Act, companies seeking investment capital were strictly limited on who they could approach and how they could approach them because of archaic SEC rules about solicitations and accredited investors. Investment crowdfunding through sites like LendingClub and RealtyShares makes it easier than ever to invest your money in a greater variety of asset classes. All of us are no longer limited to just the stock market and local real estate markets. The road to early retire requires both defensive and offensive strategies. Save as much money as you can through whatever means necessary, and learn how to research and evaluate investment opportunities. Do not settle for 2% to 4% returns, it is quite possible to achieve 8% to 18% returns with calculated risk.