Real Estate Investment Opportunities: Best Places To Invest In Real Estate
Real Estate Investment Opportunities: Best Places To Invest In Real Estate
Real estate is an investment category that’s driven the wealth of millionaires and billionaires worldwide. Relative to other asset classes, the high reward to risk ratio has stood the test of time. Demand for land in popular locations near shopping malls, schools, healthcare, and other essential lifestyle facilities continues without pause in most cases. Steadily escalating and recurring rental income encourages landlords and property owners to hold their assets for years. It’s not unheard of for signature family real estate investments to pass down through generations to children and even grandchildren.
Real Estate Is a Highly Diversified Arena
It ranges from single-family and multifamily residential to heavy industrial. In between, there’s mixed-use, offices, retail, hospitality, and warehousing (to mention but a few commercial subsections). Arguably, the involvement of mortgage lenders most significantly indicates that real estate is a dynamic and solid investment field. Loan advances touching loan-to-value ratios (LTV) of seventy percent and higher are commonplace. Often, borrowers can access these funds without personal guarantees. It endorses the inherent value real estate represents and keeps it front and center as a mainstream investment option throughout the US. Indeed, for the rest of 2021 and beyond, interest rates in the low single digits significantly energize the markets.
The Leveraging Effect in Real Estate Investing
A typical example of the leveraging effect is this: Suppose you had a property with a modest six percent annual appreciation and a standard LTV funding ratio. Would you be surprised if you could sell it ten years later, at which point:
- Your equity in the property multiplied by 260%
- More than doubling the property's annual growth rate (i.e., at 13.8%)
Don’t be; it happens all the time. Now envision that scenario on steroids, delivered to us on a plate by the recent COVID-19 pandemic. As traumatic as the health threat was, it enhanced the attraction of residential real estate in the mindsets of millions of families.
Here, we describe how private equity real estate funds are structured, the key benefits of investing in these funds and a summary of Regulation D Rule 506 that governs the types of investors that can participate in a private equity real estate fund. We then describe the different phases of developing properties a fund may undertake and provide a high-level summary of The Kona Estates Fund I, LLC, a private equity real estate fund available to accredited investors.
The Residential Market Is Hot! It’s the Place to Invest Today
The residential markets up and down the coast are hot, with a capital H, churning out house and condo price jumps year-on-year of twenty percent plus. In some bubbling pockets located in Texas, Florida, Hawaii, and California (amongst many), flippers are surprising even themselves with short-term blockbuster gains. Real estate wholesalers have emerged as a mainstream investor category that moves in and out of properties - sometimes on the same day. They take “buy-and-flip” to its outer limits - trading in real estate like it’s copper futures on the Chicago Commodity Exchange. However, be warned house flipping requires:
- Inside-track knowledge
- Oodles of stress tolerance
- Agility to take the gaps.
It’s not a place for novices or a testing ground where you invest hard-earned money to learn. Also, as markets move further toward a seller-favored bias, the wholesaling opportunities grow less and less. Long-term rental propositions make a lot more sense.
The thing is this, while residential demand is off the charts, inventory availability is dropping like a stone. For example, look no further than South Florida (that typifies many American regional markets):
- According to a YouTube update by Champagne and Parisi - a prominent realtor in Boca Raton that provides authoritative reviews - single-family home sales in March 2021 were up (year-on-year) by 23% for the highest monthly number in at least a decade and a half.
- The mind-boggling metric standing alongside this is that inventory for the same time frame was down by a whopping 63%, turning the pressure valve up and promising a continuing upward price momentum.
Affordability is becoming a significant consideration for millennials and families across all age groups. Many lower their sites from single-family ownership to condos and townhouses, rushing to get a property nailed down, sometimes amid price wars and multiple bidding. However one looks at things, sellers are in the driving seat with the pedal to the metal and full steam ahead.
Real Estate Tax Advantages
There are enticing tax incentives across the real estate spectrum, covering rentals, multifamily, vacant land, industrial/commercial buildings, shopping centers, and more. When you combine this with leveraging, real estate investing bypasses all pretenders to the throne. The benefits include:
Broad Deductions
Generally applicable to rental situations under the heading of “property management.” It covers overhead items like mortgage interest, property tax, HOA fees, operating expenses, depreciation, and repairs.
Passive Income & Pass-Through Deductions
This can apply to REIGs and other structures (see below). It impacts money earned from real estate activity that investors don’t physically participate in. The Tax Cuts and Job Act (passed in 2018) pinpoints qualified business income (QBI). The latter allows investors to deduct it to a maximum of 20 percent of their net business income, and it’s available until 2025.
Capital Gains Tax (CGT)
The rule is to regard short-term capital gains earned (i.e., from selling a property for a profit) in less than one year as regular income for tax reporting purposes. In a nutshell, there’s nothing special in that.
When real estate is held and sold over longer than 12 months, there are three capital gains tax touchpoints - 0%, 15%, or 20%. These are generally way less than anything classified under the short-term CGT category. Your income and tax filing status dictates where you precisely fall, as well as the nature of the property in the transaction. Check carefully in each instance.
Any property sold for a profit will surely drop under the CGT spotlight. The 0% slot (i.e., complete tax exemption) only applies to the sale of primary residences earning up to $500,000 of profit for the sellers. It means that many house or condo owners, taking advantage of mortgage funding, can build wealth tax-free. They end up doing nothing more than buying, living in, and selling their home years later.
1031 Exchange
1031 exchange is an Internal Revenue Code that allows investors to jump from one property investment asset to another. Thus, they can defer capital gains tax until they sell the next one. The latter asset must meet the following criteria:
- Equal or exceed the value of the sold asset.
- Be a similar type of asset (e.g., a REIT - see below)
- Be suitable for trading or a production function.
Other Tax Benefits
Embrace things like tax-deferred retirement accounts, self-employment/FICA tax relief, and opportunity zones. We cannot cover these in detail here, but we urge you to Google these headings to see if they apply to your situation. In all cases, these included, we advise consulting your CPA or tax expert to structure a tax plan that gets you all the benefits you’re entitled to.
Low Risk, High Reward
The scenario and benefits painted above are a somewhat “high-in-the-sky” overview. Astute investors appreciate that there’s no slam-dunk when it comes to committing funds to a long-term venture - real estate or not. Volatility can take you by surprise when you least expect it, so there’s no substitute for due diligence. We only need to look at what happened over the last year with social distancing and the health scare.
For example:
- “Stable” rental properties took a huge hit when the CARES Act (ended in March 2021) gave tenants the right to squat for no pay without fear of eviction. It was a tremendous bump in the road for residential landlords, still on the hook to catch up on any loan forbearance.
- On top of that, desperate tenants have begun abandoning their neglected or damaged premises in fear of being chased down for back rental payments.
- On the commercial side, stores and offices went dark as homebound communities turned to shopping online and worked remotely.
- Families moved away from frenetic city activity to the suburbs. Some congested location multifamily buildings (like in NYC) experienced price drops while single-family homes offering wide spaces and relative seclusion soared.
The bottom line is that real estate, while unquestionably less risky than most other options, is by no means riskless. Research, if conducted methodically, should carve out a strategy that suits your temperament and pocket. The vulnerabilities and the advantages of going in specific directions are vital evaluations.
Single-Family Residential sector (SFR)
How to find real estate investment opportunities? It’s the question on everyone’s mind. One productive way is to follow the big guns. Until now, large institutions, a minor player in the single-family residential sector (SFR), are doing a right-angle-turn and going after it. It's notable that this investor category, while accounting for half of all national multifamily units, owns only two percent of the ninety million SFRs, according to the NHRC (National Home Rental Council). Clearly, it's a space that both individual and professional investors will fill in the following years. With IRRs ranging between 15% and 28% for REIG style opportunities and around 15% for REITS (more regulated) the returns are attractive. The only thing left to do is align one’s propensity for risk with the projected reward.
The Different Ways to Invest in Real Estate
Remember, any developer can project anything on day one. It’s what he or she delivers years later that really matters. Flippers may have a great run for a week or two and zero for the next year. If they throw caution to the wind or grow overconfident they can lose it all. In short, investors approach their targeted assets with different attitudes, influenced by their:
- Tolerance for risk
- Desire for consistency
- Faith in the model
- Readiness to get involved in the decisions
- Understanding of the real estate types
- Need to know the investing details
Real Estate Investment Funds (REIFs)
These offer investors numerous ways into every vertical under the real estate label. Here are a few of the most popular, outlining the pros and cons one should take into account:
Real Estate Investment Groups (REIGs)
Sometimes knowing that you don’t know enough about something is a positive first step without necessarily scaring you off. People who are new to real estate investing aren’t ready to go in boots and all or don’t have the time to analyze more significant projects, detail by detail. You may be one of this massive number, most of whom have no accredited investor status but remain attracted to scaled-up options. A REIG may be just the thing the doctor ordered for your situation.
What is an REIG exactly?
Answer - a pooling system involving individuals who want to commit funds to a real estate investing theme. The REIG strategy may center on any one or more of the SFR, multifamily, and commercial categories, providing expertise in activities like:
- Buy-and-flip
- Buy-renovate-and-rent
- Property management for fees
- Leasing
- The property funding side of the equation. This theme opens the door for REIGs to enter the picture as hard money lenders at higher rates than regional banks (but with similar property-backed security).
Some REIGs depend on the leadership of a single member (the general partner). In contrast, others call on the members to participate in the decisions actively. Getting into a REIG may involve "entrance money" - especially if its management record is proven and robust. In other cases, there are no membership fees required. Besides unique focus definitions and internal management policies, REIGs rely heavily on an aggregation of group members' funds. So, in summary, REIG distinctiveness depends on:
- Pooling of funds from all the individuals within the group.
- A private, largely unregulated agreement between members.
- Members sharing proportionately in the REIGs benefits as dictated by the contract.
- Income and profits distribution to the REIG members, matching their share of the underlying real estate.
- A viable opportunity for members to participate in large-scale real estate ventures that they ordinarily would be unable (or unwilling) to fund independently.
- No limitation to the number of members making up a REIG.
REIG complexities you should be aware of
Taxation: Most times, REIGs prefer a partnership arrangement with a pass-through income accommodation allowed in US law. The partnership reports net income via K-1 tax documents, shifting the tax responsibility from the REIG to the group members - aligning with their proportionate share of the benefits. Individual partners who receive a K-1 file their partnership income on Form 1040. Corporate partners file on Form 1120. Most of the tax benefits outlined in Section B above are available to investors. Still, it would be best if you referred to your tax advisor to nail it down precisely.
Leveraging: The REIG in its chosen structure can negotiate with lenders to gain leveraging benefits as long as the bank understands that the borrower is a partnership. If personal guarantees are a requisite, things can become complicated by taking the members outside of limited liability. As a result, many REIGs invest with 100% equity at the beginning.
Losses along the way: Losses erode capital, and a point may arise where the REIG can’t continue operating without additional partners’ capital injections. A prime example of this occurrence, again, was The COVID-19 induced CARES Act. It created substantial REIG partner upheaval in multifamily developments where rentals dwindled to a trickle with evictions cut off as a remedy. The agreement terms should anticipate the loss possibilities and your resources to cover shortfalls. Inability to remedy may result in share dilution if you can’t come up with your share of the fill-in funding.
Trust: When you get into a REIG, it's practically unfettered by rules and regulations. Bad actors leading REIG activities can defraud the partnership, pushing the dormant members into a dilemma long before warning signals flash. Before committing to a REIG, make sure you know whom you're getting into bed with.
REIG Termination: Exiting a REIG can be severely problematic if the funds are tied up, and nobody is willing to take over your REIG share. Review the exit and termination agreement clauses carefully. Ask yourself if you can withstand the harshest situations (including loss situations mentioned above). Extreme scenarios may never occur, but at least you won't be blindsided if or when you try to liquidate your REIG holding but can't.
REIG Expected returns: Anything from 15 - 30% IRR. More important, however, is for investors to understand the model and trust the management team.
Real Estate Investment Trusts (REITs)
This option looks amazingly like a REIG but is quite different in fundamental respects. For one, there must be at least 100 shareholders after the first year of trading. For another, five or fewer shareholders cannot own the majority of the equity. These are only two of numerous SEC restrictions that keep REITs on the straight and narrow.
If you intend to capture all the tax benefits (see the section on it above), this is not for you. REITs stream their income back to shareholders as dividends - always treated as regular income. Further, the law requires REITs to distribute 90% of their income to shareholders, leaving minimal opportunity to use funds for capital gains inside the REIT. The key differentiators that "brand" the REIT category are as follows:
- They’re always corporations (not limited partnerships).
- They can essentially do everything a REIG can do (see above). There are:
- Equity REITs (owning income-generating properties)
- Mortgage REITs (specializing in funding arrangements)
- REITs that do both.
- They offer investors an enormous range of real estate investment or funding options, including multifamily, SFRs, warehousing, shopping malls, industrial parks, medical facilities, and more. Mostly, the income connects to renting, not buy-and-sell.
- They fit the needs of conservative investors who want only publicly traded REITs, thus establishing a high level of liquidity. There are many options in this channel, taking substantial exiting-stress out of the equation.
- They are professionally managed with chapter and verse on record for review when publicly traded. One possible downside is that the management fees can be steep, although given the excellent net returns lately, generally more than worth it. Make sure to compare these costs - it could make a difference.
Be aware that some REITs are private, making liquidity somewhat of a concern. You (or your advisor) must analyze the metrics carefully before entering such a vehicle. All REITs fall under a degree of SEC jurisdiction. Irregularities, therefore, are seldom an issue. On the contrary, transparency is a big plus. One should treat a REIT stock like a low growth industrial equity on the stock market. REIT price capital gains are possible, but the natural attraction lies in stable cash flow and risk-adjusted returns.
Real Estate Mutual Funds (REMFs) and other REIFs
If you like what you read about REITs, but want even more diversification, then buy the units offered by REMFs. They are funds with a diversified portfolio of REITs, probably with a consistent theme. Indeed, they may be an index fund (relatively passive with low management fees) owning a piece of all the critical REITs within a defined theme. On the other hand, active REMFs move in and out of REITS - presumably to capture capital gains in the REMF's stock value. In essence, they behave like any mutual fund, except real estate assets are at their foundation. For purposes of this audience, we advise constantly investing in open-end funds as a far safer bet than the other type (closed-end). Our recommendation relies on metrics that promise less complexity, better liquidity, and good transparency.
REIFs are a broad category that embraces mutual funds but may also invest in properties directly. Private REIFs are only open to accredited investors (e.g., a 506 C fund) with a specific focus and probably a high minimum investment level.
How To Choose The Best Place To Invest In Real Estate
Look no further than a REIF in Hawaii that checks all the right boxes.
- A professional general partner with credentials second to none
- A $1 billion successful track record in similar projects
- A compelling strategy to spearhead luxury single-family homes in one of the world's most sought-after locations.
If you agree that SFRs represent one of the prime accredited investor opportunities going into the 2020s, look no further than this. The sponsor/developer Kona Development Partners, LLC, offers a Class-A Preferred Interest at a favorable valuation alongside their participation. It boils down to some attractive metrics:
- A projected Target Equity Multiple of 3x
- A target IRR of 27% over the investment period
- Quarterly cash distributions once sales commence.
The three outstanding aspects from a risk assessment viewpoint are that:
- Investors will receive 100% of the cash distributions until the sponsors return their initial capital contributions. Only at that point do management fees and profit-sharing kick in.
- The funding depends on total equity reliance with zero leveraging to begin the project (see REIGs above).
- It indicates that at later stages in the development, there's the capacity to facilitate partner exits from the fund with modest borrowing if needed.
- Projecting 27% IRR with only equity in the mix reflects excellent land appreciation potential once developed.
There are also overt safeguards against equity dilutions. As recommended above, the REIF documents are available for review with detailed statistics of undertakings and why the location is five-star quality.