In my 20s and 30s, I owned around 20 rental properties. Today I own no properties directly — but I have an ownership interest in over 2,500 units.
Even that number is starting to feel like a “vanity metric.” Many of my best real estate investments don’t involve owning any units, at least not for long.
I love passive real estate investing. But most people have false assumptions about what that means. When I say “passive real estate investments,” most people hear something else: “REITs,” “real estate syndications,” or “real estate crowdfunding investments.”
Sure, those are examples of passive investments. But they only make up the tip of the proverbial iceberg.
Before you write off passive real estate investing, consider the following options that you may not know much about.
Private partnerships are one of my favorite ways to invest in real estate.
In the simplest sense, these involve going in on a real estate deal as a silent partner together with an active investor. They do the work, you provide capital, and you get a share of the profits.
Last month, our Co-Investing Club invested in a private partnership with a mom-and-pop house-flipping company based in Michigan. We provided the bulk of the funding for a series of flips, and in return will earn 25% of the profits on them.
This company does 70-90 flips per year, with a 95% win rate. To remove the risk for us, the founder personally guarantees a minimum 8% return for us on each deal. We get a personal guarantee from him, a corporate guarantee, and ownership in the properties (which have no debt).
As for the value of those guarantees, he and his company own $15.2 million in real estate, with over $6 million in equity. So yes, they’re good for the money.
We’ve worked with him before, and his partners earn average annualized returns in the 16-26% range for their money. To me, it offers a classic example of asymmetric returns.
Rather than investing as an equity partner, you can also lend money against real estate. Private notes typically pay a fixed interest rate, but you can structure these however you like. You can negotiate performance bonuses, for example, to participate in upside.
Are private notes risky? It depends. How experienced is the borrowing investor? Is this their first property or their five hundredth? What’s the loan-to-value ratio (LTV)? A note with first lien position for 50% of the property value offers far lower risk than one for 85% LTV.
I mentioned that our Co-Investing Club has worked with that investor in Michigan before. We’ve lent him a private note, secured with a first-position lien under 50% of the property value, plus a personal and corporate guarantee.
People tend to have a lot of misconceptions about real estate syndications.
A typical real estate syndication lets you invest as a silent partner in a large commercial property such as an apartment complex, retail property, storage facility, mobile home park, or other real estate investment. You become a “limited partner” or LP, and the general partner or sponsor does all the work of buying, managing, and ultimately selling or refinancing the property.
These investments require a high minimum investment, usually $50-100K. In most cases, you commit to a medium- to long-term investment in the three to seven-year range.
Like all investments, they come with risk. If the property drops in value you can lose some or even all of your investment.
And like all investments, the risk varies — by a lot. I’ve invested in some syndications with low risk and high returns, because the sponsor was able to buy at such an enormous discount and then immediately add vast value to the property.
For example, earlier this year our Co-Investing Club invested in a property where the sponsor partnered with the local township. In exchange for setting aside 50% of the units for affordable housing, the property gets an exemption from paying property taxes. Even after accounting for the slightly lower rents in half of the units, the property is generating far more NOI from Day One. And that doesn’t take into account the 100% occupancy (and waiting list) for those units designated for affordable housing.
In short, the sponsor raised the cash flow and property value instantly, without having to spend a dime on renovations.
You can also invest with operators who raise money for multiple or ongoing deals.
For instance, the deal we’re vetting together as an investment club this month is a land fund. The operator runs a land flipping business and specializes in mid-range ($25-250K) land parcels. He buys them for 35-60 cents on the dollar, then further adds value by doing minor subdivisions: splitting them into five or fewer parcels.
In the jurisdictions where he operates, minor subdivisions of five or fewer parcels don’t require zoning approval. He doesn’t have to worry about the local municipalities turning him down.
A typical deal for him looks like this: he buys a 20-acre lot worth $200K for $100K, then subdivides it into five four-acre parcels. He then sells each parcel individually for $60K.
His average land flip lasts a little over four months and doesn’t carry any construction risk, property management risk, or regulatory risk. It’s just dirt. But because he buys dirt, it’s hard for him to borrow money from a bank to operate his business.
So? He raises money from passive investors like you and me and pays 16% annualized returns in the form of quarterly distributions.
Alternatively, you can invest in funds that own many notes and loans. In most cases, these loans are secured with a lien against real property.
Sometimes these debt funds pay fixed interest. In other cases, they pay based on performance.
Consider 7e Investments as a case study. The principal, Chris Seveney, buys non-performing mortgage notes for a fraction of the loan amount. He and his team then work with the borrowers to get them caught up on payments, and then turn around and sell the now-performing notes for closer to the full loan amount.
He has great downside risk protection because he buys loans for a fraction of the property value. His average loan cost is around $195K, but the average property is worth around $500K. In the worst-case scenario, he can foreclose and recover his outlay.
But Chris prides himself on working with borrowers to get them back on track and keep them in their homes. His foreclosure rate averages under 10% — a feat, given that every loan he buys is behind on payments.
The debt fund pays around 8-10% fixed interest, depending on the investment amount. It pays monthly interest and has never missed a payment.
To better write about real estate crowdfunding, I’ve invested personally in most of the major platforms.
Some I quite like. Others, not so much.
On the plus side, they make it easy to find and invest through all of the passive strategies outlined above. Many don’t require a high minimum investment, making it easy for the average person to participate.
Just don’t expect the same asymmetric returns that you can earn when you find passive investments on your own. By their nature, crowdfunding investments are open to the public, so they pay the minimum returns they can get away with to attract investors.
They also come with plenty of overhead and marketing costs, which they recover in the form of fees. Some are transparent about those fees — others are not.
To reduce your risk even further, find some like-minded investors and go in passive real estate investments with them.
This reduces risk in two ways. First, you can split the minimum investment and invest with relatively small amounts. That makes it easier to diversify, and to spread your risk across many markets, property types, and sponsors or partners.
Second, more eyeballs analyzing an investment means better vetting. In our Co-Investing Club, we meet every month to vet and go in on a new investment together. I’ve been in real estate for over 20 years, yet inevitably our club members ask some brilliant questions that never would have occurred to me to ask.
I approach passive real estate investing through the lens of dollar cost averaging. I invest $5K a month in a new passive investment, just like I invest steadily in the stock market.
Forget trying to time the market or pick the next hot asset class or city. Just invest month in and month out with other experienced investors, and over time you’ll outperform the people who try to get “clever” by flitting around to find the next hot thing.
***
About the Author: Brian Davis is a real estate investor, personal finance writer, and co-founder of SparkRental with over two decades in the real estate and finance industries. He owns fractional shares in over 2,000 units and regularly contributes as a real estate and personal finance expert for Inman, BiggerPockets, R.E.tipster, and more.
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.