All real estate investments ultimately have to do with land and/or the structures on it. However, you can invest in real estate in two completely different ways: debt or equity.
The two have vastly different risk and return profiles, so understanding the differences (and where they fall in something called the “capital stack”) is crucial to picking the best investment for you.
When you invest in debt, you make a loan to the borrower. In return for the use of your money, they pay you back the original loan (principal) plus interest for the use of your money.
Some examples of debt investments are mortgages, bridge loans and hard money loans. The contract to repay a debt is called a promissory note; which is why some people call debt investing: “note investing”.
You can loan money for short-term (a few months to a year) or make longer term loans lasting years or decades. Payment terms might require the borrower to pay both interest and principal on every payment (like mortgages). Others (like hard money loans) are typically interest-only, meaning that the borrower pays only interest on the payments and then pays the entire principal back on the final payment when the loan comes due.
When you invest in equity, you are a part owner of the property and get to share in the profits. These profits come from rental income and/or property price appreciation.
Often equity investment returns are structured to split the profits between you and the sponsor based on certain milestones (which is called an “equity waterfall”). For example, you might invest in an apartment complex that awards you 100% of the profits up to 7% IRR. Then the investment agreement might say that you split the profit 75%/25% up to 14% IRR. And then all profit above that might be split 80%/20%.
It’s important that you understand how the split works and feel comfortable that it is protecting you as an investor and is not overly generous to the sponsor.
If you have a bit of cash each month to put toward your future, is that money best spent paying down debt or investing for retirement?
If you have a little extra cash at the end of each month, it's wise to put it toward long-term financial goals. But how do you know which goals should come first? Is it more worthwhile to put your extra money toward your mortgage or your retirement fund?
The short answer is that they're both good options. About 36% of American households have a mortgage, and of those people, the average household owes about $168,000. And in regards to retirement planning, the median amount working-age American families have saved is just $5,000 -- not even enough to see them through one year in retirement. In other words, a little extra cash would benefit most people in either of these situations.
But if you only have a couple hundred dollars (or less) to spare each month, where will you get the most bang for your buck?
Investing in your home versus investing in your future. Before you start paying off your mortgage or saving for retirement, you should build a solid emergency fund to cover six months' worth of expenses. And if you have a 401(k), it's also a good idea to contribute enough to get your employer's full match, because that is essentially free money, and you'd be foolish to turn it down.
After you have those basics covered, it's time to compare the pros and cons of paying off your mortgage and saving for retirement.
The Advantages of Real Estate Crowdfunding
Real estate crowdfunding offers investors a number of benefits, particularly when compared to purchasing a rental property or investing in a real estate investment trust, also known as a REIT.
The information regarding an underlying investment can often be limited with a REIT. This can make it more challenging to determine whether the investment is sound. Crowdfunding platforms typically research each deal before making it available so prospective investors have as much information as possible to make the most educated decisions.
In the past, in order to invest in a real estate deal, an investor would often need to have tens of thousands of dollars. Crowdfunding has lowered the bar, making real estate investing far more accessible to the average investor. The minimum investment for many deals is $5,000 or less.
Investors have a far greater opportunity to diversify their investments with crowdfunding because they are exposed to entirely new asset classes.
The advantages of real estate crowdfunding will only continue to grow as the market matures. You have to keep in mind that this is a relatively young business practice. Now that we covered some of the advantages, let’s take a deeper dive into the myths around crowdfunding your next real estate deal.
Investors in rental property often stick to the big markets, and there are a lot of good reasons to do so. For one, if you've picked a good growth market you can quickly see an increase in both the rent you can charge and in the value of the property you bought. For another, in big markets there are enough buyers so you can easily sell out when you feel like it. And third, in big markets you'll find a whole rental management infrastructure, so you aren't limited to investing in your home town.
But if you believe the economic trends that distinguish our younger adult population - more desire for rentals, less interest in property acquisition, more people priced out of gentrified urban centers, more people seeking a local society or a greater connection to the environment - investing in rental property in small-town markets can provide better long-term returns with less volatility.
America is full of small towns that are close enough to big cities - and important things like healthcare, restaurants, entertainment and airports - yet far enough away so the drawbacks of city life can be forgotten.
Many are former manufacturing towns that aren't very pretty right now, where jobs left a generation ago and the population that stayed is old. At first sight these seem strange places to make an investment - they have so much property that's empty or run down. You'll need a slightly different attitude towards investing. More patience, more interest in long-term gain. But with a smaller initial budget you can start building a real estate empire!
National homeownership rates hit 50-year lows last year during the second quarter, slipping to just 62.9 percent, according to the U.S. Census Bureau.
Since then, rates have climbed slightly to 63.6 percent in the first quarter of 2017. This is 0.1 percent higher than the first quarter of 2016 before the drop, but it's a statistically insignificant increase year over year.
But is this upward trend an indication that homeownership is turning around in U.S. markets?
It may be too soon to tell. However, current analyses are encouraging: Credit bureau and risk information provider TransUnion released an analysis earlier this month of people who shopped for a mortgage in the first quarter of the year – and 55 percent of them were first-time homebuyers.
That's up from the 35 percent of all homebuyers who were first-time homebuyers in 2016, according to the National Association of Realtors'2017 Home Buyer and Seller Generational Trends report, which was released this March.
But before we jump to conclusions about residential real estate market, let's examine key factors that will determine the future of the renter vs. owner debate.
The Millennial Question
As the generation now coming of age, millennials are largely looked upon as the group to decide whether homeownership grows or shrinks in coming decades.
The proposed $13.7 billion acquisition of organic grocery retailer Whole Foods Market by e-commerce giant Amazon holds the potential to upset the grocery cart, so to speak. Yet retail real estate investors should cheer the Amazon-Whole Foods deal, experts say.
Experts predict Amazon will use the Whole Foods stores, in part, as hubs for grocery pick-up and delivery, helping Amazon resolve the “last mile” dilemma of how to get products from local shipping hubs to nearby customers. Without a substantial brick-and-mortar presence, Amazon has struggled to effectively operate its AmazonFresh grocery pick-up and delivery service. Industry observers also expect Amazon to improve efficiency at Whole Foods’ distribution centers by incorporating the e-commerce company’s technology.
The Amazon-Whole Foods deal presents an opportunity for retail real estate investors, according to Matthew Harding, president of retail real estate services firm Levin Management. The combo with the e-commerce behemoth will help lessen “this perceived threat that all brick-and-mortar retail will be dead by next January,” he says.
Amazon’s purchase of Whole Foods should instill confidence in retail real estate investors, especially those whose portfolios include grocery-anchored properties, Harding notes. “Grocery-anchored shopping centers have always been one of the more stable property types within retail,” he says.
As many as 10,000 baby boomers retire daily. Members of this generation are increasingly looking to real estate to diversify their retirement portfolios and boost returns.
Many boomers have realized their retirement plans are not sufficient and have turned to alternative investments, such as real estate, to compensate. About 30% of baby boomers have no retirement savings and one-quarter have less than $50K saved, according to research by GoBankingRates.
These boomers, who were born between 1945 and 1964, survived the Great Recession and were raised by parents who survived the Great Depression. They have been employed in a world where pension funds are growing less common and employer-led 401(k) retirement accounts are increasingly more common.
Paying For Predictability
“The alternative investment world doesn’t become more popular until it’s time for people to retire,” The Entrust Group Director of Professional Development John Paul Ruiz said. Entrust provides services for self-directed individual retirement accounts (IRA), which, unlike typical IRAs, allow for alternative investments like real estate. Retirees typically want their investments to become more stable before making withdrawals.
“Many of our clients think, ‘What other types of investments can I hold in my IRA that are outside the securities world because I can’t handle another crash?,’ Ruiz said.
U.S. home prices rose 6.8 percent to a median sale price of $288,000 in May, according to national realtor Redfin. Home sales increased 7.5 percent over last year, despite a long-standing shortage in the supply of homes. The number of homes for sale fell 10.9 percent, leaving just 2.7 months of supply, the lowest supply Redfin has recorded since we began tracking the market in 2010. Six months is generally considered a market balanced between buyers and sellers.
The typical home that sold in May went under contract in 37 days, breaking the previous record of 40 days set in April. More than a quarter of homes sold above their list price, the highest percentage Redfin has recorded. The median sale-to-list price ratio set another record, hitting 95.4 percent in May.
(Read the full report here.)
“There is still a lot of momentum in home prices in many metros, not only on the coasts but also in places like Buffalo, Grand Rapids and Omaha,” said Redfin chief economist Nela Richardson. “Strong local economic growth and burgeoning demand from older millennials are accelerating home-price growth in this very competitive, low-inventory pre-summer market. The Federal Reserve’s latest announcement to raise short-term rates will have very little effect on buyer demand or on the overall housing market. If anything, it may motivate buyers to make their purchases sooner rather than later.”
Open house visits are a fun way to explore a property, but when you go for a visit, you have to imagine what it might look like with your own furniture, setup and style. You may know the space is a great fit for your needs, but the current owner’s furniture, staged furniture or empty rooms might not be conducive to really understanding what the home would look like if you moved in. Thanks to new developments in real estate tech, the days of imagining may soon be behind us.
Now technology is looking to fill this imagination gap through the use of virtual and augmented reality, giving buyers and sellers a new way to experience properties. As a real estate industry executive, I take an active interest in any technology that improves the overall customer experience in real estate. Here are some of the companies worth keeping track of as they continue to innovate with technology.
Immerse Yourself With Matterport
Property photos have been a key part of property marketing for decades, but thanks to advances in video and internet technology, there is no need to view properties in only two dimensions.
The classic financial benefits derived from small business ownership typically fall under two categories:
1. Earned income: salary and bonuses reported on a W2 each year.
2. Unearned (investment) income: distribution of profits from the operation and/or sale of the business.
But there are other small business ownership advantages that I call “stealth benefits,” because they’re not as evident as operating opportunities. Arguably the most dramatic stealth benefit, which often has the most wealth creation potential, is for the business owner to also personally own the real estate in which that business operates.
Here’s the classic scenario: Every business is a tenant of some landlord, likely under the terms of a commercial lease. There are many financial and strategic reasons for a small business to lease property from an unrelated landlord. But that arrangement offers the business tenant only tax deductions of the lease payment and associated disbursements, and essentially no financial benefits for the owner of the tenant business.
Now let’s consider the stealth benefit mentioned earlier. As long as the business you own is legally structured as a tax reporting entity, like an S Corp or LLC, you can accrue stealth benefits by personally owning the real estate your business operates in and leases from you. For example: Smith Enterprises, Inc. (SEI), a small manufacturer, has one shareholder, Tom Smith. SEI enters into a long-term, formal lease of the improved real estate it operates in, and the landlord, the individual who owns that property, is the same Tom Smith. Several of the stealth benefits these two entities accrue from this legal arrangement include, but are not limited to: