January 2024
Although being a landlord is a popular way to invest in real estate, Kevin says it requires consistent effort to resolve maintenance issues and handle difficult tenants. If an investor is interested in a more passive strategy, REITs (real estate investment trusts) and private funds are options to consider.
REITs are publicly traded equities, making them highly liquid. This allows for easy entry/exit, but also subjects the investment to the volatility of the stock market and interest rates. Private funds offer more control over investment type and require larger minimum commitments than REITs. These funds involve managers who are responsible for making strategic investment decisions and are generally less liquid. It is important for investors to understand the fund’s investment strategy, fee structures, and risks associated with the fund’s investment focus before committing.
Watch previous episodes of THE FINANCIAL COMMUTE here:
Ep. 69 Mastering the Balance: Liquidity vs. Illiquidity
Ep. 68 Bitcoin ETFs: What We Think You Should Know
Hello, everybody. And thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host, Chris Galeski, joined by Wealth Advisor and Partner Kevin Rex. Kevin, thank you for joining us.
Thanks for having me.
We're here to talk about investing in real estate. There's a few different ways to do it. You can invest in real estate directly and be a landlord. You can do it through a real estate investment trust, or you can do it through like a private fund that invests in real estate for you. So we're going to talk a little bit about the different ways people can invest in real estate.
We're mainly going to focus on the pros and cons of investing in real estate through either a real estate investment trust or a private fund, because those are more passive ways to invest in real estate. Being a landlord is not as passive as people may think. And then we'll talk a little bit about why structure matters and recap for people.
So let's start out by talking about the three different ways to invest in real estate. Tell us about being a landlord.
I definitely have a more biased opinion having owned a rental property for some time. I got into it like probably many people thinking, passive income you own. You own the property and rent checks just come in.
It's not that way. It is not that way at all. I mean, it is late night phone calls. It's your issues with the roof. You think about owning your own home, all of the issues that you deal with as a homeowner. Now multiply it by multiple units if you have a multi-unit property. So it's not passive.
I don't want to deter people from looking at it as an option because we believe strongly in owning real estate. I think real estate is an incredible asset class and I'm excited to talk about some of the other structures. So if you're not a landlord, the more passive way would be a real estate investment trust.
So that is a publicly traded equity that you're able to put money into, and you are completely passive. And we'll talk through some of the pros and cons of that structure and in the way that we typically access it here, which is one of my most favorite ways, is through a private partnership or a private fund.
And it's, you know, think of like a REIT being you put your money in and the manager just kind of runs with it versus the privately held fund. There is a more strict mandate and understanding of what that manager is trying to do. And the structures are different.
I mean, one of the pros about each one of them is you're getting exposure to an asset class that people get excited about, and that's real estate, because not only is there a potential for income, but also appreciation as well. And that's the beauty about real estate, at least in Southern California. We can speak to getting the best of both worlds.
Yeah. So let's talk a little bit about the pros and cons of real estate investment trust versus private funds.
Yeah, when you think of a REIT, what's funny and you and I were joking about this, the things I love about investing in it are also the things that scare me in that I'm like, Whoa, wait a second. There's liquidity so you can get in and out of a daily. And for a lot of investors that's great because owning your own property, it's illiquid.
So you put money in, you can't touch it. But within a real estate investment trust, you can...
It's just like a stock or a mutual fund. I can click a couple buttons and invest money into that asset class and I can click a few buttons and take my money out of that asset class.
There's no real minimums, so you don't need to have a $200,000 down payment or $50,000. So you can get access to real estate really easily. The downside to that is everyone else that's invested can get in and out daily. Well, the underlying asset's still real estate. So it's still an illiquid asset and there's a lot of liquidity, there's a lot of income and money flowing around, but it kind of starts and you start to get a little bit of a pause of, okay, what if everybody starts selling in a bad environment and the underlying asset isn't liquid, What's going to happen?
So that illiquidity is a great thing and it's also a tough thing to to be thinking through.
You know, one thing that's nice about real estate investment trust that you talked about was instant exposure to real estate. But it it might not be what you are thinking about or imagining. I mean, you might own certain sectors of the real estate market that you're not all that excited about, whether it be hospitality or commercial or, you know, multifamily.
It could be a number of different types of real estate. And then they're also forced to pay out a certain percentage of their earnings in the form of a dividend. I believe it's 90%, right? So it's more of an income tool, something that that that's getting you exposure to an asset class that's producing income, but it's subject to what happens with interest rates.
And there can be volatility there. Again, there's the things that we do like about it with quick, easy access is also some of the pain points.
Yeah, because it's a stock, it is going to be exposed to just even the flows of the market. Maybe real estate's doing fine, but there's panic in the economy. Interest rate sensitivity is a big one.
But the downside is they're putting money to work right away no matter what the environment's like or no matter what their opportunities are. So the don't really get to be strategic about deploying or removing capital from the real estate market. It's kind of at the whims of investors either putting capital in or taking capital out.
So then let's talk a little bit about the private fund structure. So you're going to invest with a manager that specializes in investing in real estate. It's going to be a fund that you have to sign sub docs or a limited partnership agreement to. And this group's going to try to raise money, let's say 100 to $200 million.
Yeah. So comparing it to a restructure, you're going to commit a certain amount. The minimums are typically around 100,000. I know some funds can take a little bit less. So a little bit of a larger commitment or barrier of entry that you typically have a little bit more control over the type of investment. So as you mentioned, the manager is going to say, all right, this fund is investing in multifamily or industrial or self-storage.
And so, you know what, that the guidance or what the goals are of the fund. So that's nice. What else is really great is those managers almost always have some level of their own net worth tied up in that fund. So hundred million dollar fund, they might have, you know, 1 to 5% of their own capital invested in that fund.
So it makes a big difference. If you're raising $100 million and you have 5 million of your own money in it, you might make different decisions.
We know. We know that is just for mix. It's different managing someone's money versus having your own money in. It does change things.
But then how about deploying it in terms of putting money to work? They raise $100 million. What does that look like?
Yeah, and again, comparing it to REITS that get put to work right away. The downside is this might not get put to work right away. You might wait a year or two years for opportunities for them to call your capital. So it's that capital call structure. They find a property they want to buy and they say we're going to call 10% of everyone's commitment.
So if you committed 100,000, they're going to call 10,000 and that money's going to get put to work. The positive to that is they don't have to put money to work right away. They are going to wait and be strategic. So like the REIT that just gets deployed immediately, you have to be potentially more patient. But we believe that you're going to get better opportunities because they're going to deploy capital in the right opportunities at the right time.
You know, a lot of people do view real estate as a passive way to invest. Obviously, if you're going to be a landlord, it is not passive all. In fact, a lot of the ways that we look at investing in real estate in order to do it right, you're not being passive, right? They're doing things like value add real estate.
They're buying a property that already exists. They're finding ways to make improvements, add value to it, increase rents and net operating income to increase the valuation of the property. And so it is a very labor intensive process in order to invest in real estate the way that we think it's proper to invest. But also it takes time that you can't just flip a switch and all of a sudden say, Hey, how's my real estate investment doing?
It takes time to find the right property, to make the right improvements, to get the right financing, to increase the rent, so on and so forth. I mean, it's a several year process. So, you know, when you're working with a private fund, they might have a three or four year window to find and acquire new properties, then to be patient, to look for opportunities.
Absolutely. And when you own an individual property, you're concentrated in that property. And there's pros and cons to that. If you hit a home run, obviously there's huge upside to that, but you don't have diversification and most likely you're going to buy a property either close to where you live. If not, you're managing from afar and within a fund you have anywhere from 10, 15 different properties.
Diversified in different geographical regions can be different sectors of real estate depending on the fund. So you are allowing that expert to do what they do best is to understand different segments of the real estate market, understand different geographical regions. And then I think the biggest piece you hit on is going back to 2009 2010. You could buy a property, slap some pain on it, increase rents, and you had an incredible investment.
That's not the world we live in today. You have to buy a property and add value in some way. If you're not a real estate professional, how do you know where to buy? How do you know where to in how to add value? It's just it's much more complicated space right now. And so using somebody that does it for a living, that their full time job is investing because it's not passive the way that we talked about.
Right. Let it be passive for you and let it be active for them. You don't want it to be your second full time job.
Yeah. Look, I'm a big proponent of having different forms of income coming to you, so that way you've got freedom in life. But investing in real estate is definitely not passive. We talked a little bit about why structure matters when you're investing or buying properties right at the forefront of making that investment. When you're in a real estate investment trust, your money gets put to work really quickly.
If you're in a private fund, it might take a while, but that manager is able to be patient, do the proper due diligence and find the right opportunities. Let's talk a little bit about why structure matters on the way out as your exit.
Yeah, the liquidity terms are a big deal. And so starting with owning your own property, if you want to access capital from that property, you're either refinancing and pulling money out, going through a bank, which right now can take three, six, nine months or you're selling that property, There's no real quick way. Now you can put a heat lock on it and access capital, but interest rates are pretty high, so you're pretty limited money out of a three.
We talked a little bit about it as you just click a button and your money's coming back to you, which is a great thing if you're the one wanting liquidity. But in very challenging environments, if everybody is clicking a button at the same time and the value of that fund is falling, who knows what the value is going to be when you're exiting.
And then you do have probably the least amount of liquidity when it comes to the private fund. So you really are investing in a long term vision, which in our minds that's what real estate should be viewed as. It should be viewed as, Hey, let's give this thing time to season and and create value and create income over time.
But usually the terms of those funds are anywhere from 5 to 10 years to be able to say, Hey, I want my money out. But what we do here more than is we structure the fund in a way where we're getting income along the way and the general partner is incentivized to get us money back as quickly as possible.
So they they don't get their participation profit until we've gotten back 100% of our commitment and a preferred return. And so, again, it aligns our interests in getting our risk capital off the table. They get a nice kicker, but that's great. Once we've gotten our risk capital back, we want everybody to win together. But that should be viewed again more as like a 5 to 10 year lock in, more real estate partner funds.
Yeah, I like the way that you brought it up in terms of the alignment of interests when it comes to investing in real estate and making sure that the investment vehicle or the people that you're investing with align with the actual investors themselves. And when you're with a real estate investment trusts, you kind of don't know who's on the other side of the table.
You're not able to speak with them and talk to them. Go back to COVID 2020. Let's say you were in a real estate investment trust that was, you know, even owned a bunch of multiple family apartments. Right. It feels pretty safe. You're invested in an asset class where people need a place to live. But again, March of 2020 was really, really scary.
And there was a lot of unknowns. If you're in a real estate investment trust, there might have been a lot of people that were clicking buttons to sell because they needed liquidity. They were worried about their jobs or the future of the economy. That fund might have had to offload properties during that stressful time. Whereas, you know, a couple of the groups that we invest with, the private funds, they were able to work with their tenants and find the subsidies that made sense for them for rent assistance or, you know, to kind of manage the properties in the decisions or hold on the cash flow that was coming in to help the investors stay committed long term as opposed to having to sell a property at a at a fire sale or a discount price. So totally different experience.
People think of illiquidity as, I can't access my money, that's a bad thing. But it's actually in these types of investments. That structure is the protection. If everyone could have sold and you were late to the game and hitting that button, who knows what your value would have been. But because they can't, they limit the redemptions that holds the value in just going back and touching, you know, the world was ending in 2020.
And you think about some of our partnerships. I remember, you know, KCB being one of them, where they had a they actually had a hotel and they had decisions to make. Do we sell it? Do we hold on to it? Do we take it to market because it wasn't actually up and running and they were able to decide what was best because they were in control.
They weren't beholden to investors forcing sales. They knew that they had as much time as they needed and they were able to say, look, this is an asset that we want to hold long term. It's going to be troubled right away. But if we just hold it, we have long term debt so we can weather this storm. They actually held an empty hotel for a period of time until it the world open back up and travel started and events, weddings and so forth.
But they were able to do that because of the structure. They were in control. I think that's a huge thing when you're investing in an asset class like real estate.
Look, I'm clearly biased as well. We all have our biases for different reasons. But like when I'm investing in a real investment, like real estate, I want to have as many of the things that we can control on my side of the table, right? That's the property type. That's how much we're going to put in there to add value.
That's the amount of debt and the the the rate or the time period that we have it, along with the decisions around when we want to sell as a group of partners. And, you know, when when I'm invested through an index fund or a real estate investment trust and I don't control many of those factors, that's where I get worried during uncertain times because the people across from me might not be comfortable selling and their decisions could impact the value of my investment.
And that's where I struggle a little bit.
In all of these different structures. There's a good part to them, too. So for those that don't have access to private funds or buying their own property, it's not that REITs are bad. There's just some risk to be aware of. And so it gives great access to those that smaller amounts are need, you know, need to be able to go in and out as their finances dictate.
Disclosure:Information and references to specific investments presented herein are foreducational purposes only, are not intended as an offer or solicitation withrespect to the purchase of any security or asset class, and should not berelied on for investment recommendations. The private investment opportunities discussed areavailable to eligible clients and can only be made after the client’s carefulreview and completion of the applicable Offering Documents. Each investmentopportunity is unique, and it is not known whether the same or similar type ofopportunity will be available in the future.The views and opinionsexpressed by the speakers are as of the date of the recording and are subjectto change. The investments discussed may fluctuate in price or value. Morton Wealth makes norepresentations as to the actual composition or performance of any security.All investments involve risk, including the loss of principal. Past results areno guarantee of future results. You should consult with your financial advisorto thoroughly review all information and consider all ramifications beforeimplementing any transactions and/or strategies concerning your finances
