Top 5 Investment Vehicles for Busy Real Estate Investors

If you're like many busy professionals and business owners you probably understand the merits of investing in real estate, but don't have the time or desire to be actively involved in the day to day operations of an investment.

If this is you, you may be wondering what real estate investment options are available to passive investors?

Look no further as this post will cover the most popular investment vehicles for passive real estate investors, and the pros and cons of each.

Partnerships

Partnerships are very common way to gain exposure to real estate investments, even as a passive investor.

A partnership can consist of all general partners or a combination of general and limited partners. General partners handle the day to day operations of the partnership and have unlimited liability. While limited partners' (aka silent or financial partners) liability is limited to the amount of their investment, and usually do not materially participate in the day to day operations.

The flexibility of partnerships allow investors to choose from a variety of investment strategies, however rental real estate and fix and flipping are the most common.

These partnerships usually arise between friends, family, and close associates when one or more parties desire to acquire real estate to either rent or flip, but lack the capital needed to put a down payment or complete a renovation.

Under these circumstances the person looking to acquire the property, the general partner, will seek a financial, or limited partner, who can provide the capital required to make the deal happen.

Since partnerships are equity investments, both general and limited partners can enjoy the potential upside and associated tax benefits related to the investment, and the close knit nature of partnerships can benefit investors who desire maximum transparency and trust when making an investment.

Downsides of partnerships include limited opportunities and the lack of professional management since they usually arise from members in your close circle.

Example

Joey is a young scrappy realtor who wishes to purchase an old run down property in a great location and turn it around, but can't come up with the funds to make it happen. So he asks his Uncle Sal, a busy but successful dentist to partner with him on the project.

Uncle Sal decides to put up the money required for the project if they split the profits 50/50. So they form a partnership where Joey is the general partner and handles the day to day activities and Uncle Sal is the limited partner.

Syndications

Syndications are typically structured as partnerships, but the differ in that instead of receiving capital from close friends and family, capital is pooled from many different investors, who the general partners (sometimes referred to as management team) may not have an existing relationship.

This allows syndicates to raise substantially more capital and purchase much larger properties as a result, including:

• Multifamily Apartments
• Mobile Home Parks
• Self-Storage
• Office Buildings

These properties are either acquired and held for cash flow, implement a value-add strategy to raise the property's value, or both.

Due to the size and legal requirements of the syndication model, these opportunities are usually put together by a professional management team with a previous track record of success, and are more focused on providing investors with strong returns than a typical partnership.

The downside is many syndication have minimum investments of $25k to $50k, or more, and many are only offered to accredited investors, and

Example

Tom and Chris, two experienced multifamily investors, locate an undervalued 150 apartment complex in an up and coming market and do not have the capital required for the down payment or renovation budget.

They decide to syndicate the property and raise over $800,000 from private investors they met at professional trade shows and conferences over the last few months. In return, these investors get an 8% preferred return and split the rest of the profits 70/30 with Tom and Chris.

Funds

Funds are similar to syndicates, but instead of the general partners raising capital one deal at a time. They create a fund and pool investor capital together to go out and purchase multiple properties for the fund.

The benefit of investing in a fund is you still get substantially the same benefits of investing in a syndication, but your risk is spread over multiple properties instead of just one.

The downside side is unlike a partnership or syndicate where you get to hand pick the property you chose to invest in, you are fully relying on the experience and expertise of the general partners (aka management team) to choose winning properties on your behalf, and usually without your approval.

REITs

Real Estate Investment Trusts (REITs) are companies that either own, operate, or finance income-generating real estate. REITs can be privately held, or publicly traded, but well be focusing on the latter since its what most investors have access to.

REITs can fall into one of the following categories:

• Equity
• Mortgage
• Hybrid

Equity REITs own income-generating real estate and can be focus on a single geographic area, asset class, investment strategy, or may be diversified. While mortgage REITs own mortgages directly or through mortgage backed securities. And hybrid REITs are exactly what they sound like - a hybrid of mortgages and properties.

The benefits of REITs are their liquidity, low barrier to entry, diversification, and typically pay strong dividends as they are required to distribute at least 90% of their taxable income to shareholders.

Because REITs are publicly traded and are correlated with overall financial markets similar to stocks, their liquidity is a double edged sword and can lead to strong volatility during turbulent times. And unlike the other equity investments discussed above, REITs do not carry the same tax benefits for their shareholders.

Debt Investments (Notes)

Note investing, also called private lending, is when an investor (lets call this investor the lender for now) loans another investor capital to purchase or renovate real estate. In essence the lender becomes the bank.

The investor will issue the lender a promissory note, which may or may not be collateralized by real estate. The lender will then receive interest payments in exchange for the loan. The interest rate can be whatever the two parties agree to, but typically range anywhere from 6%-15% depending on if the loan is considered a hard money or private money loan.

Hard-money is typically a short-term, asset based loan (as opposed to your personal credit worthiness) with a term of 6 months to 1 year, and mat not be backed with collateral. Hard money loans are commonly used by fix and flippers and because there is a higher degree of risk associated with this type of loan, the interest rates can be quite high, ranging from 8%-15%, and may include points.

Private money loans are typically longer term loans (i.e. 5-30 years), based on an individuals credit worthiness, and backed by real estate just like a mortgage from the bank. Because there is less risk involved in these loans, the interest rate is usually lower than hard-money.

The benefit of investing in debt over equity is the issuer of the note has a legal obligation to pay the stated interest rate on the loan and if they don't, you be able to foreclose and take possession of the collateral. This can lead to a nice steady stream of income.

The downside is you have no upside potential like you do in equity investments like partnerships, syndicates, and funds. If the investor makes a killing on the deal, all they are obligated to pay you is the stated interest rate.

Example

Joey, the young scrappy realtor mentioned in the example above wants to purchase another run down property and turn it around. However this time around, his Uncle Sal isn't in a position to partner up with him.

Joey is confident that he can complete the flip within a 6 month time frame, and after running the numbers, he knows the deal will be profitable. So he takes it to a hard-money lender who agrees to lend him the required capital for a period of 6 months with an interest rate of 12% and the option to extend for another 6 months for one point (1% of the loan).

The Bottom Line

Each of these investment vehicles have there own merits and should be carefully considered before finalizing your overall investing strategy.

Which one of these vehicles will be right for you?

It will depend on a number of factors including the amount of capital you have to invest, time horizon, desired rate of return, and risk tolerance.

Equity investments including partnerships, syndicates, and funds have great upside potential and can be perfect for investors looking to grow their capital base, but carry a bit more risk compared to debt investments.

Debt investments can provide an investor with a steady stream of income and carry less risk, but lack the upside potential of equity investments.