Last episode we took a look at how to invest in REITs, real estate mutual funds and ETFs as part of the series of eight proven techniques for investing in real estate.  This week we are going to look at a technique that is still very passive from the management side but a little more complicated.  That techinique is: Investing in Real Estate Notes.  




Definitions:
Promissory Note: A signed document that contains a legally enforceable promise to pay a stated sum to a specified person at a specified time.

• Secured Note: A note that has a tangible asset tied to the loan that is used as collateral
• Unsecured Note: A note that is not backed by collateral but by the promise to repay the loan

Mortgage: A document that collateralizes the lender by stating that the lender can take possession of the collateral (home in this case) if the borrower doesn't meet the terms of the promissory note.

• Performing Note: A note where the borrower has been paying on time and is up to date on payments.
• Non-performing Note: A note where the borrower is more than 90 days past due.

How it works: This chart shows the simple basics of how a note investing transaction would occur:

​How to invest:
There are five primary sources for purchasing notes:

1. Private Note Holders - i.e. seller financed property sales
2. Hedge or Private Equity Funds - buy in bulk from banks and servicers and then resell
3. Note Exchanges and Marketplaces (i.e. Crexi.com or  NoteTraderExchange.com )
4. Special Servicers
5. Banks and Credit Unions

​


Pros:

• Mostly passive (no management)
  • No maintenance, repairs, etc.
  • No tenants, insurance, etc.
• Secured by real property
• Long term cash flows
• Competitive returns
• Can be purchased at a discount

Cons:

• Risk of default / foreclosure
• Capital requirements
• Lower liquidity
• No depreciation tax benefit
• Limited appreciation in value
• Fees for trading on short term basis

Where to get more information:
Bigger Pockets Blog
Udemy.com

Next week we explore how you can become the bank through the lucrative technique of Private Lending.  Please reach out to me with any questions or comments using the comments button or through the contact page on my web site.  If you would like to talk more about any of these investment methods or discuss how we can partner together, please contact me.

This week we will kick off our Eight Proven Techniques for Investing in Real Estate series with a more detailed look at Real Estate Investment Trusts (REITs), Real Estate Mutual Funds, and Real Estate Exchange Traded Funds (ETFs).  These three techniques are very passive, meaning that once you purchase the investments, there is very little effort needed on your part to manage the asset(s).  

We will follow a similar format for each of the eight techniques in the series so here we go:

Definitions:
Real Estate Investment Trust (REIT) - A company that owns and sometimes operates income producing real estate such as apartments, warehouses, self storage facilities, malls, hotels, etc.

Real Estate Mutual Fund - An actively managed fund of multiple REIT firms.

Exchange Traded Fund (ETF) - A passively managed group of REIT firms generally based on an index.

How it works:
REIT - A Real Estate Investment Trust (REIT) is basically a corporation that owns and operates real estate assets that are purchased using capital raised from selling shares in the corporation to investors.  The REIT generates income from rents, capital gains, and mortgage interest and is required to return at least 90% of taxable income back to the investors in the form of dividends.  An easy way to think of it is as a middleman that pools lots of investors money to purchase large real estate assets and then returns most of the income to those investors.  The REIT itself makes money through some more complicated accounting principles such as Funds from Operations (FFO).  Basically, the taxable income that has to be returned to investors is less than the actual positive cash flow due to factors such as depreciation.  Some of the FFO may be returned to investors as dividends and the rest is used to fund the corporate operations and purchase more assets.

There are three primary types ot REITs.

1. Equity REIT- owns the underlying assets and operates like a landlord.
2. Mortgage REIT- owns the debt securities backed by the properties but not the real estate.
3. Hybrid REIT- owns a combination of real estate and mortgages

​
Real Estate Mutual Fund - A real estate mutual fund is simply a fund with a group of REIT stocks inside of it.  These provide greater diversity and potentially less risk since a professional actively manages the group of REIT stocks.

Real Estate ETF - Like a real estate mutual fund, an Exchange Traded Fund (ETF) is a fund with a group of REIT stocks inside of it.  The big difference is that ETFs are not actively managed , meaning that the REIT stocks inside of the fund mimic an index and remain the same.  There are many indexes for sectors such as residential, commercial, European, North American, etc..  ETFs also trade slightly different as they are bought and sold in real time on the markets instead of being closed out at the end of a trading day like a mutual fund.
How to invest:
REITs, Mutual Funds, and ETFs are extremely simple to invest in since they are traded on the public markets.  There are private REITs but we will save those for another day.  A public REIT stock can be purchased and sold through your broker just like any other stock.  It is wise to do some research or work with your financial planner to ensure that you purchase an interest in a REIT that matches your investment profile.  

Pros:

• Extremely passive- You will have no management or decision making responsibilites.
• Liquidity- Can be sold on the public securites markets to get your cash back very quickly.
• Simple- Other than choosing an investment, no real estate knowledge or experience is needed.
• Portfolio diversification - REITs are a great and easy way to diversify your investment portfolio.
• Competitive returns- Over the past 40 years REITs have outperformed the S&P500.
• Steady dividend income (long leases)- REITs invest in assets that provide long term, stable dividends.
• Professional management- Your real estate investments will be managed by pros so you can relax.
• Transparency (SEC requirements)- REITs are easy to research and get financials & reports for.

Cons:

• Lack of control
  • Portfolio holdings - You will have no control over what assets are in the REIT.
  • Asset management - You will have no control over how the assets are managed.
• No ability to personally “force equity”- You can't personally increase the value through "sweat equity"
• Slow growth (can only reinvest 10% of earnings) - Since most earnings are required to be returned to the investors, additional investments generally require the sale of additional shares to raise capital.
• Tax treatment (investors pay income on dividends) - Investors don't realize the tax benefits such as depreciation, etc. but rather pay taxes on their dividends as ordinary income unless they are considered "qualified dividends".  Qualified dividends are taxed as capital gains.
• Fees- Sales commissions and upfront fees can total as much as ten percent of the investment which significantly reduces the amount of money earning dividends.

Where to get more information:
If REITs, Mutual Funds or ETFs sound like your kind of investment, here are a few sources to get more information and get started on your journey to financial freedom through real estate:

Investor.gov
REIT.com
​Nerdwallet.com


​Next week we will dig into the world of Real Estate Notes to see how they work and if they are right for you.  Please reach out to me with any questions or comments using the comments button or through the contact page on my web site.  If you would like to talk more about any of these investment methods or discuss how we can partner together, please contact me.

Investing in real estate is one of the greatest wealth building activities one can engage in.  According to a Feb. 2020 report from the College Investor, over the last two centuries about 90% of the world's millionaires have been created by investing in real estate.  Unfortunately, many investors never utilize this profitable avenue because they have heard horror stories about tenants, toilets, and termites.  They think that real estate investing is all about getting late night calls for backed up toilets or dealing with unscrupulous tenants that don't pay rent.    Taking a closer look at real estate reveals that there are many different ways to participate ranging from extremely easy and passive to full time employment commitments.  Over the coming weeks, I will take a deeper dive into eight proven techniques and discuss the advantages vs. disadvantages of each.  The goal is to get you thinking about which technique makes the most sense for you based on your commitment, goals, risk tolerance, and personal situation.  The question should not be "should I invest in real estate?", but rather, "how should I invest in real estate?".

Here is an overview of eight popular and proven techniques.  Follow along in coming weeks as I dig deeper into each.

1. REITs, Mutual Funds, ETFs - Publicly traded funds that own real estate assets and distribute profits to share holders.  These are generally very liquid and are traded on stock markets.  
2. Real Estate Notes - Legally enforceable promises to repay a debt that are backed by a mortgage to collateralize the lender.  Notes are often traded at a discount and allow for long term passive income.
3. Private Lending - Acting as the lender to other investors that are purchasing properties.  The lender receives payments from the borrower providing passive cash flow and loans can be secured by an interest in the property.
4. Wholesaling - Getting a severely discounted property under contract and then immediately selling to an investor at a higher price (wholesaling) or on the retail market to an occupant owner (wholetailing).  The wholesaler profits from the difference between their contract purchase price and the sale price, usually without doing any rehab. 
5. Syndication - Method of pooling funds from multiple investors for the purpose of purchasing real estate.  Investor can either be passive (limited partner) or active (general partner).
6. Buy and Hold Rental Properties - This is the classic method of purchasing a property, renting it out, and holding on to it realizing monthly positive cash flow and long term equity buildup through amortization of the loan and market appreciation.
7.  Fix and Flip - Purchasing a property (usually at a discount), renovating it, and selling for a profit.
8. BRRRR - Buy - Rehab - Rent- Refinance - Repeat - Similar to a Fix and Flip but instead of selling the property, it is refinanced at the improved value which returns the invested capital to the investor so that they can repeat the process using the same capital.  The property is kept and rented for regular positive cash flow.

These are just a handful of techniques that investors are successfully using to profit from real estate.  Of course, there are many more variations and creative (and legal) ways to participate.   Which methods interest you the most?  Leave your comments here or reach out via the contact form at jbfoxcapital.com with any questions or to discuss further.