Should I invest in a Capital Group/RE Fund?

Question

Hi. Can anyone tell me what to consider when investing in one of these Capital Groups/Lenders, or RE funds? I'm curious as to why more folks aren't parking money here. Historically, a place like Broadmark Capital, which I'm considering, seems to be returning 10-12% annually. I've got other options to invest with a capital group local to me that's promising 12% for a one-year investment. Both companies seem stable and safe, with millions in assets, etc. They lend and acquire property and hold and flip, etc.

Is there a catch here? I'd be very happy with a 9-12% return in one of these funds or vehicles, rather than the stock market.

Any opinions? Any OTHER groups or funds I should know of?

Thanks!!!!

Chris

Is there a catch here? I'd be very happy with a 9-12% return in one of these funds or vehicles, rather than the stock market.

Any opinions? Any OTHER groups or funds I should know of?

Thanks!!!!

Chris

Brian Burke · Answer

@Christopher Salerno the most important consideration is the investment sponsor's track record. Pay very little attention to the return they are promising, and more emphasis on the likelihood that they will produce the results they are touting.  Ask to see some of their past deals so you can compare the promised returns to their actual performance. Underperformance is more common than it should be.

When investing in real estate directly, the deal is everything--buy the wrong property or pay the wrong price and your best laid plans won't come to fruition. When considering syndicated investments you still have to look at the quality of the deal but there is an additional risk factor that requires the same level of scrutiny--the sponsor.

Size is not necessarily an indication of safety or performance. I was looking at one group's track record recently. Absolutely abysmal. And this was a group that had over a billion under management. I think that the problem was that their structure rewarded activity more than performance.

Why aren't more people investing in these offerings?  A couple of reasons, in my opinion.  One being that for the most part, these investments are restricted to accredited investors.  Another reason is that in most cases the investment sponsors can't advertise. Their investor base grows organically by word-of-mouth and that is a slow process. Recent changes to securities laws are slowly changing that, but so far with only limited application.  That said, I have noticed a substantial increase in investor interest over the last year or two.

Dan Brewer · Answer

Hi Chris,

@Brian Burke made many excellent points.  Private funds and investments are becoming much more popular as investors become frustrated with the stock market and other traditional investments.  In addition, they are taking more control of their own retirement planning through the proliferation of SDIRAs (Self-Directed IRAs).  I heard a statistic that certainly seems plausible - the SDIRA market has doubled each each year for the last 10 years, and is expected to continue that trend.

Traditional investments are much easier to evaluate.  They are publicly traded, many analysts follow them, you can readily get advice from your financial adviser, etc.   But private investments are, well, private.   No ticker symbols.  So analyst reports or recommendations.   So they are much harder to evaluate.   While the performance of these private investments and funds can easily outstrip the performance of traditional investments, the risk of a bad actor (principal) is certainly higher.    And when it comes to private investments, the history, integrity and the experience of the principals involved is incredibly important.

Brian is correct, historically these private funds had to grow organically.  But generally as a result of Obama's Jobs Act in 2013, the SEC now allows advertising, with certain restrictions.  Initially, these investors had to be accredited, and their accreditation had to be verified.  However, the SEC continues to ease its restrictions, and now allows unaccredited investors who respond to advertisements to invest in certain Funds, depending on how the funds were established with the SEC.  You are likely going to see a continual easing of restrictions by the SEC, and with that, you will see not only the proliferation of many more private Funds, bit also the advertisement of these funds.

In general, this is all good for the investors.   But investors need to proceed with caution, just as if you are driving on slippery roads.   I have a few recommendations:

1.  There is no rush.  Take your time.  Do your homework.  If the investment is good today, it will be good tomorrow.  If not, it probably was not a good investment to begin with.   I learned along time ago that as soon as I thought I missed a great opportunity, there was another one not too far away.

2.  Don't get fixated too much on the return.  Focus on the risk instead.  A critical question to ask is "How will I get my investment back?"  A 10% return means very little if you lose your principal.  First and foremost, think principal preservation.  then return.  If you are not comfortable with the exit strategy for the investment, don't invest, regardless how much they are willing to pay you for the use of your money.

3.  Focus on the sector/opportunity you are investing in.  If you can't easily understand it, then don's invest in it.  If its too complex, how can you realistically underwrite the risk?  There are plenty of opportunities that are not complex.

4.  Get LOTS of information.  If the principals are upstanding, they should readily provide you with all sorts of information for you to evaluate the opportunity.  Some key aspects of their business model logically may need to be confidential, but the vast majority of what you need to evaluate the deal should not be.   And if you can't get what you want to evaluate the opportunity, then don't invest.

5.  Work with experienced, principals with a successful track record.   The likelihood they are going to continue to be successful is much higher.   Nobody is perfect, and I would certainly be suspicious of anyone who has been in the private investment business for any length of time who purports they have never lost money on a deal.  But the preponderance of their deals should be successful.  Get references from existing longer-term investors, and check them out.

6.  Ideally, invest in opportunities in which the SEC has been notified of the opportunity.  Nobody wants to make the SEC unhappy, just like no one wants to make the IRS unhappy.   Most private funds and investments are actually selling securities, which thereby falls under the SEC's jurisdiction.   It also falls under state securities jurisdiction.  The principals should readily be able to provide you documents that shows that notification has been filed with the SEC.  You can then get on the SEC website to confirm that the documents are legitimate.   The investment also has to be registered with each state, but typically not until there is an investor from that state that has invested in the opportunity.

Private funds are a wonderful investment opportunity, I strongly suggest investors look into them.  Just take your time and do your homework.

Brian Burke · Answer

Rating risk is a tough question without a black and white answer. There's a lot of grey.

The flipper has less market cycle risk because of the short turn time. But if the market turns sharply against the flipper a short time into the hold period, that limited exposure doesn't count for much.

The flipper has a high degree of execution risk.  This can be mitigated with experience. But even the best experienced flippers can have an occasional failure.  I've done over 500 flips and still have problem children from time to time.

The fund operator has a higher degree of market cycle exposure because of the typically long hold period. However, the fund operator is typically more experienced (but not always which is why due diligence on the sponsor is so important) which reduces the execution risk.  And sometimes the long hold time can result in appreciation that overcomes bad execution...something that is less likely with flips (but is a driving force behind the many posts you see that say "we meant to flip it but it didn't sell so we decided to rent it out"...whoops).

One way to balance the risks in flipping is to do it in a fund structure, which gives diversification amongst several deals at a time so that one blown deal is a drag on the overall vehicle but doesn't wipe out an investment.  Somewhat of a hybrid between your two examples.

Another hybrid example, on the fund side, is investing in value-add deals where a repositioning provides an elevation in performance on the front side of the deal (call it a "flip and hold").  This can provide a hedge against the market cycle risk.

All of this means that you can have your cake and eat it too, but you have to align yourself with a group that understands the risks and executes with capital preservation first, and return second.

Christopher Salerno · Answer

Thanks all. This makes sense to me. And thanks, Brian, for the specifics! I guess I keep looking around thinking, hmmm, the stock market was flat last year, and promises nothing but volatility these days, and here's an option to possibly get 8-10% on a one-year investment. Just seems very tempting. But then again the devil is in the details (the risk of not actually carrying a note when investing in a fund, etc.).

Ross Greene · Answer

I am in to here some responses to this as well. I would not mind a 9-12% return on my money as well.

Logan Allec · Answer

What do you guys think has more risk, lending to an experienced flipper or investing in a real estate fund?  Honest question.  On the one hand, the flipper is a little guy and can be prone to overestimate ARV and underestimate rehab costs (though this is mitigated by understanding the market), and the real estate fund is a big player with more resources.  But on the other hand, the flipper is typically in and out of the property in less than 12 months, while the real estate fund's play typically spans several years.

Jeremy Tillotson · Answer

@Christopher Salernomost active investors here can pull significantly more than that in returns. Private flippers will frequently pay 10-15% for use of money.

Should I invest in a Capital Group/RE Fund?

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