You’ve invested in your first or most recent piece of real estate - congratulations! After the stabilization period that comes with the transfer of ownership of real estate, and starting to execute your business plan, you’ll find a lull of activity and an excess of capital with no place for it to be put to work. That is the situation I found myself in recently and this post is an explanation of what came next.

Attention: I am not a certified financial planner nor an investment advisor nor a CPA nor attorney. Seek advice from these professionals to verify if the information presented in this article meets your needs. Note that I am a licensed real estate salesperson in New York and my opinions may be biased by that position. None of the products or securities listed below are sponsors or affiliates at the time of writing.

Setting Investment Objectives

Timeline — My expectation is to invest these funds for only 6-9 months then reallocate them to a private real estate investment. For me, that will be a syndication opportunity, but you are welcome to interpret that as a buy and hold, BRRR, flip, or whatever other strategy you use.

Risk — Preservation of capital is my most important objective for this investment because I need to know the funds will be available when the capital call comes in for the syndication.

However, to truly preserve the purchasing power of my capital today, it needs to be invested in something that returns a rate greater than or equal to the inflation rate. The US Department of Labor reported on December 13, 2022 that the annual CPI (consumer price index) rate in November 2022 was 7.1%[i], down from a high this year in June at 9.1%[ii]. An alternative inflation index that I find interesting, although not held to the same rigor or prestige as the CPI, is the “CCII” or “Christmas Cookie Inflation Index”. This index is produced by Charles (Chuck) Marohn, founder of the urban planning focused non-profit “Strong Towns”, is a basket of goods just like the CPI that he has tracked over since 2019. The 2022 update found the CCII rate to be 12%[iii]. Nearly 5% higher than the CPI.

Finding an investment that yields an annualized return of 7.1%-12% with minimal risk of principal loss over 6-9 months is a tall order for a seasoned investing veterans and a nearly herculean task for a “good enough investor”[iv]. That won’t stop me from trying though!

Strategies

[Listed in order of loss of principle risk]

High yield savings, money market accounts, and CDs

All three of these account types benefit from increased inflation. Banks have to spend more to borrow from larger banks and the Federal Reserve so they’re willing to offer higher savings rates to accumulate funds to lend at even higher rates for real estate, cars, and personal loans. Always remember, first and foremost, banks are in the business of originating loans. Federally insured and offering rates of 3-4%, high yield savings accounts are the least risky place to store your excess capital while saving up to buy your next investment property. A list of the best high yield savings accounts in December of 2022 as rated by Bankrate can be found in the endnotes[v]. Be mindful of account minimums, fees, and compounding period.

Certificates of Deposit (CDs) are a way for banks to guarantee your capital will be invested for a set period of time from 3 months to 5 years with many options in between. Rates are 4.15-4.7% for Nerdwallet’s list of the best CDs going into 2023[vi]. If you are absolutely certain you will not need access to this capital for the full term, then a CD is a good option to get a slightly higher return than a high yield savings or money market account with no risk of principle loss.

Summary: None of them will net the 7% annualized minimum return I am targeting, however; they still have a place in a balanced portfolio to offset riskier investments.

Real estate equity

About a year before purchasing my first investment property (a value-add, 4-unit, house hack with no money down), I asked my broker/boss where he would invest money while saving for his next real estate investment. He responded, “In other properties.” At the time I didn’t fully understand what he meant, but he had a portfolio of 40 units and meant that he would finance purchases with equity from his portfolio using line of credit or refinancing and the cashflow from performing properties to finance acquisitions. For those with a portfolio and expertise in real estate, this is the ideal short term investment vehicle.

Summary: Unfortunately, I am not in a position to leverage equity in my real estate holdings due to lack of performance in one property and comprehensive rehab in another.

Mutual Funds/ETFs

With free access to vast online resources today, it is easy to determine the historical returns of an index, find a passively managed fund with low fees that tracks that index, then invest your capital into that fund. 47 years ago today, Vanguard founder Jack Bogle created the first mutual fund available to retail investors — First Index Investment Trust, now traded as Vanguard 500 Index Fund (VFIAX). Since then, countless other funds have been started with similar objectives and success. However, the S&P 500 dropped over 20% in 2022 and the Nasdaq Composite has dropped over 30% in 2022 making a very tough year for anyone considering retiring on a diversified securities portfolio before 2030. But for the average investor with a long timeline (10 year minimum) who wants broad exposure to many companies and a simplified, time tested approach to securities investing, mutual funds and ETFs are the way to go, especially if the investor is diligent enough to dollar cost average through the lows of this bear market.

Summary: The volatility of the stock market this year and my short timeline make mutual funds/ETFs the wrong vehicle for my objectives.

REITs

Real estate investment trusts (REITs) are the mutual fund equivalent if stocks are like individual properties. A REIT is a pool of many pieces of income generating real estate and/or mortgages. They can be publicly traded on the stock market or privately held. The two factors that set REITs apart from real estate syndications are: a minimum of 100 shareholders after the first year in operation and the requirement to distribute at least 90% of taxable income to shareholders as dividends each year. Publicly traded REITs offer liquidity unlike the purchase of an individual piece of real estate. REITs can also offer diversity and exposure to a variety of commercial property types as well geographic regions that are very challenging to achieve as an individual, unaccredited investor. The requirement to distribute 90% of taxable income as dividends helps compensate for the minimal growth potential of REITs (they're giving most of the cashflow to investors instead of holding it for the next acquisition). Plus, most REITs increase their dividend rate annually. The rate of return on a REIT is dividend yield + growth + repricing return[vii].

Summary: REITs are great for liquidity and diversity of real estate exposure, but like other forms of real estate investments, the highest returns are realized by holding long term and focusing on quality sponsors/managers.

Stocks

I’m not an expert in stocks. Nor do I plan to take the time in the next 5 years to attempt to become one. There is a wide world of information on how to research companies, compare them to each other, compare them to indices, and forecast their growth potential. I have little interest in going beyond a working ability to evaluate my own companies balance sheet, income statement, and cashflow statement. My approach to stock investing is simple: invest in companies whose products or services I understand. My first semester as an undergraduate I took an introductory investing course as an elective. The professor challenged his students to experience the time value of money first hand by advising they borrow the maximum amount in federal student loans available, spend as little as possible during our years at school, and invest the difference. I followed that advice, invested in Apple, and am in a much better financial position as a result plus it gave me the investing mindset which will yield positive returns for the rest of my life.

Summary: Despite a lack of sophistication in theory, I will continue to make investing in a handful of companies I understand a small part of my strategy both for the short and long term.

Notes (loans)

This is an investment vehicle that fascinates me but that I haven't tried yet. Or at least not from the lender's perspective. Finding a flipper or BRRR investor that could afford a hard money rate of 7-12% interest rate, to meet my objective, for 6 months and that I trust is not on my radar at the moment. If I did this would be a moderately risky opportunity to make the return I'm looking for. Alternative note investing options would be a mortgage REIT or some peer to peer lending platform. Or for accredited investors, Note funds like PPR Note Co are a good option if they have 3-5 years to realize gains.

Summary: Lack of access and capital makes this the wrong vehicle for me right now.

Partnerships

Why wait or try investing outside your expertise? If you can find a partner who is willing to accept expertise you possess in exchange for an equity position, then use that to help fund your next deal. This is much easier said than done, but is possible.

Summary: Time is the cost of this arrangement for the person without capital. Time is the most finite resource of all and one I’m not able to part with more of right now. Limiting the number of projects to split your focus between is essential to actually finishing projects and maintaining some semblance of sanity.

The following four strategies have a 100% chance of principle loss because they are payments for a service; however, they also can yield a return when viewed over a long enough timeline.

Debt Pay Down

Yesterday I realized that my one private student loan, which I took out to fund studying abroad in Italy, has a variable rate now up to 6.25% and payments coming due very soon. The principal balance of the loan is $5,330 and I’ve paid the interest each month while it was only 2% over the past few years. With a loan term of 5 years, the monthly payment will be $102 per month. Although it would reduce the amount of capital I have to invest elsewhere, paying off this loan in one lump sum now would save $907 in interest, increase my net worth and would remove the loan from my mom’s credit since she was a co-signer. So, there is a case to be made for paying this loan off instead of investing in one of the other options if I’m not confident I can earn more than 6.25% in those investments.

Insurance

Business insurance. If you own a business, you need insurance. If you are an independent contractor and aren’t sure if you need insurance, contact your attorney, then contact an insurance broker. You probably need insurance. Even when a frivolous lawsuit comes up against you, the requirement to prove that the suit is baseless or that you’re the wrong entity to be sued, is on you. Depending on your business, $500-$1,500 per year may be enough to ensure that in the event of a lawsuit, your other assets are protected. The proper legal structure and estate planning round out any good asset protection plan.

Property insurance. Whether you own the home you live in, rent an apartment or live a nomadic life out of a van, you need insurance to cover potential damages to that home. Buffalo and Western New York recently experienced a once in a generation storm where residents lost heat and power for days and at least 40 lost their lives[viii]. Water pipes burst causing severe property damage and displacing tenants. Roofs leaked due to record breaking wind combined with heavy snowfall then rain. Even generators and cold climate heat pumps failed temporarily during this extended extreme weather event. Prepared property owners had sufficient coverage in place to pay for the damage incurred and very prudent landlords even had “loss to lease” coverage in their policy so they could keep getting paid while their units were being repaired. Conversely, owners who hold property in cash and let their insurance lapse are stuck with the bill for all damages incurred. Tenants with adequate renter’s insurance policies were able to get a hotel room covered for up to six weeks.

Summary: Rare or “black swan” events do happen. Allocating a small amount of liquid capital each year to insurance will yield exponential returns when the time comes to file a claim.

Estate Planning

At the time of writing, I don’t have a will. If I suddenly died without doing any estate planning, all of my assets would be frozen and end up in probate for 120 days. It would take thousands of dollars in legal fees plus an immense amount of stress on my family and business partners to sort through the mess I left for them. A couple thousand on estate planning may not yield any direct monetary return today, but it will buy me piece of mind and will save thousands later on. The return on this investment will increase each year as I continue to acquire more assets and liabilities, even if additional capital contributions need to be made throughout my life as my family situation changes, I grow older, and my investing strategy shifts towards asset protection more than acquisition, the value of my investment into estate planning will increase.

Conclusion

I spent most of the day thinking about this, reviewed all my work and found that none of these options are both feasible and meet the risk adjusted return target in my stated timeline. I did say this would be a herculean task so it should be no surprise that there isn’t a simple answer to my question. So what’s an investor to do? Accept lower returns in exchange for lower risk? Take on more risk through an investment vehicle they aren’t an expert in with hopes of achieving a higher return? Spend more time analyzing and risk missing out on even low returns by leaving capital on the sidelines?

Here’s a better idea: reframe the question.

Short term investments are more of a gamble. Long term, focused, and data driven acquisitions are investments. With that in mind, I still have money sitting in checking and savings accounts that needs to be reallocated. I’ve developed a balanced portfolio mixing most of the strategies listed above with simple rules for continual contributions and the understanding that this is a framework for longer term investments. If I happen to sell some of them in less than 10 years its only because my investment thesis has changed requiring a reallocation of capital to higher yielding investments when they become available.

Asset Allocation

If you made it to the end of this article, you’re still looking for an answer to the question I posed in the title, “Where to invest short term while saving for next real estate investment?” After much more thought and effort than I initially expected, below is a break down of how I plan to allocate the funds in my checking and savings accounts right now. The working capital, emergency fund, estate planning, and insurance buckets will be full after this initial allocation allowing me to concentrate future investments elsewhere. Your plan can and should be different based on your needs, desires, timeline access to tax advantaged retirement accounts, and risk tolerance.

Working capital (day to day funds to live on in a checking account): 10%

Emergency fund (min. 3 months expenses in a high yield savings account): 20%

Tax payment reserve (due to being a sole proprietor without W2 withholding): 30%

Estate planning (estimate): 6%

Business insurance (estimate): 2%

Individual brokerage account: 32% (12% stocks, 20% mutual funds/ETFs)

[i] https://www.bls.gov/news.release/pdf/cpi.pdf

[ii] https://capital.com/us-inflation-rate

[iii] https://www.strongtowns.org/journal/2022/11/30/christmas-cookie-inflation-index-2022-update

[iv] https://www.financialsamurai.com/how-to-become-a-better-good-enough-investor/

[v] https://www.bankrate.com/banking/savings/best-high-yield-interests-savings-accounts/

[vi] https://www.nerdwallet.com/best/banking/cd-rates

[vii] https://seekingalpha.com/instablog/47644028-jussi-askola/5488523-best-reit-investment-strategy

[viii] https://buffalonews.com/news/local/what-we-know-about-the-people-who-died-in-buffalo-niagaras-blizzard/article_98a32b72-87aa-11ed-985e-4beeb22a08f1.html