Passively investing or holding onto cash?

Question

I've been a sideline student of real estate for many years but I'm hoping to take the leap into passive real estate investments in the near future. After much research and consideration, I've decided that I don't have the time to be an active real estate investor, and I've been researching various passive investment opportunities. I'm an accredited investor sitting on a chunk of cash, but I'm hesitant to tie up large amounts of money with the uncertainty of the economic outlook with the pandemic.

I'm curious what others here in similar situations are doing at the moment. There seems to be many syndication opportunities on the crowdfunding sites, but I'm finding it difficult to assess the projections.

I've learned a ton from others on this site as well as a lot from www.therealestatecrowdfundingreview.com's Guide's and Tutorials, but if you have other resources to learn more about passive real estate investing, I would be grateful for the input.

Omar

Taylor L. · Answer

You'd probably be well served talking with a CPA who is experienced in syndications and their typical impact on investors' taxes. @Michael Plaks put up a great cautionary thread a few months ago about one of his clients being oversold on cost segregation; getting the straight reality from an experienced CPA would set you up to evaluate syndications better than any non-tax pro could do on our forums. High net worth and high income individuals do invest in syndications quite frequently, so you're in good company and the tax problems have likely been addressed before.

Dave Foster · Answer

@Omar Khan,  Your recognition of who you are and focus on passive investing is a huge step.  Along with that decision comes the realization that you're operating with different time frames and proformas with built in on and off ramps.  As @John Fortes, regardless of the vehicle real estate is going to be less liquid than equity investing in the market.  But that longer time horizon can actually work in your favor.

1. With your income which probably has you looking for tax incentives as much as top line income.  For this you'll want growth that can be tax deferred as well as give you maximum paper losses (not justifying less income vs bigger tax write offs).

2. Longevity and intent will also be a factor for you.  Going into investments that are designed to be held rather than flipped will turn your income from ordinary tax rates to capital gains.  This is huge by itself.  Secondly though, the intent to hold is what qualifies your property to be sold using the 1031 exchange which allows you to indefinitely defer all tax on gain and depreciation recapture.  This is where the long term wealth building occurs.

The only way a syndication will work with 1031 exchanges is if they allow you to take title as a tenant in common with the partnership or LLC managing the syndication.  There are those that can.  But a second factor would be that the syndication would have to have the intent to hold that property for productive use.  If they're only looking to value add and sell then that's not going to work with 1031 either.

Just a few thoughts but in general if you like the tax advantages and long term prospects of real estate investing then you have to accept the slower pace.  But there are plenty of syndications that can offer longer horizons.  And for the ultra high net worth investor going passive usually means investing in NNN properties or ground leases.  These are specifically designed with the long horizon in mind and are much less sensitive to rapid market swings as well as providing inter-recession protection (probably a phrase I just made up) but it is what is says - letting your wealth in a way where recessions no longer impact or concern you.  The long term will be your friend in many ways.

Bryan Hancock · Answer

Well that's refreshing.

Focusing more than a passing amount of time on minimizing taxes is ill-fated IMO.  Your goal as a passive investor is to identify a good risk-adjusted investment project, which involves assessing sponsor quality and the quality of the investment.  This investment needs to be held in a holistic portfolio and is subject to covariant risk/return patterns along with other financial instruments.  One must also impute both their zero returns while sourcing projects and their time in underwriting in any complete analysis.

If you do all of these things really well and pay more in taxes who cares?  99 parts maximal after-tax income, 1 part tax issues.  To tax professionals every issue looks like a tax issue just like to every hammer things look like a nail.

Further, the "buckets" for passive losses offsetting passive gains don't really matter a ton nor does a stepped-up basis at death as part of estate planning from perpetual tax-deferred wealth creation if 99 percent of one's ability to generate wealth relates to mixing their labor with capital in entrepreneurial pursuits.  Sure, this thread is about being passive.  Most people on this site are active first though and are passively passive second only to the degree someone talked them in to siphoning off part of their wealth in tax-advantaged accounts.  How does this matter if it limits your upside an options by design?

This is why threads like this are really hard to respond to.  Someone would need to know a lot about your goals and overall financial picture to advise you properly.  Stay away from people who offer advice for a living who only know securities and know nothing about small business owners too.  They have the same hammer/nail problem described above.

Bryan Hancock · Answer

It's always interesting to me to see how people who think like accountants think about the world.  The goal is maximal after-tax gain in wealth net of risk; not minimal taxes.  If you're lauding the benefits of not paying taxes you also need to discuss the tradeoffs in not being able to actively control this capital to mix your labor with it to produce wealth.

Bryan Hancock · Answer

Start small with any given sponsor and ratchet up your exposure on the next deal.  Relationships take time to build like it takes time to date your girlfriend before you ask to get married.  Rome isn't built in a day and there should be no expectation from sponsors that it will be any different with your hard-earned cash.

Michael Plaks · Answer

@Taylor L. - thanks for the shout out

@Omar Khan - here is what I recently wrote specifically about syndications:https://www.biggerpockets.com/forums/51/topics/839015-are-syndications-extremely-tax-efficientAnd here is a very helpful thread featuring several of our resident syndication experts and mentions of a lot more:https://www.biggerpockets.com/forums/51/topics/781803-learning-about-syndication

Brian Garrett · Answer

Syndications can be a great passive investment and there are lots of sponsors here on BP.

You mentioned you're unsure about tying up a large sum of money for an extended period of time like a syndication would require so an alternative would be to become a HML and act as the bank.

You can turnover your money quicker as they are much shorter terms (6-12 months) and can yield a similar IRR.

Michael Plaks · Answer

Perfectly stated, Bryan. Most accountants on this board agree with you. In fact, we often make this same point when investors focus excessively on reducing taxes.

Omar Khan · Answer

Thanks for all the responses. They were all very helpful. I guess another point to add is that I'm in a high income tax bracket which makes me wonder if the risk of investing at the moment is worth the cost of returns that are not tax-advantaged in some way.

@Brian Garrett I started looking into some of the HML options after your response and will continue to do so.

@John Fortes You pretty much hit the nail on the head in terms of where I'm at. I've started networking with sponsors and am narrowing down my criteria. Because of my tax situation, I'm looking for growth opportunities and learning more about 1031 exchanges. I'm still learning how to do due diligence on the growth considering the current economic climate. Regarding your question, I've been stashing some money in high-yield tax exempt funds but not sure if that's the way to go either.

@AJ Shepard Great advice. I'm still figuring out how to think about the criteria. The projections can always look attractive, but I seem to find more stories about the projections being missed which scares me a bit. I don't mind being aggressive, but I don't want to be stupid.

@Yannik Cudjoe-Virgil I totally agree with you. I'm looking for that sponsor that has experience with an investment opportunity that will thrive in this pandemic. It sometimes feels like looking for a unicorn.

@Bryan Hancock I appreciate this advice. I've thought a lot about whether to invest the minimum or to put in more. It sounds like you and others recommend the minimum route to start.

@Daniel McNulty I'm going to get on this right away! I've definitely been overwhelmed by all the options out there, but I think coming up with a method to analyze in accordance with your recommended parameters will help overcome the analysis paralysis.

Andrew Hogan · Answer

@Omar Khan  When you're ready to jump into multifamily investing, it will typically feel like a leap of faith. However, there are some things you can do to help boost your confidence.

- Look at the team: Is the sponsor a one-man show? If there’s a team, what do they bring to the table?

- “Stalk” the sponsor online: Do some basic internet searches. If you’re not finding much about the sponsor, that could be a red flag.

- Ask for references: Email references and set up a time to call them. Ask some open-ended questions and find out what they have to say about the sponsor.

-Keep in mind that the sponsor, their team, and track record should be in the forefront of your mind when performing due diligence.Happy hunting :)

Passively investing or holding onto cash?

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