Passive Unleveraged Investment?

Question

I have no intrinsic interest in real estate.  My interests, in order, are:

1.  capital preservation
2.  stable returns
3.  yield

So why am I here?  Because I think unleveraged residential rental real estate in middle America best satisfies my interests.  I have researched many investment options including the usual - stocks, bonds, and commodities.  None of these meet my needs today and all are overpriced.

I have read books on real estate investment and these books are badly misaligned with my interests.  The books advocate leverage to increase yield at the expense of risk to capital preservation.  They assume active real estate investing when I have no interest in this.

When I invest in stocks, I buy mutual funds.  I have neither the interest nor the knowledge to pick individual stocks.  So I pay an expert, the mutual fund manager, to do this.  Why isn't there something analogous to this for residential real estate?  This is what I want.  Yes I know the standard real estate options like REITs and real estate operating companies.  These generally have leverage, aren't restricted to residential real estate, and aren't nearly as transparent as a mutual fund.  So they don't satisfy my needs.

Any suggestions to solve my investment dilemma would be greatly appreciated.

Chris Weiler · Answer

A possible option for you is to find a business partner who has experience finding and managing rental properties. Assuming you find a competent partner, they can handle all the day to day operations and you can go on without hassles. You provide the capital and he/she provides the sweat equity. This would satisfy all the goals you stated above and should provide you a very decent return.

Franklin Schmidt · Answer

So just to clarify what I meant, when Chris said "partner", I assumed that meant I would be working too.  If I am completely passive, then I can work with someone anywhere.  But for me to be passive, I have too be sure that the deal makes sense.

Bryan Hancock · Answer

You can be a limited partner in a fund, an operation, or even specific deals without being active.

Finding an investor in target areas you want to invest in that knows what he is doing will likely get you where you want to go.  Another thing to try to figure out is how liquid you want your investment to be.  Many money hungry rehabbers will roll your money over a handful of times a year.  Buy-and-hold types will want to use the money for a longer period of time.  Private equity funds will likely want to use the money for 3-5 years or so...which is somewhat in the middle.

If you are completely passive you turn your money over to a manager and let him decide what makes sense.  This will require more up-front due diligence.  If you are evaluating each opportunity you won't really be completely passive.  Private equity funds aren't going to allow you to check out each deal.  That is what you are hiring the manager for.  Rehabbers will be more likely to let you look at each of their deals and decide which ones you want to fund.

Another idea is to call up hard money lenders in areas you want to invest in.  They will underwrite the deals and present them to you.  Your yield will go down by doing this because they will take some of it for their value center.  It will decrease the amount of work you have to do though.  First Capital Funding in Austin has a business model like this and I assume many other hard money lenders do too.

Bryan Hancock · Answer

If you want to be more involved a private equity fund won't be for you.  It sounded like you want something passive from your original post.  You would likely participate as a limited partner in a private equity fund by buying shares in the fund.

You may be well-served to look at discounted notes too.  Inflation will erode the value of the note, but if you decrease the duration with balloons and roll the notes over your yield will be handsome without the real estate headache.  You will also have a nice first position to preserve capital if you purchase the right notes with the right duration.

Do you want to be actively involved or just put money to work?  Capital preservation and yield are at opposite ends of the spectrum, but you can find pretty good yield without a ton of risk if you either know how to find the deals yourself or invest with someone that does.  Investing with someone else that does will be much easier if you don't have the time to learn how to invest on your own.  Most people that will invest the money wisely for you won't want you really actively involved in the deals though because that is why you are working with them in the first place.

Franklin Schmidt · Answer

Chris, I have no problem investing outside of El Paso as long as it isn't a partnership arrangement.  In other words, if someone in another city has constructed an investment package that looks good to me, I would be happy to invest.  But if I have to work with that person as a partner, then I want them in the same city so that I can be more involved.

Regarding leverage, this is just a trade-off of returns versus safety.  If there is a depression, your stocks will be worthless and you won't be able to pay your debts because your renters won't pay their rent.  I have no idea what the probability of a depression is, but safety means minimizing risk under all possible conditions.  I understand why a real estate expert would like leverage as a way to maximize the returns from his own expertise.  I am not a real estate expert and I don't want to rely more than necessary on someone else's expertise.  My primary goal is capital preservation.

I am just a computer programmer who got lucky with a web company, and this forced me to learn something about investing.  So I look at my programming projects as my way of making money, and my investments mostly as a way to not lose whatever money I have already made.

Bryan Hancock · Answer

No kidding  :wink:

The securities laws really are very stupid.  That is the reason you are having a hard time finding what you seek.  There has been talk about fixing some of this recently, but I wouldn't count on it happening rapidly.

Chris Weiler · Answer

Frank, if someone else is doing all the work, you don't have to limit yourself to El Paso. I have properties in Ohio I have only seen once. I have a very competent business partner that handles just about everything. I sleep very well knowing my properties are being handled by a total pro.

On another note, I just have to voice my disagreement about leverage. I'm by no means saying you're wrong. Everyone is entitled to their opinion and has to stay within their own risk tolerance. Saying that, I am a HUGE fan of leverage. I'm a long term investor and invest my money in inversely correlated ETFs. I allocate a certain percentage to each asset class and re-balance them once a year. I invest with Interactive Brokers which allows me to borrow up to 85% of my stock portfolio at a disgustingly low rate of 1.1% above 100K. I then use this money to buy immensely undervalued cash-flowing rental properties in the mid west. In the near future, I may get lines of credit against these properties for future purchases of under-valued real estate. If the stock market takes a huge hit, I will have to sell my stock to cover my leverage. Yet I would still own the properties and would be in the same boat as if I had used the money to only buy the properties in the first place. So as long as you are investing in value and have stop losses in place, I believe leverage can be a huge tool in building wealth.

Franklin Schmidt · Answer

Thanks Bryan.  How can I look into these private equity funds?  And why would a fund want to be difficult to find?  I would think a fund would want to advertise to attract capital.

Why do I think real estate is superior?  Stocks are overpriced.  Bond yields are too low given inflation risk.  Most commodities are at their all time high, so are probably overpriced.  The world economy today is weak, but there is an excess of investment capital looking for returns.  This is why most investments are overpriced.  Add to that a high risk of an economic disaster, either high inflation or recession/depression.  Unleveraged residential real estate is the only asset that I can think of that is safe and gives reasonable returns.  I looked at real estate in my town, El Paso, TX, and I see CAP rates around 10%.  There is no other investment that I can think of that gives this type of returns on an unleveraged inflation-protected asset.

I talked to my real estate broker (who I bought my house with) about how he helps people buy investment properties and I realize that most real estate people have no idea what they are doing from an investment angle.  They don't even bother trying to guess what kind of NOI they can expect on a property they are looking to buy.  The reason that all that excess investment capital out there hasn't found its way into residential real estate is that there is currently no sensible vehicle for doing this.  During the real estate bubble, it was ignorant speculators using leverage who bought real estate.  Now that real state actually makes sense for a value investor, there is no way for the value investor to invest sensibly.  Anyone who succeeds in putting together an investment vehicle for average investors is going to be extremely rich.

Chris, I recently moved to El Paso, TX, and I don't know that many people here.  The people in El Paso are very nice, but brains and ambition aren't their strong point.  If anyone on this forum is interested in moving to El Paso and working with me on this, please let me know.

Bryan Hancock · Answer

There are many private equity funds that purchase using all cash.  You should see if you can find any of those.  The trouble is that they are hard to find unlike REITs and other publicly-traded assets.  The best financial products are often the ones that are the hardest to find and that you need to be an insider to get to.  Mutual funds and like are generally sold...not bought.

Why do you feel like real estate is superior to the other investment products given your goals?

Passive Unleveraged Investment?

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