Finding a good home....for your capital

As they begin their investment journey, investors often ask themselves “where should I invest my capital?”, “Is it being used to its full potential?”, “Is it safe?”, “Will it meet my changing needs”? These are the same questions I ask myself from time to time (its a good idea to periodically reevaluate your investment strategy).

The answers to these simple questions may not be as straightforward - it involves the investor’s personal goals, financial goals, financial wherewithal, risk tolerance, investment expertise, “accredited investor” status, degree of control desired, yields they seek, time and effort they are willing to commit, to name just a few factors that need to be considered.

Since this topic comes up frequently in peer discussions and on forums such as BiggerPockets, I thought I would share my own thought process in selecting the investments for my own portfolio. This article is written with the accredited investor in mind, though many items we will discuss here will also apply to non-accredited investors.

Disclaimer– The world of investing is vast and has so many different approaches, that I am sure to upset a few readers by omitting something. I am not a CPA, CFP, lawyer, economist (nor do I play one on TV), so please check with your legal counsel and financial advisor on the best option for you. This article is meant to provide “food for thought” and is not investment advice.

Let’s start with what the investment options most investors consider. Most people consider investing in stocks, mutual funds, real estate, and precious metals. These are the “traditional assets” that most of us are told to invest in and save for our retirement (you could argue that investment grade real estate is not promoted as heavily as the other types of investments). These assets made up a majority of my portfolio for almost 20 years. It seems to make perfect sense until you take a closer look.

More sophisticated investors may look at stock options, notes, tax liens and private lending. These do require specialized knowledge, which can be learned from a variety of sources but I would not advise proceeding without obtaining that knowledge first.

The investment choices expand even further for accredited investors but so do the questions accompanying these choices. You now have access to Private equity, SEC Regulation D (private placement) deals as well. This includes things such as passively investing in private companies (think startups and early stage companies), real estate syndications, hedge funds, venture capital funds, etc.

The choices get even more complicated when you layer on which “pool of funds” is best suited for the investment – your after tax investment dollars, self-directed IRA, Solo 401(k), etc. Due to special tax rules around Self Directed IRAs and Solo 401(k)s, such as UBTI/UBIT, UDFI, disqualified transactions, we may cover that detail in a future blog post. For now, let’s recognize that there may be another set of decisions to be made in order to align the investments you desire with the appropriate source of funds in order to maximize your tax benefits.

The list below is not exhaustive by any means but gives you a glimpse of the type of investment choices to consider and my view on the benefits and risks associated with each. For simplicity sake, I have tried to limit the number of variables, but feel free to comment and add the ones which are important to you.

Stock Market - The de facto choice for most investors. Most people did reasonably well investing in the stock market over the past 20+ years including stocks, options, mutual funds, ETFs, etc. However, I have also seen many of my holdings take a 20-35% hit or some long term investments just stagnate for around 10 yrs. That made me search for a better option.

Precious Metals – I am not an expert in this area, but have purchased gold ETFs in my trading accounts and had some coins and bars which were mainly given to me as gifts. There are many who use precious metals as a way to hedge against currencies, but this was not one of the major options I was considering.

Crypto Currencies – While Bitcoin is the most popular form of cryptocurrency, there are many others such as Etherium, Litecoin, Moreno, etc (collectively referred to alt coins). Cryptocurrencies are being used as a new method of hedging against “fiat currencies” or government issued currencies. You can also play the ICO (Initial Coin Offering) and coin mining game. Cryptocurrencies are built on the underlying technology of Block-Chain which is very powerful in allowing you to decentralize a ledger/journal, no longer requiring that the “single source of truth” be kept in a single system, which could become a target of being hacked. I have invested in startups focusing on the block-chain space which can be applied to the Finance, Insurance, Food Safety, Pharmaceuticals and almost every industry here record keeping is important. This is a complex topic and may need a few articles to go into detail.

Single Family Flips – Over the years, I had done a few flips from time to time. When I had an opportunity to devote more time and capital in running flipping as a business, I gave it a shot. The years of 2011-2015 were good for flippers but then the prices started to sky rocket as myriad wholesalers and new flippers entered the market (it is possible that the late night infomercials on every other channel were a contributing factor). The profits from flipping are also considered short term gains, which in my case were at the highest Federal tax rate.

Single Family Rentals – To be honest, this came about by accident for 3 reasons – the tax benefits vs. short term gains from a flip (an immediate boost of 15%-20%), the benefit of an appreciating market and a way to manage the rehab pipeline using contractors that I trust. I would find properties (mainly REOs) which needed a little cosmetic rehab work to be “put into service” as a rental (e.g. new flooring, paint, minor plumbing, etc.) rent them for a year or two, then do a larger rehab like new kitchen and baths, and refinance them to redeploy capital (BRRR strategy before the acronym was coined) or sell them when I felt the market peaked (with an eye towards buying them back if the market significantly dipped again).

Private lending – This was a good way to put extra capital to work earning 12%-20% APR with short terms (anywhere from 3 – 24 months). I only lent to people I knew or those who had other securable assets but were looking for a “bridge loan”. For a brief period, I also considered transactional funding, which is needed for a double close and a quick 1.5%-2% for a day’s loan (but you need high volume for this to be profitable and worth the effort). The concept of private lending can extend outside of real estate as one can make loans to small companies who are underserved by banks (there are some limitations on this kind of lending via your retirement accounts, so please check with your custodian and CPA).

Early-stage Private Equity - As an active “early stage” investor or Angel investor, I was already comfortable with the concept of high risk and (potentially) high returns. For those who need a primer on this type of investing, I highly recommend reviewing the resources made available by the Angel Capital Association (https://www.angelcapitalassociation.org/). In addition to the profits, it can be rewarding to help a young company/entrepreneur, fun to see one of your portfolio companies on the TV show Shark Tank, but it can also involve a lot of “babysitting” and it can hurt to see your 6 or 7 figure investment go up in flames. This type of investing is not for the faint-at-heart. About 70-80% of the investments in this category fail. These investments are not liquid, often need follow-on investments, very volatile, high risk, little tax advantage, no leverage, and generally no cash-flow but you hope to have a few investments in your portfolio which will yield 10x-30x the originally invested amount. When do you have a good exit, don’t forget to set some of the profits aside for a hefty tax bill.

Large Multi-family Syndication – As I got more serious about real estate investing and spent more time listening to Podcasts from The Real Estate Guys, Joe Fairless, Michael Blank, Michael Becker, Rod Khleif, to name a few, and got more involved on Forums such as BiggerPockets.com, I started to appreciate the main benefits of multi-family commercial real estate (apartment complexes) – namely Appreciation (particularly forced appreciation), Cash-flow, big Tax Benefits, Leverage, Value stability and Scalability. This asset type appealed to me the most and I started investing in 200-350 unit complexes. Within a year I had invested in around 700 units with a goal of around 2000 units in 2yrs. Along the way, having looked at hundreds of deals, I got a much better understanding of underwriting for these assets and the operating processes needed.

So, what would an ideal investment look like?

How do you measure suitability?

I started to think about the key characteristics of a good investment and came up with the following list:

Risk – What is the relative risk of the asset type? Yes, generally speaking, the higher the Risk, the higher the return, but it is not necessarily a linear relationship.

Liquidity – How long will I need to tie up capital in this investment? If I wanted to, could I liquidate and transition to a different asset type?

Volatility – How volatile is the market? Is it likely to have big swings on news blurbs? e.g. Does it require me to keep one eye on the stock ticker?

Potential Returns (Yield) - How well does the asset perform on average? There is a general correlation with risk as mentioned before.

Tax benefits – Tax advantages can come in many forms. It could be that the gains are at a lower tax rate, tax credits, or deferred through a 1031 exchange, depreciation, or in some cases even tax-free (e.g. Roth IRA investments). “Real Estate Professionals” can get the most tax benefits.

Ability to Leverage – Leverage can really amplify your returns (it can also amplify losses if not treated with care). The amount of leverage you use is up to you (and your lender). Stocks can also have certain leverage in the form of Margin, but that is generally capped at 2x.

Cash Flow – This can be a hedge for gains via appreciation alone, thereby helping you balance Risk.

Using the table above, you can create a “radar graph” to compare the attributes of your top choices and compare them at a glance.

But what about diversification, you ask?

Diversification is an entire topic in itself, but Yes, I do believe in a certain degree of diversification, so the answer for me was Large Multi-Family syndications, Early Stage Private Equity and some exposure to the stock market. As market cycles change from time to time, I will continue to re-evaluate and ensure I am getting the most from my capital.

So, which investment classes or assets seem right for you? Why? Lets discuss….

About the Author

Percy Nikora is an experienced entrepreneur and investor who was also a Fortune 500 executive in the Technology, Finance and Pharmaceuticals industries. Mr. Nikora began investing in real estate in the early 2000s and currently focuses on 200+ unit multi-family properties and commercial business parks. He currently has over 1100 units and is actively seeking large multi-family and Industrial properties for Penn Capital, which syndicates high quality deals with select accredited investors and Family Offices.