All Forum Posts by: Jacob Vorreuter

@Ben Leybovich

Haha, no, I don't trust my assumptions. I hoped to represent the options realistically enough to start the discussion and solicit some opinions/input from more experienced investors and I've really enjoyed the responses so far.

You make a great point though. Related, a theme I've picked up on is that effective investment analysis hinges on minimizing the number of assumptions (yours or someone else's) and maximizing the information you can accurately project and verify. Verify utility bills, verify rent rolls via leases, verify next year's property taxes, use a real and current quote for property mgmt, landscaping, etc. Many of these datapoints seem like absolutes, when in reality there can be a lot of variance (year-to-year or vendor-to-vendor).

I'm sure this is second nature for experienced investors, but a powerful lesson for those of us just getting started.

@Carl Fischer Ah, that's great info. Thanks!

@Brian Burke Yeah, totally agree on the importance of due diligence.

My understanding of the platforms I've been perusing (mostly RealCrowd and RealtyMogul) is that you do have direct access to the sponsor. They provide contact info for anyone from a Director of Acquisitions, to a co-founder, to a chairman or CEO. Granted, I've never attempted to reach out to one of these sponsors, but it seems very cool that you as an investor get that level of access.

Additionally, these platforms have their own standards for sponsors based on track records and portfolio size. I appreciate that they've done some of the due diligence already. That's no substitute for doing my own due diligence, but at least they filter out a big portion of less qualified sponsors.

@Ivan Barratt Hey! Very cool to see you on here! I really enjoyed your webinar on RealCrowd stepping through the Nantucket Cove project. I look forward to learning about your future projects :)

@Alina Trigub That's an interesting point and something I am curious about in respect to Tom's statement. Consider the following example:

• $100,000 invested in a rental property via Roth IRA for a 5 year hold
• 80% LTV means UBIT on 80% of gains
• $8,000 cash flow per year
• $133,000 sale price (33% appreciation over 5 years or 6%/yr)
• Years 1-4 UBIT tax on $6,400 (80% of $8,000) = $1,179/yr
• Year 5 UBIT tax on income plus gain from sale (80% of $41,000) = $10,522

The investment represents a 13% IRR before factoring UBIT and an 11% IRR after factoring UBIT. That's still a great return and competitive with other investment options, like private lending.

@Carl Fischer @Natalie Kolodij I believe this is also inline with your points as well.

I'm interested in self-directing my Roth IRA and investing in real estate.

I recently read Tax-Free Wealth by Tom Wheelwright and he stresses the point that you should not nest a tax-advantaged investment in another tax shelter. Ie: don't buy real estate on which you can claim depreciation and other deductions in a Roth IRA.

What are the optimal real estate applications of a tax-free account?

Debt syndication deals / Private money lending

Participating in debt syndication deals or private money lending seems like one option. From what I've seen, these opportunities generate 8-12% annual returns.

These investments typically generate interest-only cash flow distributions that are taxed at ordinary marginal income rates, right? Or do these get taxed at capital gains rates? Do they count as passive income that can be offset by losses in real estate equity investments?

Alternative investments

I don't have many ideas here, but the one about which I'm curious is international agriculture. AgroNosotros has appeared on several podcasts to discuss their sustainable specialty coffee and cacao plantations in Panama, Columbia and Belize. Once operational, they claim these generate 13% annual returns on average. I haven't done enough research to understand the tax implications of such an investment, but I'm guessing there are fewer deductions (if any at all) to offset that income?

What other investments do you recommend to take advantage of tax-free growth?

@Basit Siddiqi Your responses have been incredibly helpful and informative. Thank you so much for the insights!

Background: I'm an accredited investor with some cash I'd like to put to work in real estate. My goal is to build up passive income generating assets over the next 5-7 years to achieve financial freedom. Although I've studied and learned a lot, I have no applied experience investing in real estate.

I'm pondering three strategies to get started:

1. Portfolio of turnkey SFRs
2. Invest in a small apartment building
3. Invest as an LP in syndicated deals

Strategies

Below is my analysis of each option, followed by my conclusion. I'd love to hear some of your perspectives and input though!

1. Portfolio of turnkey SFRs

This option would entail building a portfolio of turnkey, professionally managed SFRs. The emergence of turnkey providers unlocks markets outside my home market and makes it easy to find and purchase cash flowing properties with management already in place. I'm looking primarily at the non-gateway markets (Southeast, Midwest, Southwest).

Below I've modeled a representative investment based on several rules of thumb, including:

• income 1% of purchase price
• 3% vacancy
• expenses 50% gross income
• income, expenses and property value increase at 3%/year

Estimate:

• Purchase price: $150,000
• Income: $1500/mo
• Expenses (including professional mgmt): $750/mo
• Capex/reserves: $45/mo
• Debt service: $644/mo (80% LTV, 5% interest rate, 30 yr)
• Cap rate: 5.6%
• Year 1, 5, 7 CoC return: 1.30%, 4.40%, 6.09%
• Year 1, 5, 7 IRR: -26%, 11%, 12%
• Year 1, 5, 7 Equity Multiple: 0.71, 1.39, 1.70
• Year 1, 5, 7 DSCR: 1.13, 1.27, 1.35

I'm intentionally using an optimistic estimation to give this option the best chance at competing with option #3.

2. Small apartment building

This scenario entails buying a small commercial multi-family building in a nearby West Coast market. I'm sticking to nearby markets because this option is the most labor intensive. There are no turnkey providers for commercial multi-family, so I'd have to invest in building relationships with market-local realtors, property managers, contractors, wholesalers, build my own team and source my own deal.

I pulled two examples off Loopnet in Portland and Sacramento:

Portland 7-unit

• Gross income: $103,130
• Gross operating income: $100,036
• Total operating expenses: $30,159
• Net operating income: $69,877
• Capex/reserves: $3,094
• Cap rate: 5.6%
• Projected purchase price: $1,247,804 ($1.4M list)
• Debt service: $59,513 (70% LTV)
• Year 1, 5, 7 CoC return: 2.32%, 4.48%, 5.67%
• Year 1, 5, 7 IRR: -17%, 9%, 10%
• Year 1, 5, 7 Equity Multiple: 0.81, 1.28, 1.50
• Year 1, 5, 7 DSCR: 1.17, 1.36, 1.44

Sacramento 8-unit

• Gross income: $143,114
• Gross operating income: $138,821
• Total operating expenses: $51,170
• Net operating income: $87,651
• Capex/reserves: $4,293
• Cap rate: 4.87%
• Projected purchase price: $1,799,813 ($1.9M list)
• Debt service: $73,578 (60% LTV)
• Year 1, 5, 7 CoC return: 1.68%, 3.12%, 3.90%
• Year 1, 5, 7 IRR: -14%, 6%, 7%
• Year 1, 5, 7 Equity Multiple: 0.86, 1.20, 1.38
• Year 1, 5, 7 DSCR: 1.19, 1.39, 1.47

Similar to option #1, option #2 is probably overly optimistic. I used the sellers' income and expense actuals/projections and only tweaked vacancy rates and capex reserves.

3. LP in syndicated deals

Below is a snapshot of a few commercial multi-family syndication deals currently available on a crowdfunding platform:

$12.5M primary market new condo development

• Hold period: 2.5Y
• Target IRR: 22%
• Equity Multiple: 1.65
• Year 1 CoC return: N/A

$4.7M primary market apartment community light rehab

• Hold period: 2-5Y
• Target IRR: 16-20%
• Equity Multiple: 1.5-1.9
• Year 1 CoC return: 2.9%

$18M tertiary market apartment community value add

• Hold period: 3-5Y
• Target IRR: 18.2%
• Equity Multiple: 2.11
• Year 1 CoC return: 7%

$34M tertiary market apartment community value add

• Hold period: 7Y
• Target IRR: 16.5%
• Equity Multiple: 2.43
• Year 1 CoC return: 7.4%

Observations

Risk

In a vacuum, the types of projects being carried out by the syndication sponsors are inherintly riskier (new construction and varying levels of renovation). However, in practice, the investor probably has as much, if not more influence on risk. Compare large syndication sponsors with tons of experience to a newbie investor and the risk scale shifts hard in favor of experience.

I'm sure there's a decent chance that a sponsor encounters a complication and drops a few percentage points on the IRR to their investors. On the other hand, what's the likelihood of a first-time investor making a small or large mistake that has a severe impact on their bottom line? I'm guessing pretty high.

This, of course, highlights the importance of a new investor finding a good mentor :)

Diversification

Investing in multiple properties (options #1 and #3) offers the opportunity to diversify across multiple markets. Option #3 additionally offers the opportunity to diversify across different types of projects and different (and shorter) hold periods.

Returns

The syndication deals provide substantially higher IRRs and equity multiples.

As cap rates compress and interest rates rise it seems to have become very difficult to find stable, performing investments (residential or commercial multi-family) that produce high teens or above IRRs on a 5-7 year timeline. Many savvy investors are probably still achieving these returns and I'd guess they're doing it in two ways:

Fix and flips

Buying depressed properties, rehabbing and re-selling/refinancing (BRRR) is risky and time intensive. This sounds fun and exciting, but the time commitment really kills it for me.

Forced appreciation through improved operations

I've heard many success stories from investors that have generated great returns by finding a commercial multi-family property that's underperforming and/or mismanaged. Bringing such a property up to market rents, tightening up expenses and completing some light improvements can have a substantial impact on net operating income. Unfortunately, sourcing these opportunities is tough because they probably never hit Loopnet/MLS and would require lots of active investment in relationship building in specific markets.

Conclusion

The risk profile and projected returns of these large syndication deals makes them the most attractive option for a newbie investor in my position.

Add in a potential looming economic downturn and uncertainty of where we are in the current real estate market cycle and that only increases my anxiety as a newbie investor trying to get into the market. I trust that the sponsors managing these projects can navigate upcoming turbulence better than I can on my own.

I'd love to hear other perspectives and feedback on my estimates/assumptions.

Looking forward to hearing from you all!

Thank you all for your insightful replies!

@Basit Siddiqi Is this a timing issue or a matter of whether the income and losses from the syndication offset each other? For example, are you saying that it's possible that the sponsor will not provide me the K-1 in time to include in my tax return in year 1, so I'd have to file an extension or carry the losses forward? Or are you saying that rental income generated by the investment and distributed to LPs does not qualify to be offset by losses (depreciation, interest, etc)?

@Brian Burke Ah, ok! Let me check my understanding through an example with a fictitious investment:

Gross income: $500,000

Gross operating expenses: $300,000

Net operating income: $200,000

Annual debt service: $100,000

Net cash distributions to LPs: $100,000

Annual depreciation: $200,000

Tax loss: -$100,000

In this case, the income reported for the property is negative (a loss), but the LPs received their share of a positive cash distribution. Does that illustrate your point or did I miss it?

@Tony Kim Getting a look at a sample K-1 was helpful. Thank you!

What are the tax implications of investing in an equity syndication deal as a limited partner?

I’m considering investing in commercial multi-family equity syndication deals through a crowdfunding platform. I’ve reviewed the tax sections of several PPMs, but I’m still struggling with the legal language.

I’d like to understand the following:

1. How are gains taxed? Limited partners would expect to receive regular cash distributions, followed by proceeds from the exit event (sale or refinance). This is all considered passive income, correct? Are the regular cash distributions taxed as ordinary income or capital gains? And are the proceeds from the sale or refinance taxed as long-term capital gains?
2. What passive losses can be claimed by limited partners to offset the above passive income? It seems clear from the PPMs that LPs can claim depreciation deductions proportional to their share of the value of the property. Are LPs typically able to claim deductions on a portion of loan interest, property taxes and other commonly deductible expenses?

I understand every investment is different, but any insight into the LP tax implications of a typical apartment syndication deal would be greatly appreciated.