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Investors Must Broaden Their Perspective—Consider These Nine Key Factors
My goal is to achieve returns of 15% or higher on all my hands-off real estate investments. Upon hearing this, most people’s immediate response is dismissive: “That must involve high-risk investments, right?” This reaction highlights a common misconception: many view investments solely through the lens of risk versus return, considering only a single dimension. However, the reality is that investment decisions should be evaluated from multiple perspectives.
As an investor becomes more experienced, it’s essential to start considering investments in a multidimensional way.
Here are several crucial factors to keep in mind:
- LiquidityWhen investing in stocks, you have the flexibility to sell at any time. However, real estate investments typically require long-term commitment, often locking in your capital for several years. Moreover, the selling process can take months and incur significant costs. This is true for both active and passive real estate investments, with many passive options offering no liquidity at all—you will get your money back according to the operator’s timeline, not your own. This insight reveals how high returns with moderate risk can still be appealing when one considers the broader scope of investment factors.
- TimelineLow or no liquidity doesn’t necessarily define when you can expect to see a return on your investment. Will you receive your capital back in a year, three years, five years, or even longer? Many real estate syndications work on timelines of four to seven years, locking in funds during that period. In my real estate investment club, we aim to diversify timelines, offering a range of investments from nine months to multiple years, ensuring our investors can stagger their repayments.
- Minimum InvestmentAn operator might offer an investment with high returns, such as 20% annualized returns, but with a steep minimum investment of $1 million. More commonly, minimum investments for real estate range from $50,000 to $100,000, though they can reach even higher amounts. If you lack the required funds, you may need to pool resources with others, such as through an investment club, to participate in the opportunity.
- AccessibilityEven if you have the capital, you may still face barriers due to regulatory requirements. The Securities and Exchange Commission (SEC) restricts access to many private equity investments, limiting them to accredited investors—those with a net worth of $1 million or more (excluding their home) or annual earnings of at least $200,000. However, not all private equity investments have these restrictions, and we prioritize finding opportunities accessible to all investors.
- Tax BenefitsReal estate equity investments often come with significant tax advantages, such as depreciation and accelerated depreciation through cost segregation studies. These benefits, combined with deductions for expenses, typically result in a K1 form that shows a paper “loss” despite receiving cash flow throughout the year. Debt investments, in contrast, do not offer such tax advantages and are taxed at the regular income tax rate.
- DiversificationConcentrating your investments in one area can be risky. For example, owning multiple rental properties in Cleveland exposes you to risks tied to local economic downturns. Diversifying across different cities, property types, and investment timelines reduces the risk of significant losses. In my portfolio, I diversify not only within real estate but also across stocks and various types of passive real estate investments, such as syndications and private notes.
- ResilienceDiversification also enhances resilience against economic shocks. For instance, certain property types, such as Class D multifamily properties, are more vulnerable during recessions, with higher vacancy rates and rent defaults. In contrast, properties like mobile home parks tend to hold up better. Our investments often focus on sectors that show resilience to economic downturns, such as affordable housing projects with risk mitigations like rent caps and property tax abatements.
- Personal ValuesInvestors’ personal values can significantly influence their decisions. While upstream oil and gas drilling historically yields strong returns, some investors may avoid it due to concerns about fossil fuels. This demonstrates that returns and risks are not the sole drivers of investment decisions—personal ethics and values play an equally important role.
- Types of RiskRisk is multifaceted, and it’s essential to evaluate the various forms it can take in investments. Risks include volatility, inflation, interest rate changes, default risk (for debt investments), disaster risk, political and regulatory risk, and concentration risk. Each investment comes with a unique set of risks that should be carefully considered, especially when comparing different types of assets, such as stocks, bonds, and real estate.
Final Thoughts
How can high returns coexist with low risk? Because risk and return are just two dimensions of a more complex investment landscape. For example, I am comfortable locking up capital for several years in exchange for 15% to 20% returns with low risk. As an example, one of our recent investments in our Co-Investing Club was in a multifamily property with projected returns of 22.36% annualized, alongside significant tax benefits—despite its illiquidity and minimum investment requirements.
To excel as an investor, you must evaluate opportunities from multiple angles, considering not just risk and returns but also the various dimensions that contribute to an investment’s success. This is what differentiates sophisticated investors from the average ones.
In the previous post: “Is Now a Better Time to Invest in Real Estate Debt or Equity?“
Investors Must Broaden Their Perspective—Consider These Nine Key Factors
Has the U.S. Housing Market Finally Begun to Thaw After the Pandemic?
It seems like the housing market might be showing signs of life. According to a recent report from Redfin, pending home sales in early October have seen their largest year-over-year rise since 2021, with a 2% increase in the four weeks ending October 6.
This news is likely to be welcomed by real estate investors who have felt the market has offered limited opportunities over the past few years. However, it’s important to take a cautious approach—one promising statistic doesn’t necessarily indicate a broader trend.
Is the Housing Market Truly Recovering?
Let’s explore the different factors at play.
Interest Rate Reductions: A Critical Factor or a Red Herring?
The Redfin report links the surge in pending sales to the Federal Reserve’s much-anticipated rate cut announcement in mid-September. According to Redfin, this announcement prompted buyers to re-enter the market in late September, despite mortgage rates having already been falling for weeks before the cut.
This psychological boost is crucial. Although buyers were aware of the falling rates beforehand, many seemed to be waiting for a formal signal to act. This could be attributed to a lingering fixation on the ultra-low rates of 3% to 4% that buyers enjoyed before 2022.
Any rate cut announcement serves as a nudge for prospective buyers, making them feel that now might be the right time to purchase, even if mortgage rates had been decreasing already. In an unstable mortgage market, such announcements hold significant influence.
However, mortgage rates are just one piece of the puzzle when analyzing housing market performance. As noted by Investopedia, the real estate market is driven by four primary factors: interest rates, demographics, economic conditions, and government policies.
Demographics: Shaping the Market
During the pandemic, demographic shifts had a profound effect on U.S. real estate, with major population movements like the Sunbelt migration fueling booms in cities such as Phoenix and Austin, which later became unaffordable for many.
Age is another key demographic factor, and the millennial generation’s pent-up demand continues to be a driving force behind the rise in home purchases. Despite the challenges of the past few years, millennials who have longed to become homeowners are now entering the market in greater numbers, as more properties become available.
Rising Inventory: A Sign of Stabilization
A key factor contributing to the market’s stabilization is the growth of housing inventory over the last year. The pandemic had a significant impact on the availability of homes, with sellers hesitant to list properties due to COVID-19 restrictions and, later, higher mortgage rates.
Some homeowners, particularly those upgrading to larger homes, found it financially challenging to sell and take on higher mortgages. Others, however, simply chose to wait for a more favorable market.
Although the latest Realtor.com report shows that inventory remains down by 23.2% compared to pre-pandemic levels, we are seeing an upward trend. For instance, new listings have been rising since last year, with a 5.7% year-over-year increase for the four weeks ending October 6.
As of September 2024, some states have even surpassed their pre-pandemic inventory levels, including Tennessee, Texas, and Idaho, with others, like Washington, close behind.
Vulnerabilities in Certain Regions
However, not all regions are showing positive signs. For example, some areas, particularly those affected by extreme weather, have seen inventory spikes not because of market recovery, but due to homeowners trying to offload damaged properties they can’t afford to repair.
For instance, regions like Florida and North Carolina, hit by hurricanes, have experienced increases in home listings, but these may reflect a response to climate-related challenges rather than market health.
Opportunities for Investors
Investors should be discerning when choosing markets, focusing on regions where inventory is growing due to increased home construction rather than climate-related distress. States like Idaho, Utah, North Carolina, and Texas, which are building new homes, offer potential, though caution is needed in areas prone to natural disasters.
The Midwest and Northeast, meanwhile, still face significant challenges in recovering to normal market conditions. These regions have lower rates of new construction, meaning inventory remains scarce, which could present both opportunities and difficulties for investors.
The Bottom Line
The U.S. housing market is showing signs of recovery, but the situation remains complex and varies by region. Interest rates play an essential role in unlocking the market, but investors should also consider other critical factors, such as homebuilding trends, climate risks, and government policies. While the market is heading in the right direction, it’s crucial to examine regional differences carefully before making investment decisions.
In the previous post: “Is Now a Better Time to Invest in Real Estate Debt or Equity?“