[Editor’s Note: Last week’s Physician Financial Literacy and Wellness Conference was a huge success! Special thanks to Chrislyn and Katie for creating such an extraordinary event. And, of course, thank you to Christine Benz, Mike Piper, Allan Roth and Leif Dahleen for their fantastic keynote and/or live panel presentations, and to our amazing lineup of speakers and panelists. Most importantly, thanks to over 1,000 white coat investors who joined us and brought their energy and excitement to this interactive virtual experience!
If you missed attending, the conference will be bundled and available to view as a course on March 15th. Receive $100 off if you buy anytime between today and March 30th! If you want to access the conference right away, it is available until March 15th on the conference platform at regular pricing.]
It’s been a while since I did an update post on our real estate investments. The reason for that is primarily the push-back I got the last time I did one. You see, real estate syndicators, platforms, and fund managers don’t have any problem whatsoever with me writing good things about them. However, if I ever write something bad about them, they’re quick to point out that the Private Placement Memorandums have a confidentiality agreement in it to prevent partners from saying anything that could do the partnership harm. Without naming names, I can’t do much promoting of these businesses, but it certainly doesn’t do our readers any good for me to name names if I’m only going to tell them the good things about the investment(s). So I simply haven’t been doing regular real estate updates. The last one was over a year ago.
However, I think there is some usefulness in doing regular posts like this, even if I don’t name names. If you want to hear about the individual companies we are partnering with right now, sign-up for the Real Estate Opportunities newsletter. This post, however, can be used to show you what our experience has been investing in these types of investments. I’ll outline the good and the bad and you can use that as your guide while trying to determine how you wish to invest in real estate, if at all.
Remember our asset allocation is 60% stocks, 20% bonds, and 20% real estate. That real estate allocation is divided up 10% equity, 5% debt, and 5% Vanguard REIT Index Fund. So 85% of our portfolio is in very boring, publicly-traded, index mutual funds. That means that in this post we’re only talking about 20% of our retirement investments and a far smaller percentage of our net worth.
Also, remember that private real estate investments require you to be an accredited investor. That means an annual income of $200,000+ or investable assets of $1 million+. However, I think that you should not only double those amounts, but meet both of those criteria before looking at most of these investments, plus feel very comfortable evaluating the merits of these investments without the assistance of the SEC or an advisor.
Now, let’s get into the nitty-gritty. How have our investments done? Let’s take one category at a time.
Publicly Traded REITs
As mentioned above, we invest 5% of our portfolio into the Vanguard REIT Index Fund. We’ve been investing in this fund since early 2007. Yes, our timing into it was terrible. I think we lost 75%+ of our initial investment in 2007-2009. But we continued to invest regularly into the fund and have been rewarded for doing so. As of February 18th when I wrote this, our long-term annualized return on this fund is 7.45% per year. That sounds really terrible when I put it that way, but it’s very much a reflection of relatively poor recent returns and our particular cash flows (i.e. a large part of our portfolio was contributed in just the last 2-3 years). The actual time-weighted returns of the fund are better. Morningstar lists its 10-year return as 8.46% over the last 10 years. 2020 was a pretty lousy year for real estate. After making 29% in 2019, this fund lost almost 5% in 2020, mostly from losing 24% in the pandemic associated decline. Unlike large growth stocks and small value stocks that had a massive recovery, real estate didn’t recover nearly as much. It was up just about 4% year to date at the time of this writing.
Our records show that we have had 16 debt real estate investments over the years, all of which are private investments available to accredited investors only. The earliest of these investments were relatively small individual loans to real estate operators made via online crowdfunding platforms starting in 2015. There were a total of 10 of these and they have all gone round trip. Annualized returns on these ranged from 7.78% to 14.46%. We got every dime of principal back and all promised interest.
However, they didn’t all pay on time. While some were paid back earlier than expected, and most paid back exactly as expected, a few started missing payments, sometimes for a long period of time. The worst one was a 1 year loan made in September 2017 that wasn’t paid back until February 2020, about 2 1/2 years. Now we got paid interest for all 2 1/2 years, but it turned out to be a lot less liquid than we had hoped. These were all $5-10,000 investments, backed in first position by real estate.
We got sick of picking these individual notes and trying to diversify them. So we decided to hire a company to do it for us. Instead of owning just a few notes, we would then own dozens of them. It would cost us an extra 1% a year, but it was worth it to us to eliminate that hassle and achieve far greater diversification. Plus we could easily reinvest our earnings like in a typical mutual fund and get out of the fund when we wanted to. We hoped they might be better than us at picking the notes, too, but that wasn’t our primary purpose in hiring them. Well, that worked pretty well for about 2 years. Then this company decided it didn’t want to serve people like us anymore; it wanted to work with institutional investors. So the company decided it would no longer invest our money. But we also couldn’t get all of our money back at once. We were only going to get it back as the notes were paid. Well, that was annoying, but most of the notes were only a year or so, so not such a big deal I guess. Well, we started getting our money back in fits and spurts. I had close to $22,000 in the fund at that point in late 2019 when they stopped reinvesting the proceeds. Take a look at how the money has come back since then (these are screenshots from our investment spreadsheet):
In case the picture isn’t clear, they’ve now been returning our money for something like 16 months and we only have 3/4 of it back. At the time they started returning money we had a portfolio of loans ranging from 1 month to 12 months. Can you see why I’m annoyed? This was an investment we were told we would be able to get out of essentially immediately at our convenience. In reality, we couldn’t even liquidate over a year-long period at their convenience. And the chorekeeping for someone like me who actually records their transactions to calculate their returns is ridiculous. On our spreadsheet, each of these 57 transactions gets recorded 4 times (this investment, total debt real estate, total retirement, and total portfolio).
Technically, our return is an annualized 6.32%. But after 16 months, I can’t help but wonder how much of that $5,732 we’re still owed are we really going to get back. The records show that we still have 27 notes out, and 16 of them are delinquent. The delinquent notes total a little over half the money still owed. Hopefully, it’ll turn out like the other notes we’ve owned, where you get paid late but you still get paid, including the interest due on the delay. Obviously not happy about this one but there certainly isn’t any big loss or anything. Total reported losses so far are only $224. The delays are a little annoying, but I’m mostly just perturbed by the drip, drip, drip method of returning money to me.
As you can tell, we don’t really like picking our own notes. So the rest of our debt investments are funds, managed by a professional. All the loans in them are still backed by real estate in the first position. They charge fees, as you would expect, but they reinvest our earnings and just send us a statement every month.
The first of these was a $75,000 investment that subsequently went public and is now actually traded on the stock market. We liked it when it was private. We liked the results when it went public, but I didn’t really like owning an individual stock so I sold it for a nice short-term gain a few weeks after it went public. Thankfully we had plenty of losses from tax-loss harvesting and our overall return on the investment from November 2017 to December 2019 was 20.91% per year, way more than we had any right to expect from a debt investment. More detail on this one here.
The next fund was also a $75,000 investment. It’s an evergreen fund that targets 7-8% returns. I calculate that we have an annualized return of 7.12% over the last 2 1/2+ years. They held up pretty well in 2020, making 6.89% in a tough environment.
The next fund is a $100,000 investment into a debt fund via a third-party access fund provider. The underlying fund did spectacularly in 2020, all things considered. It fell from its typical 12%+ return to an 11%+ return during COVID. Due to the extra layer of costs from the access fund provider, our personal return in this fund has been 9.35% over the last two years.
We made the minimum $250,000 investment into the next fund as COVID was hitting. They were well aware that COVID was going to impact their returns significantly, to the point where they actually made us sign a statement acknowledging that we understood that. They’ve held a lot more cash in 2020 than usual, which obviously lowered returns. They’ve been working hard to get it invested over the last six months but are still somewhat getting up to speed. We’ve only been in it about 8 months, but our returns annualize out to 6.13%. We fully expect that to rise back closer to their previous level of returns in the 10-12% range.
Real estate newsletter readers know all about our most recent investment. We went back to the fund above that we previously invested in via the third-party access fund and just invested $100,000 directly. They lowered the minimum investment for all white coat investors. Going directly not only eliminates the middleman fees, but also provides two other bonuses — the fund is evergreen (the access fund was not) and we can reinvest our distributions.
Our goal for this asset class is to have three evergreen funds long-term. We’re pretty happy with the three we have now. When the access fund goes round trip, we’ll just roll it in directly.
We really like the stability, transparency, predictability, and evergreen nature of our debt investments. Equity investments can be very different. They also take a lot longer to go round trip. The progression from individual syndications to funds in our portfolio, however, has been similar. We have had a total of 11 “passive” equity real estate investments.
#1 Partnership Office
Our first investment is the building that houses my physician partnership’s offices and a couple of other tenants. I think we’re up to $36K or so invested in this. I’m actually the chairman of the board on this one, so it’s somewhat an active investment for me. We manage it VERY conservatively, basically using all the income to pay off the mortgage. Returns have been an annualized 7.6% since 2012.
#2 Indianapolis Apartment
The next investment was a $10,000 investment into a value-add apartment syndication in Indianapolis bought through an online platform. It had its problems but from 2014 to 2020, it paid us $2,300 or so in income and then was sold for $12,779. Annualized returns worked out to 8.71% per year.
#3 Salt Lake City Preferred Equity
We had a $5,000 preferred equity investment right here in Salt Lake City bought through an online platform. It paid almost exactly as agreed; our only disappointment was the investment was sold earlier than expected. The deal was 14% and by my calculations, that’s what we got—13.66% a year for about 27 months.
#4 Neighborhood Retail
Our next syndication was a $5,000 investment bought through an online platform in 2015. We don’t usually invest in retail properties, but we couldn’t resist this one. It was only a mile from our house and we shopped there regularly. It was just too fun every time we drove by not to own it. It turned out to be a pretty good investment too. Overall return was 17.77% per year for a period of just under 3 years.
#5 Syndication Disappointment
Our next syndication has been our biggest disappointment in real estate investing. This $20,000 preferred equity investment was bought through an online platform at the end of 2017. The plan was a value-add project on an apartment complex in Houston. Everything seemed okay for the first year, paying as agreed. Then the payments stopped. It turned out the operator had done some fraudulent things. Let the legal issues begin. The platform got involved in some legal wrangling to take control of the property, eventually doing so. However, a bunch more money was needed to save this project, so the platform actually formed a second investment to do so. They offered that investment to all of the original investors, and enough of them took the platform up on it to move forward with the project. However, we didn’t really want to throw good money after bad, so we just decided to wait and see what happened. The platform has been transparent enough about what’s going on, but it’s pretty hard to get excited about a 3 year deal that paid us a couple of thousand bucks on your $20K investment the first year and hasn’t paid us since. No way are we going to get anywhere near the projected return on this one. We would be thrilled to get our capital back, but expect a substantial loss and have steeled ourselves for a total loss. We’ll see what happens.
#6 Fort Worth Syndication
Our next syndication is a $100,000 investment into an apartment complex in Fort Worth bought directly from the syndicator in early 2018. It pays us something every quarter, but has always trailed its pro-forma. It seemed to have an even rougher time with COVID, but the 4th quarter payment was over double the 3rd quarter payment, so maybe that’s all over now. For the life of me, I can’t figure out why it has underperformed its pro-forma. Occupancy seems to be good, income seems to be good, expenses don’t seem ridiculous, but instead of getting 6% a year distributions we only got 5% a year distributions the first year, 2 1/2% distributions the second, and now with COVID, like 1.5% distributions. We’re still stuck in it for most of the next decade, but we’re hoping most of those years turn out a lot better than last year. At least all of the distributions are easily covered by depreciation.
Over the course of 2017 and 2018, we essentially moved from individual syndications to funds. This was partly our frustration with a lack of diversification in the portfolio, our acceptance of the need to file multiple state tax returns, and frankly our newfound ability to meet the minimum fund investments. We are currently invested in five funds and will probably invest in 1 or even 2 more this year to keep our asset allocation intact. Our biggest frustration with equity funds is that most of them are not evergreen. So when you need to invest more money into the asset class, you have to find a new fund and sometimes a new manager. That takes weeks to get everything lined up, and then they call your capital over a matter of months or even years. It’s just really hard to maintain an asset allocation that way. So one of the big things we’re looking for with future investments is evergreen funds that can reinvest distributions.
#7 Two Year Capital Call
The first of our funds was purchased in August 2017. Our capital was called over the next 27 months. That’s right. Over two years. Four months later, they started sending it back as they started selling investments in the fund. We appreciate that they don’t hold our money if they don’t have anywhere good to invest it, but it is frustrating to have to go looking for somewhere else to put it all the time. This fund does not provide regular distributions at all, just big lump sums when they sell investments. It’s definitely been an interesting process to watch. They started updating the value of the fund regularly so the returns are a bit more accurate than with some of these funds. Using that value, our annualized returns are 8.71%, but we’ll be surprised if the overall return when this one is said and done isn’t twice that.
#8 Just Above Water
We liked the way they managed their funds, so we decided to try another one. This one is a lower risk/lower projected return fund and actually holds quite a bit of preferred equity investments. We apparently bought in at a lousy time, just in time to catch a -5.9% return for the first quarter of 2020. We’re just now back above water with the investment after a full year. The jury is still out on this one.
#9 Called As Needed
The next two funds we bought at the same time as the previous one, February 2020. They had two very different approaches to calling capital. The first one called it as it was needed, and still has only called $54,000 of our $100,000 in capital. It seems to have had a fair bit of trouble finding good investments in 2020. That’s okay, if they don’t have something good, we appreciate that they take a pass on it. They don’t update the value of the fund regularly, so our only return has been a bit of income so far, 3.53% annualized. This is a multi-year, value-add, multi-family fund that has 2+ years to call all the capital.
#10 Immediate Capital Call
The second fund took our $100,000 immediately and invested it in a note that pays 4%. As they find good investments, they take the money out of the note and invest it. So the note gradually pays us less and less and the investments gradually pay us more and more. We’re making 3.88% so far. They seemed to have trouble finding good investments in 2020 too as evidenced by the fact that only about 45% of the fund was invested last year.
#11 8% + 70/30 Split
Our most recent fund is a $250,000 investment that pays an 8% preferred return and then offers a 70/30 split above that. It has a few months to call the funds and should be calling ours soon. As I write this, we only have $25,000 invested. We invested late in this fund’s raise (they’ve already moved on to raising money for their next fund) so we have a lot of transparency into what we bought. It’s 42 properties, mostly multi-family, across multiple states. We’ll see how it goes.
Overall, we’re reasonably happy with the performance of the equity portion of our portfolio. The income is all sheltered by depreciation but it’s a long game best played by patient investors. Ideally, we’d like to have 3-5 good, evergreen funds in this space, but we’re not sure we’re going to achieve that. More likely we’ll end up with 10 funds from 5 or 6 different managers, most of which are not evergreen. Right now we have five funds and three syndications from 5 managers, 6 if you include me.
Over the long run, we’d like to see steady returns of 8-12% from the debt portion of our portfolio and 10-15% returns from the equity portion. If we can achieve that, we think it’s worth the hassle and additional complexity of dealing with these private investments. So far, so good. If you want to learn more about these types of investments as they become available, sign-up for the Real Estate Opportunities newsletter.
What do you think? Do you find private real estate attractive? Which types do you prefer? What surprises you about our experience in this space? Comment below!