Image post 0008

Real Estate Investing — Direct Investment

What you need to know about how to start investing in real estate

 

Real estate is a critical asset class to understand, and no investor—regardless of their age or income—should ignore the importance of real estate to both their personal wealth as well as the broader economic market. It is easy (and all too common) for novice real estate investors to grow enamored with one real estate market segment or become paralyzed by seemingly endless options.

If you want to avoid confusion and learn practical, actionable advice, this guide is for you.

Real estate is an imperishable asset, ever increasing in value. It is the most solid security that human ingenuity has devised. It is the basis of all security and about the only indestructible security.

Russell Sage, American Financier and Politician


What Are Your Real Estate Investing Options?

Getting started: One may gain exposure into real estate investments through a wide range of investment vehicles.

image

Each vehicle category has its benefits and considerations, and each category may be more or less appropriate depending on your investment strategy. Moreover, each category may lend itself to multiple investment strategies.

With direct investing, for instance, there is a big difference between a wholesale strategy and a buy & hold strategy. Both are different to a fix & flip strategy. (Avenue 28 will explore these strategies and more in future articles.)


Intro to Direct Real Estate Investments

Direct investments are the most straightforward and “old-fashioned” way to gain access to property. It involves purchasing and taking ownership (or partial ownership) of a physical property. Rather than receiving dividends or other equity distributions—such as with public equities—direct real estate investors earn returns from rents or by re-selling a property for a profit.

Many individuals make their first foray into real estate investing when they purchase their first homes. That said, direct real estate investing includes commercial rental properties as well.

One of the key differentiators of direct investments is that investors get full control and discretion over all investment decisions. The drawback, of course, is that one would need to commit time and resources towards management of the property. However, when done properly, direct real estate deals are flexible, efficient, and can be extremely valuable additions to one’s investment portfolio. They may not be as suited for the beginner investor as real estate equities are, but they can be powerful for the right investor.


Benefits of Direct Real Estate Investment

  • Control and Discretion. Investing directly provides investors with the greatest degree of control and autonomy over all investment decisions. This allows for the most flexibility as you would not need to seek others’ opinions/approvals for decisions such as rental terms, renovation plans, or sales timing and pricing.
  • Lower Fees. By avoiding intermediaries (eg. investment managers, property managers), investors may save on recurring management fees. While such fees are typically a small proportion of the property value, over the life of the investment period they can add up to a sizable amount.
  • Potential tax advantages. A number of jurisdictions offer preferential tax subsidies/incentives for direct property investments, particularly in the case of residential property purchases. These taxes may have a material impact on the net profits, so investors should spend time understanding these tax implications before making their investments.
  • Leverage. It is common for property investors to take on loans to finance their purchases, and one can generally obtain favorable loan terms (relative to other unsecured loans) when it is collateralized by property. This allows investors to purchase higher valued investments with a lower capital outlay. Further, when the investment is profitable, the power of leverage can amplify the return on your equity investment. However the reverse also holds true in that when the investment is loss making, your equity returns would be reduced more quickly too.

Considerations

  1. Quantum. The investment quantum is the first, largest hurdle for most investors who are interested in direct real estate purchases. Physical real estate purchases requires significant capital, so investors would need to consider if they have the funds to allocate to this investments. This applies in particular for those interested in commercial real estate opportunities which are typically larger in size. This is why many direct investors in commercial projects invest through a collective investment scheme (a structure where many investors pool funds together to collectively invest in a specific product).
  2. Financing. Direct real estate investors generally need to arrange their own financing for the purchase. Not only does this take time, but there may be financial liabilities (such as personal guarantees) that the investor may need to personally undertake as part of the loan terms.
  3. Time Commitment / Involvement. As mentioned above, one of the considerations of direct property investments is that it may require a lot more of the investor’s time to manage the property:
    • Dealing with government agencies, utility providers, even neighbours’ issues
    • Tenant management (finding tenants, negotiating terms, attending to their requests, dealing with late payments, etc)
    • Liaising with multiple property agents for tenancies and sales
    • Property improvements and other renovations
    • Accounting and tax filings
  1. Illiquidity. Direct real estate investments are illiquid. Real estate investing via public vehicles such as real estate securities or bonds will typically allow investors to quickly monetize their investments within a matter of days. On the other hand, it would generally take direct property owners several months to sell their property and get back the sale proceeds.

What to Consider Before Investing Directly in Real Estate

The complexity, uncertainty, time commitment, and management requirements of direct real estate investments can be daunting. Before investing in any direct real estate scheme, consider the following:

  • The breadth of your investment portfolio. It is inadvisable to put all of your investable assets into a single project or asset class, even one as diverse and compelling as real estate.
  • Your liquidity needs. It is often much more difficult to exit a property investment quickly than it is to sell a stock or bond. Consider how quickly you may need the capital for other purposes when deciding what investment structures to invest in.
  • Prudent investors only enter in direct investments they fully understand and feel comfortable with. Tap into external resources to help you along the way – property brokers (to better understand the local market and for marketing purposes), lawyers (to review sale, tenancy, and loan documents), accountants (for tax filings), etc. 
A Note on Real Estate Crowdfunding Platforms

The advent and continued proliferation of real estate crowdfunding has dramatically changed the direct equity investment landscape. It is now easier than ever to source and finance large direct real estate opportunities by pooling funds from multiple investors into a single project.

However, a word of caution on investing through crowdfunding platforms: the investment structures can vary across platforms – some provide the investor with a legal ownership interest in the underlying property, while others only offer a contractual agreement without any actual ownership (which is a lot riskier, especially if the platform runs into any financial difficulties). The fees that such platforms charge vary quite significantly as well, so make sure you do your due diligence before choosing the crowdfunding platform to invest through.


Our Previous Guides

Read our previous two installments of this series, where we covered investments via public real estate equities and real estate bonds. We also covered real estate investment trusts (REITs) in our real estate equities article.


For more information on Direct Real Estate Investments, subscribe to our Mailing List.

Leave a Comment

Learn how to start investing in real estate

Thank you for subscribing to our Mailing List!

Don't show again