A MUTUAL FUND MADE WITH REAL ESTATE
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We love to speak with investors and help them on their investment journey towards financial freedom, and last week we had the pleasure of speaking with a very experienced stock investor. His question was: “How would you compare your fund to a stock or mutual fund?”
How Would You Compare Your Fund To A Stock Or Mutual Fund?
It was a great question and one we don’t receive often. We primarily focus on real estate, and it’s easy to get locked into assuming everyone understands what you’re speaking about.
This article will summarize some key terms and concepts to help stock/mutual fund investors better understand the private real estate world.
Publicly Traded Investments Versus Private Real Estate Investing
Ownership of publicly traded Stocks, Bonds, Mutual Funds and ETFs varies greatly when compared to private real estate investments, but there are some commonalities between public versus private ownership. To help frame this for stock investors: Owning a share (also called a “unit” or an “interest”) in private real estate as a Limited Partner is similar to owning shares of a stock, ETF or mutual fund.
The General Partner (GP), also known as the Sponsor or Syndicator, is controlling and managing the direction of that property for its Limited Partners (the shareholders). If the offering includes only one property, it’s similar to owning share(s) in one company.
A real estate fund is similar to a mutual fund or ETF in that it owns multiple properties, like mutual funds owning the stocks of a number of companies. The General Partner (GP) will be acquiring multiple properties and pooling them together similar to a Fund Manager for a Mutual Fund would acquire a portfolio of stock holdings.
Common Real Estate Investment Terms
Real estate investing has its own set of terms and classifications for individual properties and funds (e.g. multiple properties held as a collection is a portfolio of investments).
The two basic divisions of real estate investments are:
● Equity
Equity is the ownership of real estate as an individual share or multiple shares of a property investment. The equity in a property will grow with the appreciation (upside) and any income after expenses. The value of equity in a real estate investment can be calculated by subtracting any debt from the market value of the property. Equity shares of a property or fund are higher on the investing risk spectrum because equity takes the first loss before any debt and you can lose all of your equity in the event of a foreclosure.
● Debt
Debt is a loan on a property, typically in the form of a mortgage. Debt holders (the Lenders) receive income in the form of regular payments of “interest” on the amount loaned to a property owner. Lenders have a “first position” on payments from a property, meaning they get paid first before the property, or equity, holders. Debt investors typically lend or invest in debt instruments as a way to receive regular income from real estate, having a lower risk than those with equity.
Related Article: Understanding the Ins and Outs of Real Estate Capital Stack
The four basic Commercial Real Estate investment strategies are:
● Core Real Estate Investment Strategies
Core real estate investments are the safest type of properties with high-quality, excellent credit tenants in premier locations with long-term leases. The locations of Core Properties are typically in Primary Markets, also called Gateway Markets, which are internationally recognisable metropolitan areas. Core Properties are also the most dependable at providing consistent income. These types of properties and real estate investment funds are often compared with bonds or real estate debt in terms of their security and regular income.
● Core Plus Real Estate Investment Strategies
Core Plus real estate investments are the next step up on the risk spectrum, with quality tenants in good locations. The leases on Core Plus may not be as long, and the properties may be located in Secondary or Tertiary Markets. Core Plus properties can provide dependable income with the opportunity for higher returns. These types of properties and real estate investment funds are often compared with convertible bonds or mezzanine real estate debt in terms of returns and risk profile.
● Value-Add Real Estate Investment Strategies
Value-Add investments rely on the ability of an individual or sponsor to execute an improvement program to increase rents or the value of the property. Value-Add investments often require additional capital to complete the improvements, which impacts the ability to provide consistent income to investors. Value-Add real estate is more risky than Core or Core Plus because there are more variables that have the potential to negatively impact the returns on your investment, including the complete loss of investment capital.
● Opportunistic Real Estate Investment Strategies
Opportunistic real estate investments are the highest on the risk spectrum and often require a lot of work and the right set of conditions to go well. Opportunist investments typically do not pay regular income and, in many situations, might not pay any income until the property is sold or refinanced. Land development would be considered an opportunistic real estate investment because of the many uncertainties in building a property. Opportunistic investments may also include high amounts of debt (loans) to successfully achieve the projected returns on investment.
As a way of comparison, we will now outline the most popular investment strategies along with some common terms for investing in public market (Wall Street) investments.
Common Wall Street Investment Terms
There are numerous types of classifications for individual stocks, Mutual Funds and Exchange Traded Funds (ETF) investments. Some examples are:
● Equities = Stock Shares
Stocks are a form of securities that give shareholders equity ownership in a company. Stocks have the potential for appreciation if the company becomes more valuable and income rises in the form of dividends.
● Debt = Bonds/Notes/Commercial Papers
Bonds are debt instruments that companies use to borrow capital. Bond holders typically invest in bonds as a way to achieve regular income. Bonds are considered less risky because the bondholders are prioritized for repayment before Equity shareholders in the event of default or bankruptcy.
● Growth Stocks/Growth Stock Funds
Growth Stocks are publicly traded companies that show potential to exceed their performance and generate returns above the overall market average in the future.
● Value Stocks/Value Stock Funds
Value Stocks are classified as companies that are currently trading below what they are really worth. Value Stocks should provide a superior return when the market perception catches up with the underlying actual value.
● Small-Cap
A Small-Cap, also known as a Small Capitalization stock, is generally a publicly traded company with a market capitalization (market value) under $1 to $2 Billion USD.
● Mid-Cap
Mid-Cap, also known as Mid-Capitalization, is used to describe public companies with a market capitalization between $2 and $10 Billion. Mid-Cap companies are categorized in the middle of Large-Cap and Small-Cap publicly traded companies.
● Large-Cap
Large-Cap, also called Large Capitalization or Big-Cap, is a term used to describe public companies with a market capitalization in excess of $10 Billion.
● Blue Chip Stocks
Blue Chip stocks are an investment in large, recognizable brand-name companies with an extended history of excellent financial performance. Investors typically pay more for Blue Chip stock shares and get a lower return because of superior brand value and a history of being market leaders in their industry sector.
● Index Funds
Index funds are portfolios of stocks or bonds that are curated to match the composition, weighting and performance of a financial market index, such as the S&P 500 (Standard & Poors 500) for Large-Cap companies and the Russell 2000 for Small-Cap stocks.
● ETFs
An Exchange Traded Fund (ETF) is a type of security listed on a stock exchange that is pegged to a fin, sector, commodity or other asset but can be purchased or sold on a stock exchange the same way that a regular stock can. An ETF can be structured to track anything, from the price of an individual commodity to a large and diverse collection of securities. ETFs can even be structured to track specific investment strategies.
● Income Stocks/Income Funds
Income Stocks are shares of a publicly traded company that consistently and reliably pays dividends to shareholders. Income Funds, also known as Fixed Income Funds, are mutual funds that primarily invest in debt securities (bonds, notes, commercial paper) to provide consistent, regular interest payment income to investors. Income Stocks and Income Funds provide investors with passive income (cash flow). Dividend income from stocks and mutual funds is taxed as ordinary income.
● Cyclical Stocks and Funds
Cyclical Stocks are shares of companies that track with the general economic trends (Macroeconomic Cyclicals), including expansion (growth), peak (overheating), recession (contraction) and then recovery (start of new expansion period)—or, in Austrian Economic terms, a malinvestment (Boom) period followed by a Bust period. Cyclical stocks tend to be companies that sell discretionary (nice-to-have, as opposed to must-have) items and services, such as a new car, the latest dress, luxury goods or vacation travel. Gold mining stocks also tend to rise during recessions because investors are looking for safety and stability.
● Non-Cyclical Stocks and Funds
Non-Cyclical stocks, also known as Defense Stocks, are shares of companies that have consistent demand for their products and services that do not depend on how well the general economy is doing and are not much affected by economic cycles. For example, people need to have heat, electricity and water, so demand for utilities is fairly consistent. The new term coined for these types of non-cyclical companies in 2020 is “Essential Businesses.”
● REIT/Real Estate Investment Trust
REITs, or Real Estate Investment Trusts, are publicly traded companies that own commercial real estate. These companies, or “trusts,” have been granted special tax treatment so that they are required to distribute a minimum of 90% of their taxable income to shareholders. The drawback of REITs is that the dividends are taxed as ordinary income, which gets added on top of your other income. They are also highly correlated with the overall stock market, unlike private commercial real estate investments.
Comparing Real Estate To Wall Street
Opportunistic Real Estate Investments can be compared to investing in a startup company or a Venture Capital Fund. These investments have a high degree of risk and seldom pay distributions or regular cash flow until the property is developed/redeveloped and refinanced or sold.
Commercial property investments located in Tertiary markets can be compared with Small-Cap stock investments. The yield on your investment should be higher than a Gateway City or Major Metropolitan area, similar to Large-Cap or Blue Chip stocks. Tertiary markets have less investor volume, which limits your options to sell or reposition the property.
Value-Add Real Estate Investments rely on the ability of an individual or sponsor to execute an improvement program on a property to increase its income, translating into higher value. Income can be increased by reducing expenses along with increasing rents and other fees associated with the property. Reducing expenses will only increase income so much; there comes a point of trade-off between reducing expenses and interfering with the operations of the property that are needed to maintain or increase rents. Another way to add income and reduce expenses at the same time is getting the tenants to pay more of the operating expenses. This is why Triple Net properties are some of the best real estate investments available to passive income investors. With apartment buildings, this means getting each apartment separately metered for gas and electric or implementing a RUBS program.
Related Article: Beginner’s Guide to Triple Net Lease (NNN) Investing
Properties in need of an active management program to increase value or are distressed can benefit from a turnaround program that is comparable to a Small-Cap Growth Stock. A property is considered Small Cap because of the location of the market, project size and/or its distressed nature; the upside for appreciation of this kind of asset would equate to a Small Cap growth stock. The appreciation potential with risk is what would make this a growth stock. If this was a more stabilized property with more predictable income, we would classify this as a Small Cap value stock.
Private Real Estate Versus Publicly Traded Companies
Core Property Real Estate Investments are similar to Blue Chip Large-Cap companies, or quality credit bonds. These properties are in the best locations with high-quality, excellent credit tenants and typically have long leases. One of the most secure core property investments you will find is a ground lease beneath a large office building or shopping center in a Gateway city. These investments pay a lower return and you pay a high price for that income, but it is some of the most secure income you can possibly get in the world. If the tenants stop paying rent, the ground lease owner will end up owning what could possibly be a $1 Billion office building in Manhattan, London or Chicago.
Core Property investments are better than stocks or bonds because you own a tangible, scarce property that typically pays better income compared with the public market alternatives.
Related Article: Investment Grade Credit Ratings
Core Plus Real Estate Investments are comparable to Large-Cap or Mid-Cap stocks because they are very secure and stable with room for upside growth. Since they are stable, core properties will pay nice cash flow similar to larger companies that are more capable of paying dividend income. Buying a well-located Single-Tenant Triple-Net lease property in a good location with a few years left on the lease is a great example of a Core Plus investment. Since it has a good location, the tenant will negotiate a favorable rent increase to maintain the property and continue the benefits of the brand equity built up in the trade area.
Core Plus real estate investments can also be compared to convertible bonds because the investors receive income over the life of the investment, plus upside (appreciation) later on in the investment. Core Plus real estate investments usually pay better returns than public market alternatives. Additionally, with private real estate, the tax treatment for income reduces tax liabilities, so investors retain more of their earnings.
Both the Equity Multiple and the Internal Rate of Return include the value, or sale price, of your investment at the end of your hold period. However, one of the core benefits of investing in Real Estate is the annual, or monthly, cash flow received from the investment.
Stock Market Mutual Funds Compared To Private Real Estate
A Core Plus Real Estate Fund, like Liberty Real Estate Fund (Liberty) , can be compared to a Blue Chip, Mid-Cap or Large-Cap Fund that invests in properties occupied (leased) to Non-Cyclical tenants. Liberty invests in properties leased to well-capitalized (Blue Chip) companies in Primary and Secondary markets.
The properties are Non-Cyclical because there are not large demand swings in the industry sectors and companies that are our tenants. Owning properties leased to grocery stores, auto service, medical, pharmaceutical, daily needs & telecommunications tenants are seen as Defensive investments. This results in more stability (less volatility) and consistent, predictable income payments (cash flow). Blue Chip corporations, such as AT&T, Amazon, CVS, Exxon, 7-Eleven, Shell and Verizon, are paying the rent and have guaranteed the leases.
Another comparison for stock investors are the Stock Market Sectors: Communication Services, Consumer Staples, Energy, Financial, Healthcare, Real Estate, Technology and Utilities. The long-term leases from these tenants are contractual obligations of their respective corporations. In fact, rent is prioritized higher than bank debt, bond obligations and equity (stockholders). Plus, the buildings and properties are hard assets with real-world scarcity.
Price/Earnings Ratio Compared To Capitalization Rates
One of the most quoted metrics for stock investing is the Price/Earnings Ratio, also abbreviated as the P/E Ratio. A P/E Ratio is calculated by dividing the market price of a stock share by the earnings per share.
In real estate we use a Capitalization Ratio (the Cap Rate), which is simply the inverse of the P/E ratio. The Cap Rate is calculated using the first year’s operating earnings divided by the price (market value) of the property.
You can compare a stock’s P/E to a piece of real estate: Step 1) Multiply the Cap Rate by 100; and step 2) Divide 100 by the result of Step 1.
For example, let’s suppose the net income (NOI) for a commercial real estate investment property is $65,000 per year and the market value of that property is $1,000,000. The cap rate in this example would be 6.5%.
To convert a Cap Rate to a P/E ratio: 1) Multiple 6.5% x 100 = 6.5; then 2) Divide 100 / 6.5 = 15.38, which is your P/E comparison. So, you can use this quick tool to measure between stocks and cap rates. This isn’t the silver bullet, but it can help you run a quick comparative analysis to compare an income-producing commercial property to a publicly traded company.
Cashflow Or Dividends, It All Equals Income
Stocks pay dividends to shareholders and real estate investments pay cash flow in the form of income distributions to investors. Not all real estate investments and stocks pay regular income; some rely on appreciation to generate investment returns.
An example of a non-cash flowing real estate investment would be a ground-up development project. With new developments, you need to spend money on plans, then it could take months or years for government approvals. Next, the project must be built and then leased. This entire process could take 2 to 5 years with no income coming in and lots of expenses going out. This is why real estate development is considered an Opportunistic Real Estate Investment strategy. It is extremely risky and should reward investors with very high returns for the risk/reward ratio.
A few examples from the Stock Market are high-tech growth stocks: Alphabet (Google’s parent company) or Amazon are both examples of stocks that do not pay dividends and rely on growth and appreciation to reward investors.
Individual stocks and mutual funds usually pay dividends in the 2% to 4% range quarterly. Some stocks pay more, but the average is around 2.5% to 3% dividend returns.
In commercial real estate, especially when accounting for leverage (debt), we usually see a range of 4% to 9% annualized cash flow (investor distribution payments for private real estate). The average annual cash-on-cash income payments range from 5% to 7.5%.
You can see why once people discover private real estate investing they are sold on the opportunity for obtaining passive income that beats the stock market without the volatility. Then they discover what we cover next, that commercial real estate income is more tax-efficient so investors can retain more of their money instead of being grabbed for taxes.
Taxation of Dividends & Private Real Estate Cashflow
“Our new Constitution is now established, everything seems to promise it will be durable; but, in this world, nothing is certain except death and taxes.” – Benjamin Franklin
Heeding the wisdom of the wise Ben Franklin, investors should consider the effects of taxes on their investments. Almost all projected investment return numbers are quoted before taxes because each individual investor’s tax situation is different.
One of the most overlooked aspects of private real estate investing is that it is a much more tax-efficient way to invest your money.
Stock and Mutual Fund investors will receive a 1099-DIV tax form for dividends held in brokerage accounts. What this means is that for ordinary dividends you will have to pay taxes at your highest tax rate. This income gets added on top of your ordinary income for taxation purposes. *Disclaimer: Liberty Equity Management LLC does not provide legal or tax advice.
When investing in a private real estate syndication or Security Token, investors will receive a K-1 tax statement for their tax returns. K-1 statements are a bit more complex but allow the investor to benefit more from deductions. In real estate, these could be deductions for expenses and interest payments but may also include deductions for lowering your income with depreciation and other benefits given only to real estate investments.
Related Article: How to Utilize Commercial Real Estate for Taxes
Commercial real estate investments, as compared to stocks, mutual funds, REITs and bonds, are much better at providing passive income and reducing your tax liability. Additionally, for investors with other passive income via K-1 statements, you can use real estate deductions to offset your other passive income. If high tax levels are biting into your ability to earn income then you should investigate the benefits provided by investing in commercial real estate.
Liquidity Versus Volatility
One of the benefits of public markets, especially in the United States but also across the globe, is the liquidity they allow for investors to go in and out of stock and bond investments. However, is this liquidity all that it appears to be? Are there trade-offs and, in many cases, could they be an illusion?
One of the drawbacks to liquidity is that it usually brings more volatility. So, right now the S&P 500 index is hitting all time highs. Is that because of the underlying fundamentals of the US economy or the corporations that comprise the index? Or could it be inflation being injected into the market by massive Federal Reserve (FED) money printing? What happens when the FED stops? So while Wall Street may rocket ahead one year, it can also drop massively in one day.
Private real estate investments get classified as an “Alternative Investment” because they have traditionally been illiquid. With the advent of blockchain technology and Security Tokens approved in the United States by the SEC and other regulators around world, private real estate will become much more tradable and accessible.
Conclusion
We feel real estate has a place in everyone’s individual portfolio. You should have a generous allocation of the world’s most proven asset class. Some highlights of real estate are:
- S&P lifetime is 8% taxed at regular income on dividends
- Real estate is 7–9% with tax-efficient passive income
- Real estate is a cash-on-cash, money-in-your-pocket return (not solely appreciation)
- Real estate benefits from appreciation
- Real estate is better than stocks in times of inflation
- Commercial real estate is less volatile than stocks or cryptocurrency
- Now, with Security Tokens, Private Real Estate is accessible and tradable
Liberty Real Estate Fund is like investing in a mutual fund that owns high-quality corporate real estate. If you’d like to learn more about stable and tradable private real estate investing with Liberty Real Estate Fund, we are here to help. In fact, we are helping investors achieve financial freedom every day. Schedule a call or subscribe to our mailing list for more free educational content.
Happy investing.
Liberty Real Estate Fund Is Bonds Wrapped In Real Estate
Liberty Real Estate Fund LLC (Liberty) is The World’s First Single-Tenant Net-Lease Security Token Fund™, joining blockchain technology with 30+ years of institutional real estate investment experience to deliver stable, diversified, tax-efficient returns combined with liquidity, security and transparency.
Liberty is a real estate investment fund that acquires Single-Tenant Net-Leased (NNN) retail, auto service and medical properties in the United States. It is designed for investors to achieve: Geographic Diversification, Industry Diversification, Tenant Credit Strength, and is built with hard assets that have intrinsic value. Our portfolio of Net Lease properties is constructed with brand-name Essential Businesses operating in high-growth markets throughout the United States.
*Note: Liberty Fund/Concordia Equity Partners (Concordia) have made every attempt to ensure the accuracy and reliability of the information provided. Concordia cannot not accept any responsibility or liability for the accuracy, content, completeness, legality, or reliability of the information contained herein. The information herein considered legally-binding legal advice, tax guidance, or financial counsel.
Jason Ricks, CCIM is a Concordia Equity Partners principal whose primary focus is on acquisitions, leasing, and development. Jason is a native Texan, professional real estate investor and certified commercial investment member (CCIM). Jason’s background in retail leasing and asset management make him an invaluable member of Concordia’s team for developing strategies to unlock the value of a property. Jason also has extensive experience and familiarity with south and southwestern US markets. Jason’s most recent experience is with AMLI Residential as the Vice President for Retail Asset Management where he established and has led the mixed-used Retail Asset Management team working on premier properties worth hundreds of millions across the country. Prior to that, he served as an Asset Manager for BH Properties where he oversaw a 2.2 million square foot value-add retail portfolio throughout Texas and Oklahoma. Jason broke into the commercial real estate business as a Shopping Center broker for Tarantino Properties. He received his BS in Business Management from Oklahoma State University, where he was a Team Captain for the Oklahoma State Football Team (The Cowboys). Jason is an active member of the International Shopping Counsel of Centers (ICSC). Most recently, he was featured in the #1 Amazon bestselling book: DESIRE, DISCIPLINE & DETERMINATION (2019).
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DISCLOSURES, LEGAL AND TAX COUNSEL: Liberty Real Estate Fund and Concordia Equity Partners LLC. (collectively “LibertyFund”) and their affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction or undertaking. LibertyFund highly encourages individuals and investors to seek the counsel of a qualified attorney as well as seek the counsel of a tax professional or Certified Public Accountant (CPA) to determine if there are any potential tax liabilities or consequences as the result of anything contained herein. NO GUARANTEE: All users of this website should understand there are NO GUARANTEES of any success, outcome or profitability of any transaction or undertaking, expressed or implied by LibertyFund or any of its members, shareholders, officers or affiliates and will NOT be liable for any financial or other losses or damages incurred as a result of any undertaking. Go HERE to view complete DISCLOSURES.
