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Allocation % in Real Estate Crowdfunding Investments

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  • Allocation % in Real Estate Crowdfunding Investments

    I am 38 yo and completely a newbie in real estate investing. I definitely want to go the passive route and figured crowdfunding is the best place to start. Does anyone have any thoughts on % allocation in terms of type of investment? Specifically % breakdown on equity vs. syndicated debt vs. preferred equity. Or is there a better way on finding the right balance of risk and return in real estate? I'm thinking of allocating 5% of my overall portfolio towards real estate crowdfunding. This speculative money is considered one of my financial goals for the year.

  • #2
    We're doing this plus also doing startup investing which is even more risky (i.e.: a roll of the dice).

    Some things to keep in mind. The different RE deals get different tax treatment. Debt generates 1099 interest income whereas Equity generates K-1s which you can use passive depreciation to offset your gains (although when the property is sold and you get your principal plus profit there is a recapture).

    For me the debt is a bit of an extension of LendingClub and Prosper where at the end of the day you own part of an entity which is a major debt holder in the property in theory if things go really south then at least you have a property whereas in LendingClub and Propser there is no real physical collateral. In general the returns in CFRE are higher then what I'm getting at Prosper and LendingClub lately -- early on could easily clear double digits these days it's a bit hard.

    For us, we have dual high incomes and live in a high tax state so I stopped going after investments that generate 1099-int as at the end of the day I was giving nearly half away with taxes since all these earnings are taxed at the marginal rate (your highest bracket since it's all on top).

    I'm only looking at equity but these deals require more HW then debt. For debt you could literally just throw darts to pick them and be okay, the minimums are low so you can spread your risk (similar to LC or Propser strategy). With equity deals the minimums are much higher typically at least $25k and as high as $50k. At those price points you really want to be doing your HW and understand what you're investing in and do your own due dillegence on the property (don't blindly trust the platform to do the vetting -- it's YOUR money).

    Your stategy will be more real estate focus as in you want to diversify across different commercial classes (multi-residences, retail, warehousing, storage), across different geographies (hopefully ones you know at least something about), and class ratings.

    Also for equity your taxes are more complicated with filling k-1s and if you invest in a state that taxes non-resident investors then expect to file a state tax (for that reason I look for states with favorable tax treatment for outside investors as well as deals in state since I need to file in state anyways).

    You can start with debt at the lower price points to get a feel for the platforms and also to see the deal flow coming in. Many of the platforms have a cooling off period anyways so this is a good time to research deals and start to understand the lingo and terms.

    You also want to read up on commercial real estate so you understand all the documents and terms. You really want to understand what you're investing in and how it all works. Checkout online videos on commercial real estate and also online forums like BiggerPockets.

    For me personally for an equity deal, I look for something that will give me 8%+ CoC plus an IRR in the mid to high teens. I like some CoC as makes me feel better to have some cash flow coming in at a regular basis . Also like to keep the terms at 5Y or lower. Understand that a high CoC will inflate the IRR to be really high which can be misleading so one thing to look for or ask from the sponsor is the multiple. This will tell you what your final cash will be at the end of it. Like at a 1x multiple, I know that at the end of 5Y my $25k will be $50k (increased by 1x my original amount).

    Preferred equity is treated like equity for tax purposes and you will get a k-1. The big difference is in the terms. For preferred equity they are structured to give you a higher preferred rate but they typically have a ceiling on how much you can earn. In equity you share the upside (no cap) but you also share more risk. So it's the classic risk and reward equation.

    This being said the terms are really secondary to the actual property and the sponsor. Can the sponsor really deliver on their promises -- most give overly rosy projections that fall short of reality. And of course the details of the property and does it sound like you will get your money back in the timeframe.

    The best advice is start small especially if real estate world is new. Maybe do a couple debt deals to get use to the platform. Start researching some equity deals that look interesting. Once you see some returns coming back on your debt deals and feel comfortable with your knowledge you can do an equity deal (multi-family is what most people start as it's a natural extension to what they know, later you can diversify into retail, hotel, office/medical, storage, etc...).

    Best of luck!!!

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    • #3
      The Penguin makes some excellent points in his thorough blog post reply regarding taxation. Returns of 10% to 12% sound amazing until you realize you might only keep 50% to 60% of that. Now you've got 6% and your CPA (or you if you DIY taxes) are filing state income taxes in multiple states, and those costs / time further erode your returns.

      I've decided to table these types of investments for now, and revisit when I'm no longer making the big bucks.

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      • #4
        Excellent points, and I am waiting on becoming accredited to enter these. However people should realize that P2P / Debt investing is the VERY definition of cash flow investing. Put money, get money.

        Also realize that while the interest earned on debt RE deals may be "high", it is NOT amortized. LC / Prospoer is. That is a BIG difference. Monthly principal+interest is just better (the whole NPV / money better now).

         

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        • #5
          I have never like the P2P platforms. They just dont make any sense to me given my marginal tax rate/state. If you view it from that angle and adjust your return down to post tax numbers then the risk:reward is just awful, and there are too many other great choices with better ratios to choose from.

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          • #6




            I have never like the P2P platforms. They just dont make any sense to me given my marginal tax rate/state. If you view it from that angle and adjust your return down to post tax numbers then the risk:reward is just awful, and there are too many other great choices with better ratios to choose from.
            Click to expand...


            Zaphod, while I agree with this, there is a threshold atleast for me. For example I live in state with no income tax. Even with marginal tax, if I am getting a yield of 12% annual, then post tax I am hitting 9%. That cash flow alone is fantastic.

            I understand that those returns may not be accessible but I have been doing P2P a while and have built a pretty strong algorithm/filter for my needs. 5 years and getting strong returns still.

            Not for everyone, but I haven't found a headache free cash flow investing at my stage anywhere...yet.

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            • #7







              I have never like the P2P platforms. They just dont make any sense to me given my marginal tax rate/state. If you view it from that angle and adjust your return down to post tax numbers then the risk:reward is just awful, and there are too many other great choices with better ratios to choose from.
              Click to expand…


              Zaphod, while I agree with this, there is a threshold atleast for me. For example I live in state with no income tax. Even with marginal tax, if I am getting a yield of 12% annual, then post tax I am hitting 9%. That cash flow alone is fantastic.

              I understand that those returns may not be accessible but I have been doing P2P a while and have built a pretty strong algorithm/filter for my needs. 5 years and getting strong returns still.

              Not for everyone, but I haven’t found a headache free cash flow investing at my stage anywhere…yet.
              Click to expand...


              Sure, but you wont be a resident forever and those 12 will be 6, which given the time, effort, default risk, and platform risk is simply not worth while. 9 on the other hand is pretty great.

              Different scenarios have different setups. I currently prefer a similar idea but with a much more creditworthy counter party, the state and other municipalities. Dividends are tax free, process is zero hassle, and fits current tax paradigm nicely.

               

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              • #8










                I have never like the P2P platforms. They just dont make any sense to me given my marginal tax rate/state. If you view it from that angle and adjust your return down to post tax numbers then the risk:reward is just awful, and there are too many other great choices with better ratios to choose from.
                Click to expand…


                Zaphod, while I agree with this, there is a threshold atleast for me. For example I live in state with no income tax. Even with marginal tax, if I am getting a yield of 12% annual, then post tax I am hitting 9%. That cash flow alone is fantastic.

                I understand that those returns may not be accessible but I have been doing P2P a while and have built a pretty strong algorithm/filter for my needs. 5 years and getting strong returns still.

                Not for everyone, but I haven’t found a headache free cash flow investing at my stage anywhere…yet.
                Click to expand…


                Sure, but you wont be a resident forever and those 12 will be 6, which given the time, effort, default risk, and platform risk is simply not worth while. 9 on the other hand is pretty great.

                Different scenarios have different setups. I currently prefer a similar idea but with a much more creditworthy counter party, the state and other municipalities. Dividends are tax free, process is zero hassle, and fits current tax paradigm nicely.

                 
                Click to expand...


                I am assuming you are talking about muni bond? Whats the yield on it?

                Even with attending salary I bet I can get net 8%+ P2P - may not be LC platform but similar concept.

                I'll document all this soon.

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                • #9
                  5-6%, making tax equivalent yield of 8.78-10.53%. Its simple and no increased work than normal taxable investing.

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                  • #10
                    Which bond? (specific name?)

                     

                    That is pretty good. Do you have it on auto reinvest? Also when is the payout? Monthly?

                    If you are getting that yield monthly then sheesh that is all one may need. If it is l6 months/year payout then even with post tax, P2P amortized payments will beat it if looking at cash flow/IRR calculation.

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                    • #11
                      They are closed end funds and distribute monthly, yields are annualized. I do reinvest the proceeds back into them at this time.

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                      • #12




                        They are closed end funds and distribute monthly, yields are annualized. I do reinvest the proceeds back into them at this time.
                        Click to expand...


                        Pretty good, but bond funds have interest rate risk and if leveraged (probably given the yield you are mentioning) it multiplies that risk. No free lunch.

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                        • #13







                          They are closed end funds and distribute monthly, yields are annualized. I do reinvest the proceeds back into them at this time.
                          Click to expand…


                          Pretty good, but bond funds have interest rate risk and if leveraged (probably given the yield you are mentioning) it multiplies that risk. No free lunch.
                          Click to expand...


                          Yes, of course trade offs in everything. Minus the leverage (which you do not have to have, slightly lower yields), P2P also runs interest rate risk as all bonds do. Obviously how sensitive is dependent on leverage and effective duration.

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                          • #14
                            Except P2P loans are very short term Zaphod. Also amortized which reduces risk as their duration is half their maturity (3 year loan - get full money back 1.5 yrs). Bonds are much much longer term.

                            Anyways comes with different risks. I believe in my models and feel more comfortable with P2P generating more than bonds at this point.

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                            • #15
                              Everything is customizable to your preferences, and Im not trying to talk you out of or into anything of course. There are obviously a full range of maturities short and long for either category with bonds offering longer if desired than p2p. I dont think people are properly discounting their returns for their risks and involvement in these things. Look at all the issues with LC, there is a very real platform risk that is in no way comparable to a GO bond risk which is near zero.

                              People have been having more and more trouble with P2P lately, and it will be interesting to see how it holds up and matures. Maybe it will be something worth while, but right now its too much effort for a tax headache of returns with unreasonably high risk for me. Its fine that you dont mind and love it, and even better are doing great.

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