Frequently Asked Questions
Why should I passively invest as opposed to just buying a property myself?
1). When it comes to commercial real estate investing it takes a lot of time and expertise to achieve the goals of a business plan. By investing passively, you can achieve the financial benefits of real estate investing without the time commitment and specializations needed for success.
2). The passive investing approach allows investors to experience diversification across multiple geographies, tenant types, product types, management styles, operators, and many more aspects of the real estate sector. Diversification is a critical component to building a balanced portfolio. Even if you are an investor with experience as a successful owner/operator, it’s still very likely that you have either over-allocated to a particular asset class or don’t have significant market advantage in an asset class because you aren’t exclusively focused on it. An excellent way to achieve true diversification in real estate is to have a portion of your portfolio invested in passive investments that are managed by leading operators focused on a particular asset class.
3). As a limited partner (passive investor), you are not exposed to credit and liability risk, this grants passive investors access to low-cost debt financing through the sponsor’s track record without incurring the risk associated with personally guaranteeing a loan (Note – some loans are non-recourse but lenders still can circumvent these clauses and pursue the loan guarantor, especially if they believe the GP acted in bad faith).
What happens if I invest and need the money during the holding period?
Real estate is an illiquid investment until the refi or sale. Once an investment has been made into the fund, it's usually in for the duration of the hold period of 3-7 years. Money will be returned as assets are refinanced or sold. Investors should make sure they have the liquidity and capability to invest capital for a minimum of 3-7 years, during this time cash flow and a portion of the original investment may be distributed. Consult your financial advisor to ensure investing in real estate investments is appropriate for your situation.
What are the tax implications of investing in commercial real estate through a fund?
There’s the benefit of depreciation, which is an income tax deduction. While real estate values generally appreciate, the physical components of the property generally lose value during the hold because of wear and tear. The appliances, roof, and electrical all “depreciate” and will eventually need to be replaced. The Internal Revenue Service (IRS) understands this and accounts for this by offering an income deduction for owning depreciating assets.
Here’s how it works: Let’s say you buy a commercial property for $10,000,000. The tax assessor’s estimate of the land value is $3,000,000 and the building value estimate is $7,000,000. The land value won’t count towards the depreciation calculation, but the building value will be depreciated over 39 years. This would imply that each year, there would be a $179,487 “loss” for tax purposes ($7,000,000/39 = $179,487). Please note that this calculation does not include any benefits of a cost segregation study, which can sometimes increase the annual property write off that property owners can receive.
You can learn more about the tax benefits of real estate investing in our article: “Exploring the Tax Benefits of Real Estate Investing”. In most real estate deals, depreciation and other tax write-offs allow all cash flow during the holding period to be received tax deferred. This means that regardless of the amount of dollars received from cash flow during the hold period, the annual taxable gain will usually be net negative, or very close to it. Of course, if the property is later sold at a gain, there will be a tax based on long-term capital gains rates, as well as a tax for Depreciation Recapture for any gains of sales made from the depreciated asset. Sometimes, investors have the misconception that if they invest in a multiple property fund, they won’t get the tax benefits of owning property. This is NOT the case with our funds, which are structured in such a way that investors receive the benefits of depreciation, but from multiple properties instead of just one.
At the end of each year, investors will receive a K-1, which is a tax document for investments in partnerships. The K-1 shows the investor their annual loss or gain and will be presented to their CPA to file their taxes accurately.
Please be advised we are not CPA’s or Financial Advisors. Please consult your own financial and legal professionals prior to making an investment.
What happens if I invest through a self-directed retirement account (SDIRA)?
Since the 1970s, U.S. Citizens have had the ability to “self-direct” their retirement accounts. This allows the account owner full control over their account and gives them freedom to invest in a diverse group of alternative asset classes, such as real estate, to pay for their retirement without being forced into stocks and bonds. The legal requirements surrounding self-directed retirement accounts are incredibly complex and strict, thus every SDIRA is required to be overseen by a custodian that’s subject to government audits. Learn more about SDIRA's in our article "Unleashing Your Investment Potential - The Power of Self-Directed Retirement Accounts".
In general, having a SDIRA is extremely favorable for investors because the vehicle allows for tax-advantaged real estate investments, therefore drastically increasing the rate at which the account can grow. However, there are a few caveats to investing in most real estate deals within an SDIRA, the most important of which is the Unrelated Business Income Tax (UBIT), more specifically, the Unrelated Debt Financed Income (UDFI) tax. Regardless of the tax-advantaged status of the SDIRA, there’s a tax on the percentage of the opportunity’s gains that are contributed to debt financing. Since real estate is typically purchased with debt, it’s common that UBIT will play a role in most SDIRA investments.
For example, if your SDIRA invests in a property that’s acquired with 70% debt financing, 70% of the gains will be taxed, regardless of the tax-advantaged status of the SDIRA. However, there’s still the benefit of depreciation. Typically, the depreciation expense is not allowed when investing through SDIRAs, but depreciation and other operating expense deductions are allowed to be received when using debt financing on a purchase. This is a way to counterbalance the issues related to UBIT. Usually this results in no taxable “income” during the hold period, with UBIT being due only when the property is sold, and the gains are realized.
With that said, a SDIRA is only required to file a tax return and pay UBIT if there’s more than $1,000 of Unrelated Business Taxable Income (UBTI) earned by the SDIRA across all of its investments, as the SDIRA is allowed a $1,000 specific deduction. The SDIRA’s UBTI is taxed at the trust income rates.
For example, let’s say you invested $50,000 via your SDIRA and received $50,000 of taxable gains (net of depreciation and expense deductions). If you used debt financing to finance 70% of your purchase, then 70% of the gains (above the $1,000 deduction) would be subject to UBIT. $50,000 * 70% = $35,000 (gains attributed to debt financing) - $1,000 (the $1,000 deduction) = $34,000 of income to be taxed at the trust income tax rates. The impact of the net IRR of investments after UBIT is NOT significant, generally about 1-2% decrease in Net IRR after UBIT is accounted for.
Please consult with your CPA and attorney before making investment decisions.
What are the major risks of investing in real estate offerings?
With any passive investment, the biggest risk is the lack of control in the operations, and therefore it’s critical to identify the right investment, the right operator, the right business plan, and the right onsite manager.
Here are a few steps we take when conducting due diligence on an operating partner, as well as the key tasks that we complete to verify the investment opportunity and business plan:
1). We only partner with Operators/Sponsors/Developers that have a proven track record of success within the specific real estate opportunity.
2). We require Operators/Sponsors/Developers to have a professional property management company in-place. This can be either a 3rd party property management company or an in-house property management company (the Operator/Sponsor/Developer is vertically integrated and they own their own property management company). We then require that the property management company be experienced in the asset type, must be local to the market, must already have properties in the area that they manage, and must be experienced with various financing strategies.
3). Our team conducts a detailed review of the property manager’s systems, processes, reporting, and software for each investment.
4). We perform our own thorough market research, underwriting & analysis, and due diligence for each investment opportunity to verify and proof the business plan of the Operator/Sponsor/Developer.
5). We conduct onsite property tours & visits.
6). We present & gain feedback on potential investment opportunities from our internal team of advisors and partners in property management, financing, property taxes, insurance, and renovation/construction to verify operational assumptions and business plans.
How is the fund manager aligned with the investors' incentives?
We offer our investors an 8% preferred return, which is paid to our investors before any manager compensation kicks in, and the IRR returns are net of fees. We want to ensure that the investment is performing strong enough to meet the minimum return requirements, while allowing us to run the business operations. Our incentives are aligned with our performance and our duties – in other words, we must perform to earn.
What does the fund management fee cover?
The fund management fee is 1.75% and is used to operate the fund through fund administration, audits, legal, technology, and reporting.