A Peek Inside My 7 Figure Real Estate Portfolio: 2018 Q1/Q2 Update
Updated: Apr 2
A profitable exit on a risky investment (finally!), a dump of (awful) Lending Club loans, and a new long-term hold to avoid taxes indefinitely (with "defer, defer and die").
This is an older update of the continuing series on my portfolio. The latest Q4 2019 update of this article is available here. (Usual disclaimer: I'm just an investor and not a registered financial advisor or attorney. Consult your own financial professional before making any financial decisions). This is a continuing series, where I lift the veil on my real estate portfolio (and the little bit I have left in alternative finance). First I'll give a quick summary of my risk profile and preferences. Then I'll talk about what's changed since 2017, and finally the details of each individual investment.
First, I rely on my investments for income, so I'm an extremely conservative investor. Preservation of capital is the most important for me, so what I do may not be appropriate for someone looking to be more aggressive or speculative. At this stage of the cycle, I'm thinking defensively about the upcoming downturn, and all investments have to leave me feeling okay after I pound them with recession-level stress tests. (Here's a Guide to My Conservative Due-Diligence Process talking about how I do all of the above).
Second, I like investments that are quick and slow. Quick, meaning hard money loan funds with short lockups that are one year or less. And slow meaning long-term equity investments (7+ years) that I can ride well past the next downturn. And I hold cash to hopefully take advantage of distressed situations when the downturn comes. I avoid the 2 to 5 year value-added, high leverage investments that are 95% of the offerings on crowd funding platforms. (see "My Real Estate Investment Strategy: Part 1").
My wife and I have seven figures invested in "alternative finance". This is almost all in real estate but a little in peer to peer (and being reduced). We had an 9.3% annualized return this half-year, which was better than the 8.1% annualized return of 2017 Q3/Q4. This was from the out-performance of the residential rental homes (9.2% versus 7%), and also the exiting of an opportunistic real estate development syndication (which yielded 160%, but was the only a very small part of the portfolio). I was able to liquidate quite a bit of my Lending Club portfolio on the secondary market (they had underperformed significantly), and moved those funds into a long-term hold with MG Properties. How it breaks down Here's how it was invested:
) Residential rental properties (46% of portfolio). Return: 9.2% (income only)
This is the biggest part of my real estate portfolio, and my "bread and butter". These were purchased with no debt, which I believe hardens them well against a severe downturn. Residential renters tend to be more stable and longer term than multifamily/apartment renters. I target working class neighborhoods with affordable rents (to maximize the renter pool, and align myself with the long-term trend of a growing lack of affordable housing). I also pick neighborhoods that are low in crime and properties that meet my yield and other minimums. (Finding great properties like that by hand, is actually really time-consuming. So I wrote software that goes in and does the analysis on thousands of properties at a time.I might write about it in a future article if people ask about it.) The recent returns have been better than normal, because repairs have been less than projected. I don't expect this to last, and they should revert back to the averages. But it's nice when it happens. The 9.2% return only includes what it made in income. And as an extra bonus, due to a hot property market, the price has appreciated over 20%. (I don't expect that to happen every year, so I didn't include this in my returns here.). 2) Short-term 1st position debt (36% of portfolio): Return: 9.5%. This is my 2nd biggest strategy. First position debt is the safest part of the capital stack, and short-term allows me to possibly liquidate quickly if conditions change. (Here's a three-part article on how I do due diligence on hard money loans.) About 60% is in BroadMark Capital Fund 1 and 2 (averaged about 11% over the last year). It has a 65% loan-to-value maximum, a good uncured default rate (less than 2%), no leverage, and only loans in non-judicial states. It does construction loans, which have added execution risk, so I balance that out with a second fund that doesn't do any construction. About 40% is in a local acquisition/rehab hard money loan funds called Arixa Capital Secured Income Fund. (It averaged about 8% over the last year). They target 60 to 65% loan-to-value maximum, a very good < 1% uncured default rate, non-judicial states and no leverage. Doing this meant accepting a lower overall yield than Broadmark, but I feel the diversification protection is worth it. (If you'd like more details on all the things I look for in a hard money loan investment, check out this three-part article series.) 3) Long-term NNN leases (10% of portfolio): Return: 6% income, 5.2% price appreciation = 11.2% total. The next largest part of my portfolio is invested in a triple net lease (NNN) fund from Broadstone Triple Net Lease Fund. A triple net lease is a lease in which the tenant is responsible for almost everything (maintenance, taxes, etc.) and the landlord's responsibilities are very minimal. The leases lock the tenant in for 15 to 20 years with built-in escalations, so it makes for a much more predictable income stream than a typical real estate investment with much shorter leases. The Broadstone fund specializes in recession resistant and Amazon resistant industries like medical, fast casual restaurants, etc. And it has extremely low leverage at 40% LTV, is a very hard to find core plus investment and generates healthy income and price appreciation. This is a recent acquisition for me, but it returned a little over 6% in income last year, and 11.2% total after also including price appreciation. 4) MG properties (5% of portfolio): Return: 5% income = 5% total. I took money that was formerly in peer to peer, and moved it to this sponsor. MG Properties is one of those very rare sponsors that appears to have gone multiple cycles without losing any investor money. They do multi family value-added, using moderate leverage, and high skin in the game (10 to 33%). They also are one of the few to implement a full-featured TIC 2.0 1031 exchange pipeline, which allows taxpayers to defer all taxes indefinitely. This is a long-term 7 to 10 year hold, and on exit I intend to 1031 exchange into a follow-up investment with MG (to defer capital gains). Ideally, I would like to hold a position with them forever, and when my wife and I pass away, pass it on to our son (who would inherit it on a stepped-up basis, and also not pay any capital gains). See this article on "How to Invest in Passive Real Estate Without Paying a Penny of Tax (Legally): Part 2: "Defer, Defer and Die"". 4) Peer to peer (2.5% of portfolio). Return:4.8%. I made a lot of progress liquidating my least favorite part of my portfolio. I used to be a huge cheerleader for both Lending Club and Funding Circle. But over the years, I've grown increasingly unhappy with the quality of the underwriting and the annoyance of the "tax inefficiencies". My returns have dropped from the high 9% in early years, to under 5% now, and I'm concerned with what will happen if we have a downturn. So as I described in this article, I've been liquidating this portion. 5) Other (2.75% of Portfolio) Return: 160%. 2.75% of my portfolio was in a deal for development of raw land I entered several years ago when I wasn't as concerned about a recession. It was supposed to run only one year but took several years to exit. It made up for the 0% return by returning 160% this year. However, I'm not interested in reentering anything like this at this stage of the real estate cycle, because I feel it's too risky. If a downturn hits, this type of investment can be stuck in limbo for a long time. After the recovery following the next downturn, I'll consider reallocating to these types of investments. Going forward: I intend to invest in a couple more MG Properties deals this year, if I like the way they look. I'm going to continue to liquidate my peer to peer holdings and considering diversifying into other short-term debt offerings if I like how they're underwritten. I'd like to buy a multifamily property directly (with no debt) in Tampa, but it's extremely competitive, so I'll see how that goes. I'll continue to look for long-term holds at attractive prices riding long-term trends. And I'm also staying open to new alternate asset classes. Cash is King I also have a fair amount of cash waiting for new opportunities that may arise after we go through the next downturn.