[This is a guest post from emergency physician Akhil Saklecha, MD, who I met over lunch at the ACEP Scientific Assembly last fall. Akhil is also a partner in a venture capital firm, Artiman Ventures and on the board of HomeUnion. This post is about his experience investing in real estate. I have no financial relationship with Akhil, Artiman, or Homeunion, but I do with some online crowdfunding companies, so there are some affiliate links in this post. That means if you sign up and invest with them after going through these links, I might make some money. There are lots of ways to invest in real estate with varying degrees of hassle factor. This post introduces readers to another place on the continuum between minimum hassle REIT index funds and maximum hassle direct ownership where you fix toilets. Homeunion is a firm that provides a “turnkey” experience to allow the control and benefits of direct ownership, while decreasing the acquisition, management, and selling hassles.]
Akhil Saklecha, MD
I’ve always wanted to invest in real estate. Ever since I made my first dollar as an emergency medicine resident in Akron, Ohio, I was attracted to owning hard assets, such as rental properties, rather than company stocks. I loved the idea of having positive cash flow, potential tax savings, possible appreciation, and a personalized portfolio of homes. My father-in-law, who owns several single-family homes, would walk through potential properties with me and discuss the pros and cons of ownership, as well as values and rents. I learned a lot about becoming a landlord, but each time I came close to making a bid on an investment property, I hesitated and pulled back. I was afraid of the hassles of leaking pipes, broken appliances, and midnight phone calls from distressed tenants. It was an odd dichotomy — I was very comfortable with taking care of a critically ill patient, but could not handle the uncertainty of owning investment properties. Yet, deep down, I knew this wasn’t the end of my adventures in real estate.
According to a study by Fidelity Investments, the salary of the average physician using their investment products is $299,000, compared to the $60,000 annual income of non-physicians. In 2014, 55% of practicing physicians were worth $1 million or more by age 50, and by age 65, almost half had accumulated over $2 million in wealth, according to Fidelity’s research. Depending upon our financial goals, we would be well advised to create a diversified investment portfolio, consisting of individual stocks, bonds, mutual funds, and real estate to hedge against unforeseen shocks in the domestic market or global capital markets. The first three categories are easier to access for mainstream investors through institutions such as Charles Schwab or private wealth managers, but real estate is a different story.
Smaller investors can easily purchase into a public real estate investment trust (REIT), which is similar to a mutual fund, but backed by real estate. However, REITs are highly correlated to the stock market and subject to the same shocks, limiting the diversification benefits of investing in real estate. Home prices, meanwhile, have proven to be uncorrelated with the S&P 500 over the past 25 years.
There are also newer investment alternatives, such as RealtyMogul, RealtyShares, Equity Multiple, Origin Investments, Fund that Flip, Lending Home (all of these are or have been WCI advertisers) and Fundrise, which are crowdfunding platforms that allow investors to purchase fractional shares of real estate assets or loans for various types of properties. Unlike REITs, these projects are not subject to capital market swings. However, investors utilizing these platforms surrender the tax benefits, asset selection and disposition decision associated with wholly owning investment properties. Furthermore, fees can be substantial and many crowdfunding platforms only accept accredited investors, which is an unnecessary threshold for investors in single family homes. While these options may make sense for some, I still wanted to own and make decisions regarding actual properties, because my financial goals are unique and not necessarily aligned with those of crowdfunding platforms, such as when to sell.
Investing in Single Family Rentals
My research showed that single-family rentals (SFRs) satisfied my personal requirements of having an affordable, tangible asset with cash flow, appreciation, and a tax shelter. It made even more sense when I realized that I could use the current low mortgage rates to my advantage, as monthly rental income could more than cover my loan payments, even on a 15-year fixed-rate loan. The proceeds from rental income serve to pay down my assets’ loans and cover all of the expenses related to ownership. At the same time, real estate appreciation and rent growth have outpaced the rate of inflation over the long term, which increases my equity and cash flow over time. SFRs have produced average annual returns of 7.8 percent over the past 25 years, according to data from the U.S. Census Bureau.
The tax benefits of owning real estate are substantial, and can only be fully realized through direct ownership. Investors are able to depreciate the asset over time, while deducting the mortgage interest from rental income. Furthermore, property taxes, HOA dues, maintenance, and insurance can be deducted from rental income, thereby lowering one’s annual obligation to the Internal Revenue Service.
As a busy professional, the thought of investing in SFRs, particularly in areas where the returns are maximized, can be daunting. Several companies occupy space in the SFR rental sector, but only a handful offer investors a one-stop solution. HomeUnion, which I’m on the board of, and REI Nation are two such companies. HomeUnion operates in 18 markets, while Memphis Invest limits its focus to three metro areas. Memphis Invest purchases and rehabs properties, and then sells those assets with tenants in place to investors – but it’s a manual process and still hyperlocal. HomeUnion, on the other hand, uses a powerful data and proprietary analytics platform to create a customized portfolio of SFRs in different regions, so that investors can focus on maximizing returns with diversified geographic risk, instead of on individual properties in one local economy. HomeUnion then secures or helps arrange financing on behalf of its clients, acquires, manages, and sell properties in a hassle-free manner. Either of these companies can help professionals reach their goal of diversifying through real estate.
The access to a platform such as HomeUnion is covered by an acquisition fee of up to 3.5%, similar to the front-end load of an actively-managed mutual fund. This supports the use of the data analytics and the company’s on-ground team in every market in which it operates. The ongoing monthly payment is an asset management fee of up to 10.5% of the rent during tenant-occupied months. In addition, the company provides monthly reporting on performance, quarterly updates on the economic environment of each market, annual tax forms, and it handles all of the aggravating issues of ownership. Selling a property includes all of the standard processes and fees as with any other home sale, but with the added benefit of marketing to HomeUnion’s worldwide customer base.
Indeed, technology has enabled new avenues for individual investors to seamlessly participate in one of the largest financial markets. As stock markets rise or fall in bubble economies, physicians can, and should, take advantage of this opportunity to invest in real estate as a diversification of their finances into one of the best-performing asset classes.
[Editor's Note: Each method of investing in real estate has its pluses and minuses. Significant downsides of turnkey properties include not being able to drive by and check on it (assuming it isn't in your metro area), being reliant on another company (that could go out of business) for management, lower levels of diversification, and higher minimum investments. The main upside is you get to decide when you sell and you can theoretically exchange from one property to another until you get the step-up in basis at death, so the tax treatment may work out better than investing in syndicated properties, and you still get to avoid fixing toilets.]
What do you think? Would you consider directly owning a turnkey property in another city? What about in your city? Do you see this as a better option or a worse option than purchasing shares of a syndicated property? Comment below!
Featured Real Estate Partners
Appreciate the information! A couple of questions:
3.5% acquisition fee of the total purchase price and 10.5% monthly fee of the rent. Any other fees? Is this negotiated or standard fee? Do we have the option to forego on the property management service and fee at anytime after the original purchase?
After purchasing the property, the title is 100% under our names?
For the last 2-3 properties done at home union, what was cash flow like after management fee and cash on cash return?
Is it only for single family homes ? How about Multi units.. if so what’s the largest done so far ?
I own several properties locally.. but I would love to obtain properties around cities that we travel frequently but where I’m unfamiliar with the local markets. Then i could also take advantage of deducting those travel expenses that i would otherwise not have been able to deduct… to check on the “property”… is this service in only select cities? I’m interested in purchasing near Chicago, New York, Vegas?
Could you comment on liability issues? Right now I manage my properties in a llc and notify my insurance company on new acquisitions… I assume this doesn’t change if I’m 100% owner? Perhaps another layer of protection as a renter could legally go after home union for example as the property manager if negligence?
You said these firms also assist in the financing side as well.. is there any special advantage home union has for example compared to conventional financing through our local banks?
Again appreciate the article and responses, very informative!
Regarding this comment, “SFRs have produced average annual returns of 7.8 percent over the past 25 years…” I wasn’t able to make the connection to your census bureau source… Probably still just waking up, but would you mind going into your calculations in a bit more detail here?
“The main upside is you get to decide when you sell and you can theoretically exchange from one property to another until you get the step-up in basis at death, so the tax treatment may work out better than investing in syndicated properties…”
This is a fallacy. Some syndicators don’t do 1031 exchanges which costs their investors a lot of money in taxes. However, others do. Our company http://www.37parallel.com absolutely does do exchanges which maximizes the tax benefits of owning real estate.
Also, their has been no discussion of the increased risk to investors that crowdfunding has introduced to the real estate investment space by gutting the consumer protections inherent in the Securities Act of 1933.
Your website is a little vague. There is no info on how things work with your company. If I didnt know better it could be a blog about multifamily investing in general and the benefits thereof. No details on how your company actually works. More like an educational program. Even in your materials when you sign up for more info there is only one slide with a smidgen of the goals and how they will create cash flow, still nothing on structure.
This seems to be an issue with all of these sites. They may be totally fine as an investment vehicle but they come across as a product being sold and little transparency of the process. This should sell itself. There was more info in one paragraph of this post (the rest was a pitch) than one the Home Union site as well.
These companies need to change their style unless they are hoping no one has any skepticism or further questions, and no, no one wants to talk to a salesmen on the phone. The second we see that we have to have a talk with an “investor specialist” or some such thing it is a major turn off and likens you to insurance sales men. Let the opportunities speak for themselves and let us decide.
It would be cheaper to spend a couple months on zillow learning the market in question, flying out and buying yourself, setting up any rehab (honestly best if that is minimum, lots of ways to lose money there), and then get a property management company to run it from there. You have no more protection from one property management company than another, doesnt make a lot of sense to interject this middleman.
If we want to into the weeds, I think can get a step-up in basis with interests in partnerships, too using Sec. 754:
Way, way more detail than people need but…
http://www.thetaxadviser.com/issues/2015/aug/accounting-for-death-of-partner.html
>If we want to into the weeds, I think can get a step-up in basis with interests in partnerships, too using Sec. 754:
Ugh. Meant to say,
“If we want to *go* into the weeds, I think *you* can get a step-up in basis with interests in partnerships, too *,* using Sec. 754:
Even if it is an option with the syndicator, you don’t get to control when the syndicate sells or what is available when it does. There are certainly more options there if you’re the only owner.
Regarding crowdfunding and consumer protection, I’ll watch for your guest post on the subject. 🙂
I will concede that as a fair point – that you have less control using a syndicator. However, we are talking about passive investing. People who are interested in passive investing in real estate typically give up liquidity and control in exchange for a hard asset managed by an expert (at least the syndicator SHOULD be an expert). For those seeking control in real estate, they might be better served by investing actively.
As for the post on crowdfunding, it has already been written:
http://nesteggrx.com/crowdfunding-the-good-the-bad-and-the-ugly/
Thanks for the link. I agree with you that buying even a turnkey property is far less passive than a syndicated one.
Fees seem pretty hefty. How do your average investor’s returns looks after you take these out? Most WCI readers would balk at mutual funds with a 3.5% load or expense-ratio approaching 1% let alone 10.5%. What is the minimum investment needed to buy in?
Unfortunately the only real estate investment you’re going to find with Vanguard like expense ratios is the Vanguard REIT Index fund with it’s associated issues (higher correlation with other publicly traded stocks than I’d like.)
But keep this in mind- each real estate property is like a separate business. Every business has expenses. The expenses of Wal-mart don’t show up in the Total Stock Market expense ratio, but as an owner of Wal-mart, you’re paying them just the same.
With equity mutual funds, because the markets are efficient, there’s a strong negative correlation between fees and net return to the investor. With real estate syndications, given the less efficient marketplace and the ability of good syndicators to add value, I think there’s a realistic chance that both the syndicator and the investor can win. The challenge is finding the syndicators who can do that for you. (Personally, if I find a syndication I like, the fees will not stop me from investing.)
You’re right, the lower the fees the higher your returns, all else being equal. But you can’t compare the fees from a real estate syndication to those of a mutual fund ER. They’re different entities.
All true but people will go for investment with lowest ER no matter the asset class. You taught us that – low cost index investing FTW!
I also taught you to understand what you’re investing in!
Fees matter, no doubt. But you have to compare like to like.
I just dont see the difference in buying an out of state property and hiring a do it all management company for this price. Cheaper to fly out and inspect, buy and then hand off to prop mngmt than this as advertised.
Also, website is terrible. Reads like a pitch to VCs (in fact some slides look like they were used this way) and an educational brochure on considering the asset class. People that make their way to the site do not need to be educated on the asset class as the primary goal, they need to know the setup of the company and how the investment, distributions and sausage gets made. All this hiding behind an “educational” front makes it look shady. Not saying I’ve seen any amazing sites doing it better, but it leaves a lot to be desired. Idk, maybe people randomly stumble across real estate crowdfunding syndicates daily and just need a board room pitch of an education to get them to invest.
Thanks for the feedback. I also don’t find being the sole owner of an out of state rental property particularly attractive for my tastes, whether done myself or via a turnkey firm. I don’t know that everyone feels that way however. I also think getting good property management is difficult and have no idea if this firm is better than most because they hope to get more of your business for the other aspects of real estate buying/selling/management etc. Obviously I don’t evaluate a guest post based on the quality of the website.
well said Zaphod.
Your website is a little vague. There is no info on how things work with your company. If I didnt know better it could be a blog about multifamily investing in general and the benefits thereof. No details on how your company actually works. More like an educational program. Even in your materials when you sign up for more info there is only one slide with a smidgen of the goals and how they will create cash flow, still nothing on structure.
This seems to be an issue with all of these sites. They may be totally fine as an investment vehicle but they come across as a product being sold and little transparency of the process. This should sell itself. There was more info in one paragraph of this post (the rest was a pitch) than one the Home Union site as well.
These companies need to change their style unless they are hoping no one has any skepticism or further questions, and no, no one wants to talk to a salesmen on the phone. The second we see that we have to have a talk with an “investor specialist” or some such thing it is a major turn off and likens you to insurance sales men. Let the opportunities speak for themselves and let us decide.
It would be cheaper to spend a couple months on zillow learning the market in question, flying out and buying yourself, setting up any rehab (honestly best if that is minimum, lots of ways to lose money there), and then get a property management company to run it from there. You have no more protection from one property management company than another, doesnt make a lot of sense to interject this middleman.
Couple of thoughts: Heavy fees. Article didn’t mention ROI, and reads more like an ad. That being said, could be a decent way to diversify.
Is their really no correlation between s&p500 and home prices? Where is this data?
It is a true statement that real estate has either a low correlation or is uncorrelated to the stock market. Here is one of many articles you can find on that subject:
http://finance.zacks.com/relationship-between-stock-market-real-estate-prices-10244.html
In fact, JP Morgan looked at the 20 worst quarters for a 60% stock / 40% bond portfolio between 1978 and 2012. During those 20 down quarters, real estate was up 17 of the 20. The author is correct in his assertions.
Interestingly, REIT’s are highly correlated to the stock market. That is due to the fact that they are a sector play within the stock market (real estate flavored stock) and not direct ownership of real estate.
Again, this is pretty far into the weeds, too, but Green Street Advisors have written/published research whitepapers (often referenced by others but only irregularly available for free) that suggest over time REITs and direct real investment do quite similarly.
BTW, referencing this guest post so no one thinks I’m Mr. Negative about direct real estate investment:
https://www.whitecoatinvestor.com/ten-tax-loopholes-for-active-real-estate-investors/
What do you mean it didn’t mention ROI? First, there’s no guarantee of any return at all with an investment like this. Second, the article actually gave a figure for rent increases of 7.8% with a link to census data.
Correlation between the stock market and real estate markets are fairly low. For example the correlation between the Vanguard 500 fund and the REIT index fund is about 0.45 (http://adviseronline.investorplace.com/parts/tools/correlation-tool.html?fund1=500+Index&fund2=REIT+Index). I would expect the correlation with direct real estate investments to be even lower since they aren’t traded on the same stock market.
There is no guarantee of return in any investment (save few – even that is mostly emotional).
I meant what is their specific return after expenses. Census data has 10.5% ongoing fees and 3.5% – suppose I can subtract and get the net returns but wanted their company specific returns.
While it makes sense, and I expect the same, expectation and hard data are different. I will believe an organized study. Will check out the link above. If market tanks are people really out there looking for houses? may be there is a delayed slack in the RE market as well. I’ll google around a bit for this for my sake.
10.5% ongoing fees and 3.5% aquisition fees* (not sure what average fees census data has).
I agree its hard to understand that people are buying houses at the same prices when the country is in a deep recession. Lot of people are jobless, who are not jobless fear loosing their jobs. Only thing working for housing would be Fed probably has decreased interest rates to prop up the economy, causing low APR loans for houses increasing their sales or possibly prices. But I still find it odd that people are buying more or paying more because its cheap to loan even though the number of people with jobs have gone down and hence number of people looking for houses have gone down.
At best in deep recession, they should cancel each other out, any thoughts?
I’m not so sure that the correlation between REITs and the over stock market is strong, although it’s certainly not zero: http://www.forbes.com/sites/rickferri/2014/01/07/reits-and-your-portfolio/#6c530e36142d
Personally, I have a hard time believing that the return can justify these fees, which create a decent head wind…
David Swensen, in his “Pioneering Portfolio Management” book, talks about how alternate asset classes are really inefficient so it often is possible to beat the averages… but he then discusses at length how important it is to not only get a truly above average performance from the asset manager but to also have an agreement that aligns interests. The fees are the big issue there obviously…
I assume few people here are taking an active management approach to any substantial chunk of their portfolio, but Swensen’s “Pioneering…” book is a great read. (It makes one realize just how optimal a passive strategy is.)
There are plenty of articles that would disagree.
http://investors.morningstar.com/news/cmsAcontent.html?t=VEIEX&src=Morningstar&date=05-21-2015&nav=no®ion=USA&culture=en-US&ProductCode=mle&resourceId=677010
Ultimately, I find it interesting that the bulk of articles that claim that REITs provide great diversification and low correlation to the stock market come from REIT companies and financial advisors who get paid for selling paper assets (the same people who prefer to report average annual returns instead of CAGR).
I think you’re incorrectly assuming that real estate fees can be directly compared to a mutual fund ER.
Re
“The tax benefits of owning real estate are substantial, and can only be fully realized through direct ownership.”
Don’t I realize the same tax benefits (deduct my fractional share of depreciation and expenses; capital gains treatment on sale, etc.) with fractional ownership/syndications, such as those offered by 37parallel/Dennis Bethel? (If not, what are the differences?)
I have a portfolio of single family residences. Overall, I think it will serve me well for the rest of my life, but I have found most firms underestimate the vacancy and maintenance costs. My experience (Dallas/Ft. Worth area) is that, even with excellent management, it’s realistic to budget 20% of gross rents for vacancy, maintenance, and repairs.
I’m also very please holding real estate notes in my IRA. This arena can be a mine field; you need to either have someone you trust vetting the notes, or need to be able to perform due diligence yourself. If you can clear these hurdles, the advantage is much higher income than bonds without the volatility of equities.
>”… tax benefits of owning real estate are substantial, and can only be fully realized through direct ownership…”
I assume the issue referenced is that you don’t meet material participation rules in syndicates so the passive loss limitation rules delay deducting passive losses?
>…realistic to budget 20% of gross rents for vacancy, maintenance, and repairs…
I kind of think the Census Bureau’ POMS study suggests operating expense ratios are higher than that. Here’s link to main page of this, but there is a ton of useful info:
https://www.census.gov/housing/poms/
Operating expenses include not only maintenance/vacancy but also property taxes, insurance, and management. Total operating expenses are much higher than maintenance/vacancy. It’s fairly easy to accurately estimate taxes/insurance/management; maintenance/repairs/vacancy can vary a great deal and are often underestimated.
I must say that I am not a CPA, but the tax benefits of investing in real estate passively should be the same for direct ownership in residential real estate as well as direct fractional investing in larger properties:
Multiple Deductions
Depreciation
Accelerated Depreciation / Cost Segregation
Tax-Free Refinances
Elimination of the 3.8% ACA tax on net investment income (due to depreciation)
1031 Exchanges
Step Up In Basis Upon Death
Of course the Real Estate Professional / material participation rules apply to active investors and most people who work full time in a different industry do not qualify for those. Ultimately, whether you are active or passive, you should check with your CPA or trusted tax advisor to see what you qualify for.
>… “Of course the Real Estate Professional / material participation rules apply to active investors and most people who work full time in a different industry do not qualify for those”…
One option that some married couples can use with direct real estate investment is making one spouse a “real estate professional”… that means the spouse managing the direct real estate investment portfolio generates deductible passive losses that then shelter the other spouse’s income.
The Morningstar article says the correlation was 0.44 and is now 0.79. I suppose if the correlation stays at 0.79 going forward there’s not a significant diversification benefit. But keep in mind that the last decade showed less correlation of most asset classes. If the REIT correlation moves closer to its historical average, I think there is somewhat of a correlation benefit.
0.79! Yea. Not good. I don’t have hard data but I believe the more people invest passively in real estate via REIT the more it correlates with general market.
You’re right that correlations change over time.
You mean more correlation? As financialization increases, so do correlations. This will only increase as current paradigms continue on the financialization path.
“SFRs have produced average annual returns of 7.8 percent over the past 25 years”.
Anyone who has owned rental properties knows that statistic has ZERO correlation with the ROI from owning a single property (or even a handful of actively managed properties). There’s nothing wrong with the basic business concept he’s pitching, but Home Union always make money (3.5% upfront + 10.3% annually) regardless of whether the investor ever earns a penny. That sounds like an extremely expensive mutual fund without any track record.
The worst aspect is you’ll never know the actual ROI until after you buy a specific property. They can (hopefully) provide real-life investor returns for a given area, but that’s hardly better than the useless Census Bureau stat. You can’t apply general RE market returns to a specific property with any confidence.
It would be far more appealing if they took a percentage of actual investor returns, not a percentage of gross rents. I understand why Home Union doesn’t do that (although I know many individuals that offer that type of partnership in return for financing) and can’t help thinking “Well, we might as keep the property filled with paying tenants regardless of market rates, credit scores, previous history, repairs, appreciation” or numerous other factors I care about when buying a property and putting a tenant in place.
Bingo. Said it better than I did. That mentioned return is apples to oranges. Not saying this is not viable but that’s a blanket statement and NOT homeunion returns. That was my inquiry.
Completely unrelated to the real estate offering…
Did anyone notice the Fidelity analysis showing 55% of physician’s hit $1M by age 50? That sounds great and easily in line with WCI’s expectations. In contrast, taking another 15 years to hit $2M sounds pretty mediocre.
Yea pretty ridiculous. Would be interesting to see why such slow growth ? Past mistakes / divorce / boat that got wrecked x 3?