Invest in Real Estate Without the Headaches Of Direct Ownership

An “accredited investor” is a category of person permitted to participate in certain unregistered securities offerings. A simple way to think of the line-drawing exercise the SEC is engaged in here is that the more capable an investor is of fending for him/herself in an offering, and the more able an investor of withstanding a complete loss on the investment, the less the SEC is concerned about mandating the obligations of a public reporting company on an issuer.

For natural persons, an “accredited investor” is anyone who has either: (1) earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, or (2) a net worth of over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence). There are other exemptions based on financial sophistication, but these thresholds are the most generic in terms of determining accreditation status.

For entities, there are a number of tests to determine whether the entity in question is accredited. For the most part, if the entity has over $5 million in total assets or all of the owners of the entity are accredited, then the entity will be deemed to be accredited.

A Registered Investment Advisor (RIA) is a person or firm who advises high-net-worth individuals on investments and manages their portfolios. RIAs have a fiduciary duty to their clients, which means they have a fundamental obligation to provide investment advice that always acts in their clients' best interests. As the first word of their title indicates, RIAs are required to register either with the Securities and Exchange Commission (SEC) or state securities administrators.

A real estate limited partnership is a group of investors who pool their money to invest in property purchasing, development, or leasing. The general partner assumes full liability and one or more limited partners who are liable only up to the amount they contribute. The general partner is usually a corporation, an experienced property manager, or a real estate development firm. The limited partners are outside investors who provide financing in exchange for an investment return.

In a LP, a general partner manages the partnership entity and brings in limited partners using a subscription agreement. Candidates subscribe to become limited partners. After meeting standard requirements, the general partner decides whether to accept the candidate.

A general partner is one of two or more investors who jointly own a business that is structured as a partnership, and who assumes a day-to-day role in managing it. A general partner has the authority to act on behalf of the business without the knowledge or permission of the other partners. General partners typically bring specialized knowledge and skills to the partnership and contribute to its pool of contacts and clients. The IRS doesn't require partnerships to pay corporate taxes on profits. Instead, each partner receives their share of the profits as income and file and pay their own taxes.

A Limited Liability Company (LLC) is one type of legal entity that can be formed to own and operate a business. An LLC is allowed by state statute and each state may use different regulations. LLCs are very popular because they provide the same limited liability as a corporation, but are easier and cheaper to form and run. Most private real estate investments are structured as LLCs where the investor will buy units in the LLC as a limited partner.

Owners of an LLC are called members. A few types of businesses generally cannot be LLCs, such as banks and insurance companies.

The Qualified Intermediary (QI) is an entity who, for a fee, acts to facilitate the 1031 exchange by entering into a contractual agreement for the exchange of properties, avoiding constructive receipt.

When investing in real estate, it is important to understand how the property could increase in value or yield income, as well as the amount of time it would take to recognize those gains. To determine potential profits, it is important to account for the “time value of money,” or how the value of money changes over time based on inflation, opportunity cost, and risk. Future profits must be “discounted” in order to calculate the present value, as money is understood to depreciate over time. IRR is a discounted cash flow analysis at which the net present value of an investment or project is zero, or the rate at which a project breaks even.

The multiple on invested capital, or MOIC, is an investment return metric that compares an investment's current value to the amount of money an investor initially put into it. It is most often used with illiquid real estate investments, such as private equity investments or crowdfunded and syndicated real estate investment deals. It's important to consider both the realized and unrealized returns of the investment. In addition, it's important to only consider net investment value, meaning the amount of equity you own. As an example, if a $100,000 investment was returned upon liquidation with an additional $90,000 of profit the total distribution would be $190,000.  The multiple on this example would be shown as 1.9x.

A cash-on-cash return is a metric normally used to measure commercial real estate investment performance. It is a rate of return that measures the annual return the investor made on the property in relation to the amount of mortgage paid during the same year. It can be used as a forecasting tool to set a target for projected earnings and expenses. Cash-on-cash return analysis is often used for investment properties that involve long-term debt borrowing.

Waterfalls are a financial structure that dictates how returns on a real estate investment are distributed to investors. For passive investors, cash distributions will typically flow according to a waterfall distribution schedule. The structure largely depends on the nature of the deal, including the investment timeline and certain return hurdles. Typical waterfall structures will have an initial preferred return paid to investors followed by a split of profits between the GP and the LP investors.  Often there are return hurdles that will change the splits on distributions once the return hurdle is met.  Thus, the analogy of a waterfall.

A distribution generally refers to the disbursement of assets from a fund, account, or individual security to an investor. The income generated from an investment trust or real estate property is awarded to investors, typically as a monthly or quarterly distribution.

The capitalization rate (cap rate) is used in commercial real estate to indicate the rate of return that is expected to be generated on a real estate investment property. This measure is computed based on the net income which the property is expected to generate and is calculated by dividing net operating income by property asset value and is expressed as a percentage. It is used to estimate the investor's potential return on their investment in the real estate market.

A 1099 form reflects income paid by other businesses to a contractor, vendor or freelancer. A K-1 reflects income for a partner from a co-owned business such as investments in LLCs and partnerships and often pay out more of their cash flows because of their legal structures. In some cases, a share of the losses, deductions, and credits provide numerous potential tax benefits to partnership structures. Both K-1 and 1099 forms show reportable taxable income.

Net operating income (NOI) is a calculation used to analyze the profitability of income-generating real estate investments. NOI equals all revenue from the property, minus all reasonably necessary operating expenses.

NOI is a before-tax figure, appearing on a property’s income and cash flow statement, that excludes principal and interest payments on loans, capital expenditures, depreciation, and amortization. When this metric is used in other industries, it is referred to as “EBIT,” which stands for "earnings before interest and taxes". NOI will indicate to a property owner if renting a property is worth the expense of owning and maintaining it.

Private real estate investing is the use of private individuals’ money (not a corporation’s funds) to purchase privately held real estate assets, usually meant for commercial use.

A Real Estate Investment Trust (REIT) is a company owning or financing income-producing real estate and are often publicly traded. Both private real estate investments and REITs are organized pools of capital invested in real estate.

The minimums are typically higher for private real estate investments since there are fewer people investing per project, while REITs typically have a low investment threshold. Private real estate typically has a low correlation to the public stock market.

Commercial real estate is property that is used exclusively for business-related purposes or income-generating purposes. This broad category of real estate can include office space, industrial, multi-family rentals, and retail. Commercial real estate provides rental income as well as potential capital appreciation for investors. Investing in commercial real estate usually requires more sophistication and larger amounts of capital from investors than does residential real estate.

A multifamily home is any residential property that contains more than one housing unit, such as a duplex, a townhome or an apartment complex. Units can be next to each other or stacked on top of each other. A multifamily home is also referred to as a “multi-dwelling unit” or MDU.

Industrial real estate refers to properties used to develop, manufacture, or produce goods and products, as well as logistics real estate that supports the movement and storage of products and goods. Industrial real estate covers a broad group of properties types, including office space, light manufacturing facilities, food manufacturing temperature-controlled facilities, warehouses, fulfillment centers, sortation centers, and last-mile delivery stations. There are three classes of properties: A, B, and C.

A triple net lease (triple-net or NNN) is a lease agreement on a property commonly found in commercial real estate. With a triple-net lease, the tenant or lessee promises to pay all the expenses of the property, including real estate taxes, building insurance, and maintenance in addition to the cost of rent and utilities. Triple net leased properties have become popular investment vehicles for investors because they provide low-risk, steady income.

A 1031 exchange is a swap of one investment property for another that allows capital gains taxes to be deferred. The term comes from the Internal Revenue Service (IRS) code Section 1031. A The properties being exchanged must be considered like-kind in the eyes of the IRS for capital gains taxes to be deferred. If used correctly, there is no limit on how many times or how frequently you can do 1031 exchanges.

Opportunity Zones are tax incentives to encourage those with capital gains to invest in low-income and undercapitalized communities. the program provides three tax benefits for investing unrealized capital gains in Opportunity Zones:

• Temporary deferral of taxes on previously earned capital gains. Investors can place existing assets with accumulated capital gains into Opportunity Zone Funds. Those existing capital gains are not taxed until the end of 2026 or when the asset is disposed of.
• For capital gains placed in Opportunity Zone Funds for at least 5 years, investors’ basis on the original investment increases by 10 percent if invested by Dec 31, 2021.
• Permanent exclusion of taxable income on new gains. For investments held for at least 10 years, investors pay no taxes on any capital gains produced through their investment in Opportunity Zone Funds (the investment vehicle that invests in Opportunity Zones).