Ben Fraser is the Managing Director and Chief Investment Office of Aspen Funds. Prior to Aspen, Mr. Fraser was a commercial lender at First Business Bank specializing in government backed loan originations (SBA & USDA), for one of the top SBA lenders in the nation. Prior to that he was a commercial credit underwriter for Crossfirst Bank, personally responsible for underwriting over $125MM in C&I and CRE loans across a variety of industries.
Read more about Ben
Many people chalk up the success of ultrahigh net worth individuals (UHNWI) to luck or trust funds, but the truth is, most of these people have common characteristics and strategies when it comes to guarding and growing their wealth.
And I’m not talking about obvious habits like “start investing early,” which I’ve read in countless lists. There are real, practical tools that multimillionaires and billionaires use.
We’ve studied the methods of these individuals for a while and found that many strategies are applicable to ordinary Americans also seeking to build wealth. So, that’s what I’m going to share today—the UHNW investor’s top keys to success.
Dominate The Tax Game
Propublica published an article releasing data from the tax returns of the wealthiest Americans. What it revealed is the overwhelmingly small percentage of taxes these individuals pay.
While there may be lots of opposing viewpoints on extreme wealth and wealth disparity in this country, the truth is that all of these top-earners found perfectly legal ways to, as a percentage, pay less in taxes than average American workers.
If you want to keep the wealth you’ve built, there are a few things we can learn from these tax strategies.
Focus on growing your “balance sheet” versus your W-2 income. This means focus on things that grow your net worth, rather than the income you earn from a job. For example, owning a rental property is an asset that adds to your total net worth through increased equity and appreciation over time, and comes with its own set of tax advantages. You will pay less in taxes for things like this than the income you earn from your 9-to-5 job.
Understand Economic ‘Tides’
Economic tides is my term for describing the bigger economic undercurrents that affect the short-term “waves” or activities. We write big economic updates with predictions for the coming year at the end of each year, and our advice is always the same: Look at the bigger fundamental drivers of supply and demand that will impact the economy over many years, not current oscillations of the stock market or latest doom-and-gloom headline.
These tides are things like long-term trends in inflation, unemployment, consumer and business sentiment, housing market supply and demand, interest rates and tax policies. Understanding the underlying trends and their trajectories will help you make solid long-term decisions for investing and protecting your wealth.
Consider Investing In Alternatives
Most UHNWIs have large portions of their investment portfolios allocated to alternative investments—or things other than stocks and bonds. Data from KKR shows that the allocation percentage the ultrawealthy have in alternatives is usually over 50%, compared to the 5% average investors put in alternatives.
While there are of course risks, as an asset class, alts tend to provide higher returns with less volatility than other markets. A balanced portfolio with true diversification is key.
If arguably some of the most successful investors invest heavily in alternatives, there is lots of potential there.
Use Debt As A Tool To Their Advantage
I won’t name any names, but we’ve all heard the financial gurus who paint all debt as the ultimate evil. But it’s simply not true. Good debt or “leverage,” i.e., debt used to buy assets, can actually be a significant tool for building wealth.
This is a hallmark move of the ultrawealthy. Even though UHNWIs certainly have the money or access to the money to purchase something they want, like a business or apartment building, instead, they borrow against their net worth and take out a loan to buy these assets.
Why?
Well, first of all, this allows them to keep their capital in their investments, which are ideally earning them additional returns.
Secondly, this debt they take on generally has a lower interest rate than their tax liability would be after liquidating an investment (another tax advantage like strategy No. 1).
And thirdly, debt is one thing that doesn’t adjust for inflation. With even moderate inflation, that debt is devalued over time, making that borrowed money even cheaper to borrow in terms of real money than the interest rate indicates.
Understand Risk-Adjusted Returns
If there’s one thing that too few investors take into consideration that the ultrawealthy understand, it’s that not all returns are created equal.
At face value, two different investment opportunities can have the same return. Say there’s a private alternative that returns 9% annually. To get a similar return in the public markets, you might have to turn to junk bonds. Well, junk bonds are notoriously risky, which means that the returns can be very volatile, leading to significant fluctuation, and potential loss of value.
To truly compare two investment options as apples to apples, you need to apply some qualitative analysis to normalize the potential returns, adjusting by risk factor.
Use Your Network To Find Good Opportunities
This strategy is probably the most obvious one among the list, but is not usually given the importance it deserves.
Your network can be an invaluable source of tools and resources, and of course, potential opportunities. The ultrawealthy are adept at leveraging their relationships to find new places to invest, as well as pulling on the experience of those they know to evaluate those opportunities.
While the majority of us will never be mega-millionaires, that doesn’t mean we can’t still apply some of the strategies that help the wealthy reach financial success.
Investment Opportunities with Aspen Funds
We have several private funds for accredited investors on our Offerings page. Regardless if you know which fund is right for you, our Investor Relations team would like to get to know you, your interests, and your timeline so that we can best serve you on your alternative investment journey. You can start by scheduling a call here.
Ben Fraser is the Managing Director and Chief Investment Office of Aspen Funds. Prior to Aspen, Mr. Fraser was a commercial lender at First Business Bank specializing in government backed loan originations (SBA & USDA), for one of the top SBA lenders in the nation. Prior to that he was a commercial credit underwriter for Crossfirst Bank, personally responsible for underwriting over $125MM in C&I and CRE loans across a variety of industries.
When the economy is unpredictable and tumultuous, a few things happen…
The stock market (and retirement accounts) can have drastic fluctuations, often wiping out years of gains overnight.
People’s ‘risk meters’ go into overdrive – keeping them in jobs they don’t like, scaring them away from continued investing. Unfortunately, in this current environment, because inflation is high, the future value of their savings is being chiseled away.
Navigating the complexities of a challenging economy without a crystal ball is tough – and knowing where to focus your investments to keep earning returns can be difficult.
Here’s something to consider. The best types of investments to focus on when the economy is unpredictable have 2 primary features: lower risk and income-producing.
Top features for investment opportunities in an unpredictable economy
Lower Risk
Oftentimes, inexperienced investors view stock market investing as “low risk.” After all, if millions of other investors are doing this, it has to be safe, right? The truth is, the stock market has inherent volatility that many investors don’t consider.
And volatility kills the power of compounding. That’s why, when the economy is not stable, you want to focus on investment vehicles that are stable and carry lower risk.
How do you find lower-risk investments?
Finding investments that are lower-risk may seem daunting. Of course, you need to do your own research and due diligence, but here are a few steps to consider that can help you identify opportunities that are less risky:
Look for inflation-protected investments. In our current economic environment, high inflation is a key factor in the instability. And when inflation is high, it can have a big impact on your cash. Let’s say your money is tied up in a 5-year investment that doesn’t adjust for inflation, like bonds. By the end of that period, you may have “technically” made money on your investment, but the value of the dollar has decreased – and your debt terms didn’t adjust with inflation. So in reality, you made much less. Looking for inflation-protected investments, or investment vehicles that naturally adjust to inflation, can mitigate a lot of risk and protect your capital. One of the best inflation-protected vehicles is real estate. Mortgage rates, property prices, and rent historically track (and beat) inflation. Other asset classes that can be a hedge of protection against inflation because they aren’t as sensitive to public equity markets are commodities like oil and gas.
Look for investments backed by actual assets. Investments whose value is (at least partially) based on a physical asset are almost always going to be less risky than investments where this isn’t the case. Venture capital, for example, is a riskier investment because you’re betting on the future success of a business. Owning a share of a valuable piece of artwork, on the other hand, gives you the collateral of the actual piece of art. Maybe its value changes, but it most likely won’t go to zero. Common investment vehicles that are backed by assets include art, collectibles, and – most notably – real estate. Real estate can include everything from multifamily syndications to industrial properties to mortgage note investing.
Look for a track record. Aside from the actual investment opportunity itself, it’s also paramount to evaluate the risk associated with the operator of the investment. When the economy is unpredictable and you’re looking to lower risk, it’s especially important to invest with operators that have a solid track record. Key things to look for in a track record include length of time in operation, total assets under management, whether any return payments have been missed or delayed, past capital losses and historic performance during challenging economic environments, like during Covid. While past performance doesn’t guarantee future performance, positive indicators in all these areas can help mitigate some risk.
Want to learn how you can earn 9% passively? Learn about our Income Fund.
Income-Producing
Finding investments that produce regular returns in the form of monthly or quarterly checks are always top of mind for investors. But this becomes especially important in periods of economic uncertainty.
Income-producing investments can help supplement earned income or provide a financial buffer if you hit any road bumps during an economic downturn.
Types of income-producing investment assets
Alternative investments:
Real estate. One of the easiest places to find investments that will generate regular income is real estate. There are crowd-favorite options like syndications in multifamily, commercial, and retail properties. There are also lesser-known real estate investments like mortgage note investing.
Oil & Gas. Investing directly into existing oil fields can produce strong yields. While these types of investments can have more volatility given the ties to commodity prices, generally the risk-adjusted returns can be compelling. And similar to real estate syndications, these types of investments can be available to accredited investors.
Other less-common alternative investments that can produce income are things like investing in farmland that generates dividends or buying catalogs of music that produce royalties.
Public markets:
Dividend stocks. Dividend stocks pay investors dividends usually on a quarterly basis, based on company earnings. The dividend amount varies and is determined by the company’s board of directors each quarter.
Bonds. Bonds are essentially loans to the government at a fixed-interest rate. You receive payments at this fixed amount on a fixed schedule according to the loan terms.
REITs. Real estate investment trusts are publicly traded shares in a company that owns physical real estate (like office buildings), collects rent from tenants, and distributes the majority of its earnings as dividends.
Investment Opportunities with Aspen Funds
One of the first funds we created at Aspen is our Income Fund, which was designed to provide 9% current income for investors. That fund has been operating for 9 years, and we have never missed a preferred return payment. To learn more about the fund, register to watch the webinar.
Ben Fraser is the Managing Director and Chief Investment Office of Aspen Funds. Prior to Aspen, Mr. Fraser was a commercial lender at First Business Bank specializing in government backed loan originations (SBA & USDA), for one of the top SBA lenders in the nation. Prior to that he was a commercial credit underwriter for Crossfirst Bank, personally responsible for underwriting over $125MM in C&I and CRE loans across a variety of industries.
Investing in industrial real estate has been an investor favorite for decades, especially for institutional investors. The industrial sector has consistently demonstrated resilience, even during economic downturns, making it an attractive opportunity due to its stability and profitability.
With the rise of e-commerce and the increasing demand for warehousing and distribution centers, the industrial real estate market is thriving. In this article, we will delve into the economic trends behind industrial real estate (including a new driver of growth) and look at some of the key benefits and risks of investing in this asset class.
What is Industrial Real Estate?
Before we go too far, let’s first set the stage – what is an industrial property? Industrial real estate refers to properties used for industrial purposes, such as manufacturing, warehousing, distribution, and research and development. These properties can be standalone buildings or multi-building complexes, and can include features such as loading docks, high ceilings, and heavy power supplies. You’ve probably driven by them and not even realized what they were used for. But this sector of real estate is essential to the growth and vitality of the U.S. economy.
And if you haven’t been following trends for this asset class in recent years, it’s actually experiencing a huge boom. What is happening?
Growth Trends in the Industrial and Manufacturing Sector
Industrial real estate values have been flourishing in recent years, far outpacing other forms of commercial real estate like retail and office buildings.
There was an initial boost to industrial real estate in 2008-2009, rising in pace with retail and office. We can also see in the chart above, that inflation (the dashed blue line) has been growing steadily over the past 40 years. All forms of commercial real estate have been pretty close to the inflation line over all that time. But over the last 10 years, industrial real estate has been skyrocketing, now surpassing retail in the last few years. So, what’s been causing this surge in valuations?
This next chart shows the supply and demand trends for industrial real estate.
The gray bars are the number of completions (or newly constructed properties) in a given year, being brought to the market. The orange bars show net absorption, meaning the properties being leased up (or absorbed), and taken off the market. In the past two years we’ve seen record absorptions.
Even with record levels of industrial real estate being developed, these properties are being absorbed even faster. If you follow the yellow line, we see the net vacancy rate is dropping. Vacancy rates now are hovering around 2.9%.
So what’s going on?
Key Drivers of Growth in Industrial Real Estate
The large growth for industrial real estate can be attributed to several factors: the rapid rise in eCommerce, supply chain disruptions, and the reshoring of manufacturing to US soil.
Rising E-commerce Strengthens Demand for Industrial and Manufacturing Space
E-commerce has been a huge driver of the industrial boom over the past several decades. As e-commerce has grown, the need for keeping inventory and for distribution and warehousing has massively increased.
In the above chart, you can see e-commerce sales spiked substantially in 2020 as the pandemic hit and people weren’t able to leave their homes and instead needed to get things delivered to them.
But after that spike, it very quickly dropped and then started to plateau. We believe that e-commerce growth as a percent of total sales will probably continue to increase, but at a much slower pace, as people still prefer to shop in person for certain things.
E-commerce growth, which has been one of the biggest drivers of industrial real estate for so long, is starting to slow down. But at the same time, we’re now seeing several new trends causing a resurgence of industrial growth – bringing manufacturing back to America and the “re-inventorying” of critical manufacturing components. And we believe that’s going to be another big rocket booster to industrial real estate.
Supply Chain Disruptions Highlight Importance of Resilient Operations
We have all seen plenty of headlines in the last few years about supply chain disruptions. Here’s an interesting case study.
Ford, like many other automakers, has been dealing with the effects of a severe microchip shortage. Tens of thousands of Ford trucks are sitting in parking lots, unable to be sold. The missing microchips, which are needed to complete the cars, have been held up by supply chain disruptions. This is a byproduct of having outsourced the manufacturing of these critical components overseas.
Because of this, Ford has over $2 billion of potential revenue that they can’t capture just sitting in parking lots. So the question is, “how valuable is it to Ford to control the manufacturing of this critical component?” The answer is very important!
And Ford isn’t just an isolated case, this is happening all across U.S. (and even European) manufactures. Supply chain disruptions have had a significant impact on industrial real estate in recent years. The pandemic has disrupted global supply chains, leading many companies to reassess their logistics and storage strategies. This has resulted in increased demand for industrial real estate as companies look to bring their supply chain operations closer to the end customer.
Reshoring Manufacturing Drives Need for Industrial Real Estate
For decades, we shipped our manufacturing jobs overseas for the most. But it has started to shift in the last few years. The number of manufacturing jobs that will be brought back to the US is projected to hit 350,000.
Here’s another chart showing manufacturing employment.
If you look back to the 1990s, the manufacturing employment trend was pretty clearly heading downward. But instead of continuing to see a decrease, we’ve started to see an uptick in US manufacturing jobs in the last 10 years.
Outlook on Industrial Growth
Despite very strong underlying growth factors over the long-term, stubbornly high inflation and economic slowdown concerns may make for slower growth in the short-term. Commercial Property Executives (CPE) research highlights that “although both investor and occupier demand is still high, absorption, rent growth and sales activity are simmering down.” Though CPE expects labor shortages and rising construction materials to be some of the biggest challenges for industrial developers this year, it also forecasts that “industrial assets are anticipated to be among top performers across the commercial real estate sector in 2023.”
Deloitte’s research is also showing a positive outlook for commercial real estate in 2023 from survey results. “When it comes to real estate fundamentals—cost of capital, capital availability, property prices, vacancy levels, leasing activity, transaction activity, and rental rates—most respondents (66%) expect improving or stable conditions for next year. Respondents point to leasing activity, tightening vacancies, and rental growth as having the strongest potential for improvement.”
From An Investor’s Perspective – Is Industrial a Good Investment?
When it comes to assessing the actual opportunity for investors in industrial real estate, there are several things to consider.
Risks of Investing in Industrial Real Estate
Risk of vacancies: Many times these properties can be occupied by a handful or even a single tenant. If that tenant stops paying or becomes insolvent, that impacts potential cash flow in the short-term.
Build-to-suit risk: When a developer undertakes building an industrial property to the specifications required by the tenant, that’s called build-to-suit. This customization means the property may be harder to lease out again should the tenant ever leave or stop paying rent.
Speculative Development: On the other side of the development coin are “speculative” developments, meaning no tenant(s) are identified prior to construction. This could result in a vacant property if not developed correctly or it’s in a non-growth market.
Modernization risk: The industrial sector is always evolving, meaning requirements for machinery, loading docks, HVAC equipment loads, or building access could change. This can potentially leave the building outdated and in need of expensive modernization.
Benefits of Investing in Industrial Real Estate
Strong demand: The demand for industrial space has been growing due to e-commerce growth and the increasing need for warehousing, manufacturing and distribution centers.
Long leases: Because moving large-scale operations to another industrial facility can be a big undertaking, most tenants stay put for a while, and leases can be much longer than in other types of commercial real estate.
Long-term appreciation: Industrial properties tend to appreciate in value over time, and as shown in previous charts, values have significantly outpaced other asset classes and inflation.
Inflation hedge: Inflation can increase operating costs, but rental income from industrial properties can also increase, offering protection against inflation.
Tax benefits: Industrial real estate investments can offer favorable tax benefits, including deductions for depreciation and operating expenses.
Less oversupply risk: While other real estate asset classes may hit market saturation with more available properties than demand, this is less likely in the short term for industrial real estate, given the steady e-commerce trends, historic undersupply, and growing industrial space needs with the reshoring of manufacturing processes.
Investment Opportunities in Industrial Real Estate
While we are not investment advisors and you should speak with your own financial counsel, at Aspen, we are very excited about the opportunity in Industrial real estate, both in 2023 and in the longer-term.
If you’re curious to hear more about these trends and a specific investment opportunity, register for our webinar on Thursday, Feb 16, 2023 at 2pm Central.
*Please note nothing contained in this communication constitutes tax, legal, insurance or advice of any kind, nor does it constitute a solicitation or an offer to buy or sell any security or other financial instrument. If you are not the intended recipient of this message, any use, dissemination, distribution or copying of this communication is strictly prohibited. Investors should conduct their own due diligence, not rely on the financial assumptions or estimates displayed in this email or on the website, and are encouraged to consult with a financial advisor, attorney, accountant, and any other professional that can help you to understand and assess the risks associated with any investment opportunity. Investments in private placements involve a high degree of risk and may result in a partial or total loss of your investment. Private placements are generally illiquid investments. Investors should consult with their investment, legal, and tax advisors regarding any private placement investment. Please review the Private Placement Memorandum for a full explanation of this investment along with key risks.
Ben Fraser is the Managing Director and Chief Investment Office of Aspen Funds. Prior to Aspen, Mr. Fraser was a commercial lender at First Business Bank specializing in government backed loan originations (SBA & USDA), for one of the top SBA lenders in the nation. Prior to that he was a commercial credit underwriter for Crossfirst Bank, personally responsible for underwriting over $125MM in C&I and CRE loans across a variety of industries.
Just hearing the word “recession” can make any investor freeze up a little.
When the economy takes a dive – where should you park your capital? Should you pull all of your money out and hunker down? Will any opportunities weather the storm?
As investors, our goal is to make a return on our investment and preserve capital. This can certainly become more difficult in a challenging economic environment like a recession – but it’s possible.
While many investors are inclined to think there’s little money to be made through these times, the reality is that there are many viable opportunities that surface during a downturn.
The Keys to Investing During a Recession
All Recessions Are Different
While most recessions might feel the same in the sense that we tighten our belts as the stock market dips, the economy slows down, and unemployment spikes – the reality is that every recession is different.
What caused the last recession is not going to be what causes the next recession. The economic factors are never the same. The key to successfully navigating investments during a downturn is to understand what’s causing the economic shift.
Understanding the Economic Tides
One of the things we talk about all the time on our podcast is understanding economic tides – the big, long-term economic trends creating opportunities.
Anyone can be a successful investor when the economy is on a tear. After all, a rising tide lifts all boats, right? But if you also want to make money when other boats are sinking and the market isn’t piping hot, you have to understand what’s going on beneath the surface.
Some current examples of these “tides” are the state of supply and demand in housing, the emerging energy crisis, and how stimulus measures during the pandemic affected savings, spending and employment. These will give you insight into what will happen in the economy long term. Check out our 2022 special economic report for a fantastic overview on these trends.
There are always opportunities to profit during a recession if you align yourself with long-term trends that will continue despite headwinds.
“Be fearful when everyone else is greedy. Be greedy when everyone else is fearful.” –Warren Buffett
Have Liquid Reserves
Generally speaking, it’s good to have liquid reserves. Cash is necessary for personal living expenses and opportunities, especially if any surprises come your way. But cash is also important because some of the most significant investing opportunities will happen during a recession. If you have available cash, you can take advantage of those investment opportunities when they arise.
8 Recession-Proof Investment Strategies to Evaluate Opportunities
So if you have capital you’re looking to deploy, but are concerned about recession – what should you be looking for when you’re evaluating investment opportunities?
Emphasis on current cash flow. It’s not uncommon to find investments that offer a big return. But for most of them, that return is built into the backend – and may not for years into the investment before the business plan is achieved. During a recession, it’s important for investors placing their capital to emphasize investments with existing cash flow. If a real estate investment comes up against renovation obstacles because of a slowing economy or supply chain issues, or leasing the property is slower, cash flow can help weather that storm and continue making debt payments until circumstances shift.
Multiple exit strategies. It’s important even in the best of economic times to not have your strategy be contingent on one particular outcome. This is even more true during a recession when investments are more susceptible to unforeseen changes. Look for opportunities that include multiple ways to generate a positive return on your investment.
Overall leverage. When you’re considering an investment, evaluate the underlying capital stack (if you’re unfamiliar with this term, I have a very in-depth article that breaks this down). Deals with lower leverage will have more sustaining power during a recession because they have less debt service requirements. It should be easier to generate cash flow against lower debt payments. Higher leverage deals should be viewed with caution.
Diversification. Every recession impacts different asset classes differently. Even with a deep understanding of economics and investing, it’s impossible to fully predict what will happen. Diversifying and having exposure to a variety of asset classes will reduce your risk.
Big allocation in private alternatives. Private alternatives have many benefits, and if you’re diligent in searching for diversification, emphasis on cash flow, and multiple exit strategies, putting a portion of your investment dollars here can be advantageous. The hidden strategy here is that illiquidity, often considered a downside of many private alternatives, can actually be helpful during a recession. The temptation for many investors who do have liquid investments to sell during a recession is high, even though it’s usually a bad time to sell. Lack of liquidity removes the emotional reaction of selling at a bad time and can create better outcomes in the long run.
Three bonus strategies for investing in our particular current economic environment:
Inflation-protected assets. We believe inflation is going to remain higher for a while, so look for inflation protected assets like multi-family, self-storage, and residential housing; assets that will benefit from higher inflation.
Energy space. There is also a unique opportunity in the energy space, due to inflation and the brewing global energy crisis. Supply is extremely low, there has been little capital investment over the last decade, and though there’s been a strong effort to transition to ‘green’ energy, we cannot yet meet that demand and still rely heavily on oil and fossil fuels.
De-globalization. Supply chains have been majorly disrupted both during and post-Covid. The cost to deliver goods is high, driving many companies to bring manufacturing distribution back to the US. This will create additional opportunity in the industrial space, as US companies look to fulfill demand.
Ben Fraser is the Managing Director and Chief Investment Office of Aspen Funds. Prior to Aspen, Mr. Fraser was a commercial lender at First Business Bank specializing in government backed loan originations (SBA & USDA), for one of the top SBA lenders in the nation. Prior to that he was a commercial credit underwriter for Crossfirst Bank, personally responsible for underwriting over $125MM in C&I and CRE loans across a variety of industries.
As we near the end of the year, many people start evaluating their finances and thinking about how to prepare for the coming year. If you still haven’t made any financial moves, don’t worry – there’s still time. But you’ve got to move fast.
And with the unique economic circumstances – post-pandemic supply chain issues, headline inflation numbers peaking, and impending tax changes – it is important to evaluate how you can be set up for financial success. So how can you best prepare your finances to come out ahead?
Here are 4 things you can do to help you prepare financially for the end of the year and heading into 2022.
1. Focus on tax-advantaged investments
With taxes possibly rising next year, it’s a good time to not only be thinking about your investment strategy and the asset classes you think will perform well over the next several years, but also paying attention to an investments’ tax-advantages.
Tax-favorable investments can help lower your tax liability come tax season, which allows you to keep more of your wealth. And if you can deploy cash into certain investment vehicles before the end of the year, you may be able to apply those tax write-offs to your 2021 income.
One of the main tax advantages to look for is depreciation. When your investment portfolio includes assets that depreciate, whether something tangible like a property or intangible like a patent, that depreciation can reduce your taxable income or allow you to defer income taxes into future years. One of the best ways to get depreciation is by investing in private real estate syndications or funds. These have the advantage of being passive and many are still available to invest in before year-end. The best options are often available for accredited investors only, but if you aren’t, there are still some great choices available in Reg A+ funds.
Another tax-advantage to look out for is one where the earnings of the underlying investment are taxed as long-term capital gains, which can save you significantly on your tax bill compared to investments generating short term capital gains. Long-term capital gains taxes are on a graduated scale for taxable income at 0%, 15% or 20%. Capital gains tax rates may increase in the coming year, but they’ll still be lower than ordinary income tax rates.
And finally (my personal favorite), look for investments that can take advantage of opportunity zones. These zones are geographic areas designated as economically distressed, where investment is encouraged to spur economic growth and job creation. Money invested in these areas for certain lengths of times can reduce your cap gains to 0%, and also defer your taxes on previously earned capital gains. Again, many are available as passive syndications fundable this year.
It should be apparent, but never make an investment based solely on its tax advantages. That should only be one factor among many to consider. Also, it is important to discuss with a CPA how these tax advantages can work in your favor. There are certain rules and limitations on how these can be utilized in your personal situation.
2. Max out your IRA or solo 401K
If you have not yet maxed out your IRA or solo 401K account for the year, now is the perfect time to do it.
There are a few reasons to do this. Firstly, with traditional retirement accounts, you’re contributing pre-tax money, which means you’re investing more upfront than if you invested after-tax dollars. This gives your account a greater chance to grow over time.
The other primary benefit is that, because these are tax-deferred investments, you can reduce your taxable income by the same amount you contribute.
You can contribute up to $6,000 per year, or $7,000 if you’re over 50. If you’re a business owner with no employees, you can create a solo 401K and contribute up to $58,000 in 2021.
We would also recommend opening a self-directed IRA or 401K which provides much greater flexibility and options for investment.
3. Refinance your mortgage and take out your equity
We know many people find this topic controversial. Some people don’t feel comfortable with this strategy and would rather pay off their housing debt. But with inflation running at 6% and mortgage rates at 3%, “real” interest rates are below zero, meaning you are essentially being paid to borrow. This is one of the best strategies to make inflation work for you.
Inflation has a two-fold impact here. First, inflation works in favor of borrowers by deflating the value of your mortgage debt. Over the course of 15 or 30 years, as you pay back your mortgage, you are paying it with dollars that are worth less than dollars today. For example, if you take out a 30-year fixed-rate loan for $300,000, and inflation continues at 6%, you will pay only $120,000 in today’s inflation-adjusted dollars. See this fun inflation mortgage calculator here. Second, inflation generally increases asset prices, meaning your home may be worth more today than it was even a year ago. A cash-out refinance allows you to capture that extra equity and put it to use.
The key here is to invest the equity you pulled out into something that is stable and that can generate additional growth or income. And if the income or earnings from that investment are higher than the interest fees you’re paying on your mortgage, it’s a net positive.
It’s important to mention that before you embark on a change like this, you need to understand the additional risk you create by increasing your leverage. But as long as you have additional income coming in to cover your higher expenses, your risk is significantly reduced.
4. Deploy cash into inflation-protected assets
Last year we recommended that you keep some cash on hand, as the looming economic recovery post-pandemic and political transition added much uncertainty to the market.
This year, we’re recommending you deploy your cash (including the cash you pull from your home equity) into assets that provide protection against inflation. Those who lose the most in a high-inflation environment are those with hordes of cash, as the value of cash continues to decrease as inflation increases.
Assets that provide protection against inflation are assets whose value continues to grow over time, like real estate, which is our personal favorite. Others can include gold, cryptocurrencies, commodities, and even much of the stock market.
So, to wrap up…
Whether you are already fairly protected against future unknowns or plan to take action, the end of the year is always a great time to reevaluate your portfolio, current exposure to risk, and make changes heading into the new year.
Ben Fraser is the Managing Director and Chief Investment Office of Aspen Funds. Prior to Aspen, Mr. Fraser was a commercial lender at First Business Bank specializing in government backed loan originations (SBA & USDA), for one of the top SBA lenders in the nation. Prior to that he was a commercial credit underwriter for Crossfirst Bank, personally responsible for underwriting over $125MM in C&I and CRE loans across a variety of industries.
The term ‘alternative investment,’ might bring to mind an investment that only large institutional investors have access to, or at least an investment that is generally too complicated for the average investor to understand. This is a common misconception, and until recently, may have been somewhat true. But, with recent regulation changes, access to this class of investments has opened up to a much broader audience and the benefits are far more advantageous than you might expect. Precious metals, oil and gas, venture capital, hedge funds, real estate — all of these are part of the alternatives, or alts, class of investments.
All alternative investments fall into one of two broad categories: public or private investments. An alternative investment you’ve likely heard of are REITs, or real estate investment trusts. This is a common public alternative investment. Your financial advisor probably has mentioned them, and you may even have some REIT holdings in your portfolio. And while REITs can be an okay option, they miss a lot of the advantages of private alternative investments. Many investors aren’t aware of the distinction. However, private real estate funds significantly outperform REITs. We find the biggest gap in most investors’ portfolios are in private alternative investments, and that is what we are going to zero in on.
So, Why Invest in the Alternative Asset Space in the First Place?
If the average individual investor were to compare their investment allocations with the big guys, they’d find a massive difference.
Take a look at this data that highlights the disparity between how institutions (the big guys) and individuals invest.
The average institutional investor (hedge funds, family offices, endowments) has up to 30% of their portfolios in things other than stocks, bonds and mutual funds. These investments can be in real estate, venture capital, and hedge funds, among other things. Compare this with the average individual investor who is putting 95% of their money into the stock market.
While the public market (stocks and bonds) is not bad, these institutional investors know something regular investors don’t know about the benefits of alternatives.
This is another interesting chart showing the investment allocations of the Yale Endowment fund. This fund is an interesting case study because many decades ago, Yale diverted money from just stocks and bonds into more alternative assets like hedge funds, real estate, and even timber. This grew the endowment from $1.3 billion in 1985 to $31.2 billion in 2020.
Yale has outperformed its domestic equity index (an index fund that invests in US stocks) by a good margin over the past few decades, hitting nearly a 10% annualized return over the last 20 years ending July 2020. During that time frame, the stock market return was 6.2%.
So if the wealthiest and most successful investors are investing large amounts of their portfolios into alternatives and seeing better returns, why aren’t regular investors doing this?
Well, up until 2012, before the Jobs Acts passed, individual investors didn’t have many options outside the public markets unless you had pre-existing relationships with the sponsors. But now because of the passing of this Act, accredited investors now have access to private investments that before were reserved for bigger family offices, and institutional investors with relationships with private equity firms. Institutional investors have been investing in this asset class for decades, but now there are new avenues for individual investors to explore – and with some significant upside.
Different Types of Alternative Investments
Generally speaking, an alternative investment is something that is an “alternative” to stocks, bonds, mutual funds offered on Wall Street.
The most common types of alternative investments are: hedge funds, private equity, venture capital, oil & gas, and real estate. Some even extend the definition to gems and precious metals, art & antiques, and collectibles.
Here are some of the broadest categories of the most common alternative investments:
Hedge Funds: these funds can invest in a wide range of securities and are generally limited to publicly traded investments. There are many different types of strategies, but usually the goal is to use their specific strategy to generate returns in both up and down markets.
Venture Capital: these firms focus on investing equity into privately-owned companies. Generally, these companies are at an early-stage or start up level with the goal is to grow rapidly and eventually seek an exit either by acquisition of another company or by an Initial Public Offering (IPO).
Private Equity: this is probably the broadest category of the three, as it encapsulates all other private investments other than venture capital. Fund managers in this class can range from smaller million-dollar funds to multiple billions. The types of assets they invest in extend from real estate, to infrastructure, to oil & gas, to debt. Another large subset of private equity seeks to take controlling interests in operating businesses.
While hedge funds and venture capital investments do have many benefits for the investors that fit their criteria, the majority of investors will benefit more greatly from private equity alternatives, especially as that is where the greatest gap lies for most investors. Private equity alternatives are where we will concentrate our discussion.
6 Benefits of Alternative Investments
1. Generally Uncorrelated to the Stock Market
Every investor who has been in the stock market for any length of time has likely experienced some big wins… and major losses. Anyone who is nearing retirement or currently retired has experienced the heartburn with watching their portfolio drop, sometimes in dramatic fashion. Diversification is one of the main reason’s investors seek alternatives investments. A recent survey by iCapital Network of top U.S. investment advisors found diversification and attractive returns as two of the top reasons to invest in alternatives.
An investment that is uncorrelated to the stock market, means that it does not change relative to the ups and downs of the market. Many investors think they are diversified by holding REITS or other publicly-traded alternatives, only to find that they are just as volatile and don’t add much value to an investment portfolio.
And this is why we make the key distinction between public and private alternatives.
Many investors have discovered private alternatives as a way to protect against volatility, diversifying their portfolios. This way, when the stock market drops significantly, they have a hedge of protection and not all of their investment portfolio will be affected. The stock market is famously unpredictable, even in a stable economy, and alternatives are largely shielded from the unpredictable swings in the public markets.
A great example is in real estate. Let’s say you are invested in mortgage notes or have a rental property. Even though the stock market has fluctuated significantly over the last few months, your borrower or tenant is going to keep paying their mortgage or rent.
2. Lack of Volatility
In a traditional public investment, the share price fluctuates based on a variety of factors (many times not directly tied to a company’s performance), but is generally not tied to an actual asset. Because shares of a private investment are not publicly traded, you avoid the volatility of public investments. Plus, your investment is also typically backed by a real asset.
Some may say that volatility is not a concern if you are a long-term investor, and despite the ups and downs of the stock market, it still averages ~6-8% over the long-term (depending who you ask). But what they don’t understand is that volatility kills compounding. Here’s a scenario that might change your mind.
Below, I’ve shown two scenarios where you initially invest $100,000 and let it grow over 30 years.
In Scenario #1, you invest the $100,000 in the stock market. You have big gains, but also big losses (i.e. volatility). But, your “average” return over 30 years is 10%, not too bad, right?
In Scenario #2 you earn a respectable, but rather vanilla 9% return per year, every year.
Albert Einstein once said, “Compound interest is the eighth wonder of the world.” Here is displayed the incredible power of consistent compounding.
Scenario #1:
Scenario #2:
Even though the “average” return was lower in the second scenario, because it wasn’t volatile, it was able to compound and the end result is over 6 times higher than the first scenario. This a dramatic illustration, but the point remains, volatility kills the power of compounding.
3. Direct Ownership
In most public investments, what you’re buying is a paper asset – the discounted value of future expected earnings. You don’t really own anything. Even if you invest in a REIT, you’re many levels removed from having your name on the deed of the real estate property.
If you are buying fine wine or art, you directly own those bottles of wine or that oil painting. If you have bought a rental property, you directly own the home. If you buy a mortgage note, you have a lien against a property. Or if you invest in a private fund, generally have direct ownership of whatever asset they purchase. In the case of Aspen’s Income Fund, all investors become part owners of a fund whose name is on the title deed of each mortgage it owns. If Aspen were ever to disappear, investors would still retain that ownership in the mortgage and the rights as a lender to the property.
4. Direct Tax Benefits
Alternative investments can also provide compelling tax benefits. With many alternative investments you get to keep more of your profit because of the structure. In many private alternative investments, you become a part-owner of the fund or syndication and as such the tax benefits get directly passed on to you.
The two most important tax benefits are pass-through depreciation and long-term capital gains treatment. Many real estate funds or syndications deduct depreciation expense (a non-cash expense) from net income reducing taxable income. Oil and gas investments have very favorable depreciation/depletion tax treatment.
Aspen Funds uses pass-through LLCs of which investors become a part owner of. In our funds, a portion of the income is considered as long-term capital gains, which provides a very favorable tax treatment.
Many investors are also unaware that you can invest in private alternatives with qualified retirement funds, such as a 401K or IRA. Depending on how you structure the investment, you can grow your investment tax deferred or even tax free.
5. Strong Income
Not all private alternative investments are cash-flowing investments – i.e. they pay you back in cash on a monthly or quarterly basis – but there are many that do, generally in a cash-flowing real estate strategy. Some can produce strong income, in the 8-10% range annually. Many funds are structured to have a preferred return where the investors get paid first, in cash.
Anyone who has tried to generate income from public investments, such as CDs, bonds or dividend paying stocks knows how difficult this can be. We routinely talk with investors who are struggling to generate cash flow in their portfolios, generally in the low single digits. As already discussed, the public markets can be very volatile, increasing the risk just to generate a small yield.
Most busy investors place a high value on their time, and actively managing an asset or portfolio requires an enormous amount of work. Let’s take real estate as an example, as that is where most investors think to start actively investing. After getting excited about the prospect of purchasing a single-family home as a rental or even maybe, a small multifamily apartment, they quickly realize how much work is involved and how large the learning curve is. There is an endless supply of educators that are selling their “5 Step Plan to Success”, but ultimately it is hard work – finding co-investors, obtaining financing, structuring the deal, finding and evaluating properties, etc. At this point, many investors give up and just assume that there aren’t any other options.
But, again, because of the regulation changes there has been a whole new world opened up, many of which are completely passive. As an example, Aspen’s Funds are completely passive and don’t require any ongoing management from investors. The other advantage of truly passive funds or syndications is that you can leverage the expertise, team, and relationships of experienced operators.
Disadvantages of Alternative Investments
While private alternatives have many benefits, there are a few drawbacks. The most common roadblock for investors looking to get into alternatives is liquidity. If you’re investing into a private fund, most will have a lockup period anywhere from 3-10 years before you can withdraw your initial investment (though many pay out a return during the lockup period). This makes sense when you understand private funds are generally tied to an asset and to liquidate an investment requires liquidating the asset.
However, some classes of private alternatives, like note investing, can overcome this hurdle because there is an active secondary market. In our Income Fund, we have designed it to have only a 1-year lockup period with liquidity thereafter.
Another disadvantage, is that many alternative investments require investors to be accredited (hyperlink to definition), i.e. a high net worth investor. However, changes to regulation continue to open up more options to non-accredited investors.
Who Are Alternatives Right For?
Alternative investments can be a great fit for any individual who wants to further diversify their portfolio.
Depending on your stage of life and level of interest in actively managing your investments, different alternative investing strategies will be more appealing.
Active Investor
For the active investor looking to roll up their sleeves, many popular alternatives in real estate, as well as other industries, open up. Ideal alts for active investors include owning rental properties, flipping houses, or private equity with more of an active management approach.
Passive Investor
For the passive investor, alternatives can provide strong returns that won’t require additional time to manage. Alternatives that are ideal for this type of investor are private equity, mortgage note fund investing, collectibles and precious metals.
Retired or Income-Focused Investor
For those in or nearing retirement or looking for income, alternatives provide a low-volatility source of income, similar to dividend investing, allowing investors to replace or supplement their earned income or retirement income. Alternative investments that fit best for this type of investor will mostly fall within funds — private equity funds, private REITs, private real estate funds, etc.
Ben Fraser is the Managing Director and Chief Investment Office of Aspen Funds. Prior to Aspen, Mr. Fraser was a commercial lender at First Business Bank specializing in government backed loan originations (SBA & USDA), for one of the top SBA lenders in the nation. Prior to that he was a commercial credit underwriter for Crossfirst Bank, personally responsible for underwriting over $125MM in C&I and CRE loans across a variety of industries.
Billionaire Andrew Carnegie was once quoted saying that “90% of all millionaires become so through owning real estate. More money has been made in real estate than in all industrial investments combined.” I don’t know if that number is true, but it’s undeniable that real estate has been a consistent place for long-term wealth creation.
While most investors get excited about the idea of investing in real estate, that excitement quickly dissipates when they imagine buying rental properties and then dealing with difficult tenants and property maintenance issues.
Thankfully, in the last decade there’s been a massive shift in the democratization of investing in real estate. Investors can now invest passively in a variety of real estate assets, without the headaches of traditional property ownership. This is especially enticing if you’re a high-earning individual and you don’t want to leave your day job, or if you are approaching retirement and need passive income. [Note: while there are several investing options for those building their net worth, the majority of opportunities are reserved for accredited investors.]
But with this shift towards opening up the wide world of passive real estate investing, a new challenge has arisen. With so many options available, where do you even start?
This is what I’m going to cover in this article. I want to help create a framework for understanding the wide world of passive real estate investing and what is available. Once you understand the basics of these frameworks, you’ll be better equipped to evaluate potential investment opportunities and their risks.
Before we dive in, the most important question should be addressed first – what are the advantages of investing in real estate?
Why Invest in Real Estate in the First Place?
First, common sense says that to be a successful investor, you should model what other successful investors are doing. And the simple fact is, most ultra-high net worth investors love passive real estate investing. TIGER 21 is an exclusive investor group for ultra-high net worth investors. According to a recent poll of their investor database (which accounts for around $85Bn of collective wealth), these investors have allocated a large portion of their wealth to real estate (their highest allocation percentage, by the way).
Let’s take a look at some of the popular reasons investors choose to invest passively in real estate:
Your investment is backed by real assets
The stock market is arguably the most common investment avenue, given its extreme ease. But, when you invest in stocks, you’re essentially betting on the future earnings of the company whose stock you’re buying. Sometimes those bets work out, other times they don’t. This creates significant volatility (or large price swings) and carries a risk of losing your investment.
But with real estate, your investment is generally backed by a physical asset. If you invest in apartments, you are an owner of that property. If you invest in a self-storage facility, you are an owner of that facility. If you buy a mortgage note or tax lien, you are a secured lender and have a legal right to the property if the borrower doesn’t pay. This provides a hedge of protection around your capital and mitigates the risk of loss.
Returns are generally higher
Researchers from the Federal Reserve Bank of San Francisco published an extensive research paper in 2017 called the Rate of Return on Everything, 1870-2015. They found that over the last 150 years real estate was the best-performing investment class.
Lower volatility
The aforementioned research paper also addressed another very important consideration when investing: risk, as measured by volatility.
While two different investments can have the same return, to compare apples-to-apples, you must look at the risk-adjusted return. This accounts for volatility, or the degree to which the value (price) of an asset changes. If an investment has wild price swings, it is more volatile, making it more risky.
And based on their exhaustive research over the last century and a half, the bank found that real estate was significantly less volatile than the stock market.
Next, I’m going to break down the broad categories of passive real estate investing by:
Types of passive real estate investment
General investing strategies across different investment classes
Different parts of the capital stack
Most common structures when passively investing.
Types of Passive Real Estate Investments
When looking at the types of real estate investments available to investors, I group them into 3 broad categories: residential, commercial, and miscellaneous.
Residential
Passive real estate investments that fall into the residential category are mostly short- and long-term rentals. A second kind of residential real estate investment that is less well known is to purchase the debt or mortgage note on a property. When you own the mortgage on a property, you are paid the monthly payments and interest as though you were the bank. In many cases, these notes are bought at a discount and can generate high consistent income for investors.
The value of these residential investments is driven by comparable sales. We’ve written about this extensively, but we are bullish on the residential market due to limited housing supply and increasing demand.
Commercial
Commercial investments in real estate span quite a range. The most well-known is multifamily housing (or apartments), another common choice for those looking for investment properties. But beyond multifamily, there is also:
Retail
Industrial
Office
Hospitality
Self-storage
Mobile homes
Low-income housing
Farmland
Senior housing
Student housing
That’s quite a list. The world of commercial real estate investment is expansive. And while it is beyond the scope of this article to break down the pros, cons, and value drivers of each asset class, it is best to view each asset class from a macro-economic perspective, looking at the long-term drivers of supply and demand, when evaluating an opportunity. This is important as many of these types of investments have long-term time horizons, where you may be invested for 5, 7, or 10 years.
In contrast to residential real estate, the value of commercial real estate investments are driven by cap rates, or capitalization rates, which is the net operating income generated by a property divided by the price. This is effectively the yield (or rate of return) a property generates on an unleveraged basis.
Miscellaneous
The last category is a catchall for more unique real estate investing strategies. Two that I’ll briefly highlight are tax liens and raw land.
Tax liens are issued by a municipality when a borrower fails to pay their property taxes. Similar to a mortgage note on a property, tax liens can be purchased at discounts and secured by the property.
Raw land, just like it sounds, is a plot of undeveloped land. For investors, this is often a long-term play, banking on the land appreciation and/or future potential development, or it can be wholesaled for a quicker profit.
Passive Real Estate Investing Strategies
There are 5 main strategies when it comes to investing in real estate, each with their own set of advantages and disadvantages. I’ve ranked them in order from most risky and highest potential return, to least risky and lowest potential return.
Distressed real estate investing
Distressed real estate investing is when an investor buys an existing asset that has some level of distress and fixes it. Oftentimes these assets have price tags far below the actual intrinsic value, selling at a discount because not everything is operating as it should.
While there are always opportunities to invest in distressed assets, greater volume of distressed assets often comes in counter-cyclical waves. When there is distress in current economic cycles, it creates pressure and often results in underperforming assets.
Because of the nature of fixing an asset in distress, investors should make sure the operator they work with has the track record and expertise needed to turn the asset around. This is critical.
While distressed asset investing can carry significant risk, it can also produce outsized returns.
Real Estate Development
Real estate development is when an investor identifies there’s a need for a particular type of property (e.g. apartment building, hotel, etc.) and builds it. Investing with experienced developers is very important as the development process can include buying the raw land, taking it through the entitlement process, getting the development plan approved, securing building permits, etc.
Opposite of the distressed real estate investing strategy, development is often pro-cyclical. Meaning, as the economic cycle is booming and demand increases, development projects do well. As the economic cycle turns, development is usually the first to take a hit.
Because of the scale and long timelines of these projects, there can be a lot of risk:
Market risk – no demand for the asset by the time it’s finished
Interest rate risk – project takes too long and return is minimized from high interest rates
Construction costs risk – overhead costs of development increase (e.g. materials, labor, etc.)
Plan approval risk – plans or permitting may not come through
Again, though there are many risks involved, there is also opportunity for significant gain.
Opportunistic Strategies
Opportunistic strategies in real estate represent an opportunity to reposition an asset, for example turning a hotel into multifamily housing, an old mall into a warehouse or office space, or an industrial facility into a storage facility. Many times the cost to reposition as asset is less than a new development, which creates margin for potential profit.
As trends change over time, it stands to reason that properties uses can change too. Opportunity in this strategy is driven both by macro-economic trends, as well as changes in particular markets.
Again, since these opportunities are often big and expensive undertakings, it’s very important to find sponsors with a good track record doing this before investing. But like the distressed and development strategies, there’s potential for high returns.
Value-Add Strategies
The value-add strategy is one of the most common strategies when it comes to investing in real estate. As the name indicates, value-add means taking an existing asset and improving it somehow. The majority of passive investment opportunities in real estate likely fall into this category.
Here’s an example. We know someone who bought an apartment building with several hundred units. The new owner researched the market to find out what was in demand in the area and found that 1-bedroom apartments were in greater demand than the 3-bedroom layouts in his property. So, he took a portion of his large 3-bedroom units and converted them into two 1-bedroom units. The 3-bedrooms would rent for $875 a piece, but the 1-bedrooms would each rent for $600, creating an extra $325 in monthly rent for each of the units he converted. The new owner created $2M in value on a $10M asset by doing that, and because the units were then new, could rent them at top-tier prices.
Value-add strategies seek to increase the net operating income by either reducing expenses or increasing revenue. These strategies are used on underperforming properties (though not necessarily distressed) and carry less risk than the strategies mentioned prior.
Core Strategies
The final strategy is investing in core assets. Opportunities that fall into this category are usually institutional assets in metropolitan areas, like a beachfront apartment complex in Miami. It’s a stable asset without a lot of downside. Because of the high-quality assets, however, the returns will be lower, though they are lower risk.
Capital Stack in Passive Real Estate Investing
There are 3 primary ways to passively invest in real estate. Capital stack is a common phrase used, which refers to how an asset is owned, either through debt, equity or some combination.
Debt
Senior debt is generally in the first position, meaning it is the first money paid out and is often secured. This level carries the least amount of risk.
Typically, institutional investors invest in debt because they get paid first. Because of this, there is lower risk, and your capital is more protected.
Debt is often thought of as low-yield but can actually be high-yield in many cases, especially in distressed debt investing.
Preferred Equity
The preferred equity position in the capital stack is a junior position, paid out after senior debt, but before the equity investors.
Sometimes there are may be two types of equity offered by a sponsor: preferred and common. Preferred equity investors get paid first and often at a higher rate (like 8-10%), but they do not share in the upside if the project performs well. There is less risk, but returns are usually capped.
Equity
The second type of equity and final part of the capital stack is common equity. Equity investors are usually betting on the upside of the project, and as such have to believe in the strategy of the sponsor. At this level, they’re taking the most risk that the asset will perform well. If it does, they will make the most money, but lose the most if it doesn’t.
In every deal, there is something call the cash flow waterfall, which is simply the order and timing that each position in the capital stack gets paid. When evaluating real estate opportunities, these are the questions you want to be asking:
Where am I in the capital stack?
How do I get paid?
When do I get paid?
Investment Structures in Passive Real Estate
There are 3 common structures when investing in real estate passively, generally falling into one of 2 buckets: public and private.
Public
Public REITs are what most investors are experienced with. In general, investing in publicly-traded investments can give investors greater insight into their investments and can provide high levels of liquidity, as there is an active market to buy and sell shares. The downside is there can be lots of volatility.
REITs
REITs are usually the first step for investors looking to diversify outside of stocks and bonds.
REITs purchase or finance income-generating commercial real estate, everything from offices and warehouses, to medical facilities and data centers. They are publicly traded on major stock exchanges.
While REITs can provide some diversification, over the last few years the correlation of REITs tends to follow the trends of the broader stock market fairly closely, providing less diversification over time. Because of that, REITs tend to be volatile. You also don’t get any of the tax advantages of investing directly in real estate when investing in REITs.
Private
In a private real estate investment, you are investing directly with the operators of an asset. Successful operators have a specific strategy and a good track record. Private investment opportunities do not trade in the public market. These are often called alternative investments, or alts, and can be a powerful addition to an investor’s portfolio.
Syndications
Syndications generally pool money from numerous investors in order to purchase a large, single asset. It will have a specific strategy and timeline associated with executing said strategy. Once the execution is complete (which can take several years), they will either refinance or sell the property, hopefully for a profit, return your capital, plus whatever interest you got paid along the way.
Pros of syndications include a higher level of visibility into the specific asset being purchased, as you are aware of the property prior to investing. The primary drawback is a lack a diversification, with your investment all going to a single asset.
Funds
Funds gather investments from numerous investors and deploy it to buy many assets in a single fund. This can be within multifamily, commercial, or residential real estate notes. These are often blind pools, and you won’t always know what’s included. Instead, you might know a range of requirements the sponsor is evaluating against. Because of this you need to trust the sponsor’s track record, underwriting process, and that they have the expertise to execute their strategy.
Generally, the benefits include greater diversification within the number, type, and geographical location of assets, while drawbacks include limited visibility into the assets being purchased.
Drilling down even further, there are closed-end funds and open-end funds. Closed-end funds generally have a target investment goal and raise funds for a window of time, before closing new investments, deploying the capital, and then working through their determined exit strategy. An open-end fund, also called an evergreen fund, allows investment at any time and deploys capital and works out exit strategies on a continual basis. This is how the fund we operate works.
I know this was a lot of information to digest, but understanding these frameworks will make you a better investor as you pursue investing passively in real estate.
Ben Fraser is the Managing Director and Chief Investment Office of Aspen Funds. Prior to Aspen, Mr. Fraser was a commercial lender at First Business Bank specializing in government backed loan originations (SBA & USDA), for one of the top SBA lenders in the nation. Prior to that he was a commercial credit underwriter for Crossfirst Bank, personally responsible for underwriting over $125MM in C&I and CRE loans across a variety of industries.
This article was originally published on Forbes.com.
With housing prices having just finished their eighth consecutive year of strong gains, you may be sitting on a good amount of equity in your home. Sitting on that equity can feel great. But is it the smart choice? Or, does it make sense to take advantage of record-low interest rates with a cash-out refinance and put that equity to work elsewhere? In this article, I want to provide a framework that should help you evaluate your personal situation.
The State Of Housing Prices
Easy money policies have been in place since 2008, and their main effect has been to produce asset price inflation. Almost every asset class has been buoyed, including housing prices. Since 2013, housing prices have grown by roughly 5% or more per year, with 9.2% growth from December 2019 to December 2020.
For many homeowners, this has translated into one thing: equity. And that leads to the question: Is now the right time to pull equity out of your home?
The Case For Pulling Your Equity Out
There are, of course, a lot of things to consider when weighing the decision about refinancing or not. We’ll take a look at the risks shortly, but let’s first consider a few factors that make a case for pulling out your equity.
• Mortgage rates are at historic lows. One of the biggest factors that makes a cash-out refi so appealing is that it’s currently cheap to borrow money. With mortgage rates being this low, there are many other places you could put your withdrawn equity that could earn you much more than you’d be paying in mortgage interest.
Not to mention, because rates are so low and you can lock your rate in for a long time, a refinance at this time could mean your new mortgage payments might not increase much, if at all.
• Inflation makes fixed-rate debt attractive. Many people overlook this valuable feature of debt. If you get a 30-year, fixed-rate mortgage, your mortgage payments over the lifetime of the loan actually get cheaper in terms of real dollars. As inflation continues over those 30 years, you’re making payments with dollars that are worth a little bit less each year. Inflation is a smart debtor’s best friend. Our analysis shows inflation is not a risk right now but may be in the future. Without inflation, leveraging this debt can be a win. But if there is inflation, this could become a home run.
• Borrowed equity is tax-free, and interest is tax-deductible. Borrowing the equity in your house also provides several tax advantages. First, the equity you borrow is not taxed because it is borrowed. Second, the additional interest you pay on your mortgage is tax-deductible, making your effective borrowing cost even lower.
• Having liquidity creates opportunity. Having cash or quick access to cash allows you to take advantage of opportunity when it comes your way. This is especially true in an economy recovering from Covid-19 because there are opportunities in distressed or discounted assets on the horizon, among other things.
What About The Risks?
While the opportunities associated with pulling your equity out are strong, nothing is without risk. Here are a few scenarios where it doesn’t make sense to cash out:
• You have a high debt-to-income ratio (DTI). If you’re already overleveraged and your DTI is high, you shouldn’t do anything to increase your debt. This only exposes you to more risk.
• Your income is at risk. When leveraged folks get in trouble is when they lose the ability to service the debt. If your job or business income is at risk or unstable, this strategy is not for you.
• Your new investment vehicle isn’t stable. If you increase your debt and then invest in something volatile or unsure, you risk losing your capital and being in a worse position. Picking the right vehicle is important, so there’s a hedge of protection.
What About If We’re In A Housing Bubble?
I don’t believe the overall housing market is in a bubble or at risk of “correcting.” But I’d argue this point doesn’t matter much anyway, so long as you can still earn with the capital from your equity. Say you were to pull out money and then the value of your house tanks. Well, you might be unable to sell your home until it recovers in value, but as long as you have invested wisely, you still have that extracted capital generating additional income or growth.
This is the whole point of pulling out your equity: To put that capital to work earning for you by finding a stable, safe investment earning more than the interest rate on your loan.
Deciding Where To Invest The Money
The main factor you want to be looking for when deploying this capital is low volatility. This certainly removes things like bitcoin and other cryptocurrencies or your brother-in-law’s startup, but also the stock market and public real estate investment trusts (REITs) from the list, given the volatility.
You want to find something where the risk of loss is minimal. This could include municipal bonds, which though yields have been lower in recent years, generally see positive returns, with tax benefits too. Dividend-paying whole life insurance is also safer and can earn 5%-6%. Real estate runs the gamut of risk and return, but returns of 7%-9% are doable.
There’s Opportunity, But You Need To Weigh The Risks
The short version of this is that when done wisely, pulling out your equity can provide an opportunity to increase your net worth and cash flow, though I recommend you weigh the risks and make sure you have a safe, reliable investment vehicle to put your equity into.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
Ben Fraser is the Managing Director and Chief Investment Office of Aspen Funds. Prior to Aspen, Mr. Fraser was a commercial lender at First Business Bank specializing in government backed loan originations (SBA & USDA), for one of the top SBA lenders in the nation. Prior to that he was a commercial credit underwriter for Crossfirst Bank, personally responsible for underwriting over $125MM in C&I and CRE loans across a variety of industries.
We’re coming up on that point in the year when most people start thinking about finances, estimating how much income you’ll earn, evaluating how your investments are performing, and how it all will impact your taxes.
It’s a great time to start preparing for the coming year.
With this in mind, it’s important to take account of your financial strategy so you’re not caught off guard by any major swings in the market.
Here are 5 things you can do to help you prepare financially.
1. Store up cash or liquid assets
Today, many people forget that cash is a valid investment class. Cash is not only the safest asset class, in turbulent times it can also be the top performing asset class, and having access to cash in turbulent times can mean the difference of sinking or swimming. Having cash, or the ability to quickly access it, is an extremely important aspect of your investment strategy during uncertain markets.
By having some reserves set aside, you create a buffer in case your income or financial needs change.
As important as creating financial breathing room, having some cash set aside will make you more prepared to take advantage of investment opportunities that may present themselves. As a result of the ongoing economic challenges, there may be opportunities to purchase discounted or distressed assets. If you have cash available when others don’t, you’re going to be at a major advantage. As an example, think of those investors that had cash available after the 2010-11, after the crisis, and were able to purchase deeply discounted real estate in desirable areas when others were selling out of financial distress.
Another part of your investment portfolio to evaluate is your semi-liquid assets, such as lines of credit, short-duration money markets or CDs, or other assets with some measure of liquidity. Semi-liquid investments still provide some return, but are easier to access or liquidate. Moving some of your capital into semi-liquid investments can be a good strategy in addition to storing up cash, so long as you can access your money if/when you need it.
2. Refinance your mortgage and take cash out
Now this is likely a controversial topic, and may even seem counter-intuitive as part of de-risking your finances. However, with a strong housing market and historically low mortgage interest rates, this can be a great strategy to take out some of the equity in your house, while possibly keeping your monthly housing payment similar or the same.
You may be asking, “How does increasing my debt reduce my risk?” Well, it all depends on what you do with the cash you take out. If you use it to go and buy a boat or new car, that wouldn’t be very wise. But, as we just discussed in the prior point, having extra cash will provide you with reserves and an opportunity fund.
We encourage folks to get as much 3% money as they can, as long as they can put that money to work safely for more than 3%. We live in extraordinary times, and those with access to credit have unequal advantage over those who don’t, and if you do, you should make abundant use of it.
Debt is a tool of the wealthy and a key component of wealth creation if used wisely. We shouldn’t fear debt, but learn how to master it, like the wealthy do.
If you run into financial challenges and don’t have cash, sitting on a lot of equity in your house isn’t going to help you in the short run. If anything, it will only make the decision to foreclose that much easier for a bank if you have a lot of equity.
In sum, if you have cash, you’ll create a lot more peace of mind and opportunities. You can also use some of that cash to create another income stream Which leads us to…
3. Create another income stream
The oft-quoted statistic is that the average millionaire has seven streams of income. Whether or not this is the magic number, the reality is most high net worth individuals (HNWIs) have multiple streams of income.
We’ll spare you another list of “14 side hustles that take over all your free time and will earn you $1K a month.” But we do recommend creating additional sources of income.
The logic of doing this is intuitive, as having multiple sources of income creates diversification, and makes you less reliant on just one source.
Creating a new income stream can mean a lot of things, and can broadly be categorized into active and passive income. This can include anything from a side consulting business to passive investments in real estate. Most HNWIs look for something that is passive, where they don’t have to trade their time for money. Often they work with other private equity fund managers or real estate sponsors to generate this passive income, like we do with our Income Fund.
Having another source of income can help provide more margin in your budget and safe-guard you against any surprises.
4. Focus on tax-advantaged investments
This is always an important consideration for HNWIs. But especially in an election year.
Depending on how the election plays out, we may have very different tax rules come 2021. It’s a good time to not only be thinking about your investment strategy and the asset classes you think will perform well over the next several years, but to also pay attention to tax-advantaged investments. Tax rules may be changing and it’s important to be aware of those changes and take advantage of different investments that have more protection against higher taxes.
Finding investment opportunities where earnings are taxed as long-term capital gains can save you significantly on your tax bill compared to investments generating short term capital gains or ordinary income. Long-term capital gains taxes are on a graduated scale for taxable income at 0%, 15% or 20%. Much lower than short-term cap gains taxes.
Another big tax advantage to be aware of is depreciation. When your investment portfolio includes assets that depreciate, generally real estate, that depreciation can reduce your taxable income or allow you to defer income taxes into future years.
5. Consider opening a self-directed IRA
A lot of investors have been opening up self-directed IRAs (SDIRAs) to expand their investment opportunities with their qualified monies.
Most employer IRAs or IRAs at large custodians are usually limited to the investments on those platforms. By using an SDIRA, it completely opens up the opportunity set you can invest in, allowing you to self-direct your investments into options like real estate, gold, alternative assets, and private funds.
The main value of using a SDIRA to expand your investment option is diversification. You can diversify some of your risk away from the current volatility of the market, and truly invest in alternatives vs other publicly-traded investments that are all correlated together. If alternative asset classes are new to you, you may be interested in learn some benefits of alternatives.
It’s easy to put off reviewing your financial strategy, but now is a great time to take stock of your current financial situation and make a few changes. Evaluate your investment portfolio, exposure to risk, access to liquid assets, diversification and tax implications. Hopefully this has sparked some ideas for you to make changes heading into the new year.
Ben Fraser is the Managing Director and Chief Investment Office of Aspen Funds. Prior to Aspen, Mr. Fraser was a commercial lender at First Business Bank specializing in government backed loan originations (SBA & USDA), for one of the top SBA lenders in the nation. Prior to that he was a commercial credit underwriter for Crossfirst Bank, personally responsible for underwriting over $125MM in C&I and CRE loans across a variety of industries.
We have been asked a lot recently by current and potential investors about how our funds are weathering the pandemic and whether there is any cause for concern given current economic circumstances. Very simply, our funds continue to perform well, and we have every expectation for them to continue to do so. Our monthly preferred returns have remained consistent and undisrupted. In fact, we continue to raise capital at a rapid pace from investors looking to diversify out of the stock market.
There remains a lot of uncertainty in the economy with a plunging GDP and high unemployment rates. But our founders, Jim Maffuccio and Bob Fraser, after suffering losses in two previous downturns, specifically designed the Aspen Funds’ business models to be robust and able to weather economic storms.
Investors have asked why the fund continues to perform well, and if we expect that to continue.
We don’t have a crystal ball, but we remain cautiously optimistic and have outlined 5 reasons why we expect continued strong performance of our Aspen Income fund:
Deep equity repositioning. Several years ago, we made a strategic and significant shift in our portfolio composition. We began shifting our portfolio to generally stronger equity positions that would be more capital protective. Our portfolio today reflects these efforts. Our overall portfolio Investment-to-Value (ITV, or cost basis relative to collateral value), is 60%, which means, on average we have 40% equity covering our positions.
Refinances. Given the continued low interest rate environment, banks today are slammed with requests for refinancing. Our borrowers too are refinancing, and unlike other lenders, when an Aspen loan gets paid off in a refinance, we profit. On average, Aspen pays 69 cents on the dollar for our loans. So, when one of our borrowers pays us off with a refinance at 100 cents on the dollar, we make a profit.
Solid price to rent ratios. A key underwriting factor we evaluate is the price to rent ratio of each asset. In most cases, Aspen borrowers pay far less to live in their home than if they rented. This creates a stickiness factor for current homeowners too, as it is cheaper to pay their mortgage than rent elsewhere. Additionally, this becomes an alternate source of cash flow in a worst-case scenario and we take the asset back
Home prices. Our economics research team has continued to uncover indicators of strength in the price of residential real estate. There is abundant evidence of strength underlying the housing market, especially in the entry-level & middle market. And with the Fed again stepping in to purchase mortgages, we will see mortgage rates driven to the floor, which will add further support.
Bankruptcies. We have seen a slight uptick in bankruptcy filings. But bankruptcies actually help Aspen. As a secured lender, our loan is preferentially treated by bankruptcy courts. Any unsecured loans wiped out by the borrower free up cash flow to pay the secured lenders like Aspen. And instead of relying on the borrower alone for payments, we now have the bankruptcy court enforcing borrower payments to Aspen.
Bottom line, this fund owns 470 great assets, in bread-and-butter homes across the US, homes that today have now become a family’s very sanctuary from the crisis.
If you have any questions on this fund’s performance, or would like any additional information, please feel free to reach out.
Ben Fraser is the Managing Director and Chief Investment Office of Aspen Funds. Prior to Aspen, Mr. Fraser was a commercial lender at First Business Bank specializing in government backed loan originations (SBA & USDA), for one of the top SBA lenders in the nation. Prior to that he was a commercial credit underwriter for Crossfirst Bank, personally responsible for underwriting over $125MM in C&I and CRE loans across a variety of industries.
Private Equity: this is probably the broadest category of the three, as it encapsulates all other private investments other than venture capital. Fund managers in this class can range from smaller million-dollar funds to multiple billions. The types of assets they invest in extend from real estate, to infrastructure, to oil & gas, to debt. Another large subset of private equity seeks to take controlling interests in operating businesses.
