Passive Investing — Is it Right for You? An Interview with Joel Block
Empire Investment Club: What characterizes an active investor versus a passive investor in today’s real estate investing environment?
JB: Active investors are people who own their own properties and may manage those properties themselves or have a property manager manage them. Active Investors need to have some expertise and a network of connections in order to be successful. In other words, you have to be able to get deal flow. Also, you don't want to go into the multiple listing service because that's not really deal flow—that's kind of average market availability properties that more people are looking at so it’s more competitive.
Typical brokers offer mainly average properties, so you're only going to perform average or probably even below average. What you really want is access to properties that you wouldn’t have access to otherwise, so where do you get them from? Well, you get them from people who are in the know—people who spend their whole day being in the know. For example, if you're a doctor and you spend your whole life studying certain things that are very complicated you get very, very good at that after a while. Investment real estate professionals have expertise that might be about understanding markets, pricing or conditions, plus they know people and have a network they rely upon. They can predict when things are going to come on the market before other people do, such as relationships with banks and mortgage companies who provide early access to off-market or foreclosure opportunities.
There's another a group of people who are just too busy—passive investors fall into this category. For example, if you're a professional and you're busy running your business, you know your main goal when you get paid is for your money to work as hard as you do. If your money is not working as hard as you do, there's an imbalance and you're not really maximizing the opportunity that comes from leveraging your passive time. Because you only work a certain number of hours a day, so the rest of the day, the clock can be working for you. It can be leveraging your money
EIC: What are your thoughts about diversifying your portfolio with real estate?
JB: You have to put that money to work and you have to put it to work somewhere. A lot of money gets put into the stock market through retirement funds and other things. However, many people will ask for their portfolio to have some exposure to real estate. You want to expose your portfolio to stocks and you want to expose your portfolio to things that are going to escalate to create real diversity across all of your investments.
“Real estate is dealing with something that’s unusual...there’s an imbalance of supply.”
I think the stock market has kind of topped out for a while now. Inflation is going to start to press it down a little bit, although it's still holding pretty well. But the market has really risen a lot in the last five years. I don't think we're going to take a precipitous drop, but I think that we're at the top. What the market is going to do is difficult to predict, but it does have cyclical fluctuations over time.
Real estate is dealing with something that's unusual. As interest rates go higher, real estate prices tend to come down. But because there's such an imbalance of supply because they haven't done a good job of building over the last ten years—there hasn't been enough new inventory built to keep up with the demand plus there's a whole new market of these millennials. They delayed home purchases for about ten years. They didn't follow the normal pattern of young people who get married in their twenties, buy a house in their thirties, etc. Millennials disrupted the pattern.
There is demand all over the country for real estate because young people and new people are coming into the market and they're coming in with a lot of money. We have a lot of foreign buyers and people who make very, very good wages. Real estate prices are high and they're going to probably stay high and they even go higher and that's the environment. It's basic supply and demand.
In this economic environment, if you're not getting your money to work for you as hard as you could be and you don't have time to take care of tenants and toilets, then you need to figure out how are you going to get exposure to real estate. The way that you do that is by partnering with somebody who's an expert in the field. That's why passive investments in real estate are so strong. The private securities market is where most wealthier people invest. That doesn't mean it's only for wealthy people, but wealthier people certainly play in this arena.
Real estate is less liquid—it’s a long-term investment. If you’re not going to buy a building directly, or if it’s too much for you to do by yourself, you find someone in the business to find people to be in a group and align yourself that person. These people are called issuers, syndicators, and are the active investors. They have deal flow, knowledge, access and much of what they put together is very favorable. The main reason investors go into it is, 1) they are too busy/can’t do it themselves, and 2) they want to mitigate their liability.
EIC: What kinds of passive investments are there in the real estate industry?
JB: Every asset class—houses, duplexes, triplexes, apartment buildings, nursing homes—an investor can go into groups that are selling those things. The private security market is bigger than the U.S. stock market. Most real estate is held in private securities, but you can’t easily sell these securities. A REIT is something sold as a share, and is more complex than private securities.
EIC: What if an active investor has properties and wants to participate in a syndicated fund such as the Empire Capital Fund (ECF), but all of their cash is tied up in their current properties?
JB: They’re not likely going to refinance those properties to get into another deal or a fund like ECF. If the preferred return is 8% and they can borrow at 4%, it’s favorable to reinvest. If they’re paying 6% in interest and the return is 8%, the spread isn’t enough of a margin, so it’s not favorable. It’s better if they extra cash that’s liquid and accessible. Some choose the option of a self-directed IRA (SDIRA). Many people have assets tied up in retirement funds. In an employer situation, they can leave their assets with the asset manager, but if they leave the company, they have flexibility. They can either leave the money or take it and self-manage the money in an SDIRA. They could put it into a private investment that has a higher return. The SDIRA moves the money for them. They are designating where it goes; they control it. SDIRAs offer more flexibility than a lot of people realize.
EIC: How does this relate to and work around a 1031 Exchange?
JB: The real estate environment has special tax rules. An investor would sell a four-unit building, get the cash, pay the tax, and use the money to buy the next building. If they are trading one thing for something else, especially if they’re similar like-for-like real estate for real estate, the tax is deferred until the end. (Like-Kind Exchanges from the IRS)
EIC: Is it good for a portfolio to have both passive and active investment strategies?
JB: It’s not good or bad, it’s a personal preference. If you like getting your hands dirty, dealing with tenants and toilets, active investing is fine. If you want to just be a doctor, take the personal money and spread that money, into investments, that’s a good strategy as a passive investor.
EIC: What are the downsides of active investing?
JB: Uninsured accidents, interest rules change, taxes change, etc. The same is true for passive investing, however, passive investing is where you’re dependent on someone else to do it for you. Some people are hands-on. It’s a personal decision. Some people love passive investing. Some people love active investing. Some people have a hard time with passive because they are dependent on someone else. It’s a relationship business. People need to be educated about options they have and don’t have.
EIC: Why don’t more people invest in private securities like the ECF and what is the risk?
JB: Jennifer de Jesus is low risk because she’s defined and knows the area and has the network to build a portfolio with higher yield potential, otherwise she won’t invest in those properties. Most of the challenge for private security funds such as Jennifer’s ECF is awareness and building relationships, which Jennifer is doing more of, selectively, to bring more people together to invest in the ECF who are looking for a trustworthy fund manager. 🏠
Joel Block, CPA, CSP, is the founder of the Syndication and Hedge Fund Symposium, Joel Block is a Certified Speaking Professional (CSP) and a recognized expert in Investment Crowdfunding. Joel runs a real estate hedge fund and has spent years in the venture capital business. Joel has conceptualized, capitalized, operated and sold several companies, one of which he sold to a Fortune 500 company.
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