Protecting Your Real Estate Investment Portfolio Through Shared-Risk

February 3, 2018 by Danielle N
sharing investment risk

There are many real estate investment alternatives available to accredited investors that are seeking to build long-term wealth through stable, low risk investment platforms. A combination of traditional and innovative investment strategies will provide a diversified portfolio with a low risk profile. Some of your many options include REITs, mutual funds, IRAs, 401(k), direct private lending, and crowdfunding. Each of these has unique benefits depending on your overall investment goals. Here we’ll discuss some of the benefits and disadvantages of each of these options.

Mutual Funds

Mutual funds can be an excellent choice when you’re seeking an extremely low risk profile. These investments are typically well diversified, and require no participation. One of the key downsides of many of these funds is that they require you to pay asset management fees, and are sometimes poorly managed, resulting in minimal returns, if not losses. There are many mutual funds available, and by applying due diligence and networking with other investors, you can find a fund that may fit your objectives.

Most mutual funds provide moderate levels of returns, although they don’t bring you the maximum potential ROI on your investment. Mutual funds typically offer a very low entry threshold that make it an affordable option for non-accredited investors. Mutual fund investment units also have excellent liquidity and can be easily sold or traded. Despite these benefits, mutual funds typically do not outperform the market.

Retirement Accounts

Retirement accounts such as cash balance pension plans, IRAs, and 401(k)s provide very low risk and moderate returns. The less than optimal returns are offset by the deferred tax benefits. Contributions reduce your taxable income, and offer steady growth over the long term. The downside is that if you choose to withdraw funds, even for the purpose of investing in real estate, you may be subject to tax penalties.

There are certain forms of retirement accounts that allow you to maintain control and have some choice over how your funds are invested, while retaining the tax benefits; however, you’ll need to speak with a qualified tax professional about these types of opportunities. An attractive feature of retirement accounts is that you can have your contributions automatically deposited to your retirement account, providing inbuilt accountability and ease of contribution management.

Direct Private Lending

Direct private lending is one of the highest return investing activities, although it carries the greatest risk. When you lend directly, you’ll need to do independent due diligence to ensure that the project, and its leaders, are credible and have the experience to execute the development. An excellent benefit of private lending is that you can typically demand first lien position to give you the most security in collateralizing subject property. In the event that the borrower defaults, you will have first right to recover funds in a foreclosure proceeding.

To maintain proper control, you may need to hire personnel such as researchers and assistants to help you in conducting due diligence tasks, and in maintaining oversight of the projects that you invest in. Some of the downsides of private lending include a lack of tax benefits compared to forms of investment that involve ownership, and no long-term appreciation on investments.

Real Estate Investment Trusts (REITs)

REITs are another viable option for accredited investors. This type of investment entity owns income producing properties or mortgages and distributes 90% of its earnings to investors. Diversification of REIT portfolios offer stable income dividends and appreciation. Investing in real estate investment trusts offers good liquidity as shares can easily be traded or sold.

A disadvantage is that income is taxed in the year that it is earned and is treated as ordinary income. Another downside is that due to the fact that REITs have to pay out such a large share of earnings to investors, it limits the overall growth of the portfolio due to a lack of capital to reinvest in new projects. The amount that the trust retains its typically taxed at the highest corporate rate, further diminishing availability of funds for continued investment.

Crowdfunding Platforms

Crowdfunding is the newest iteration of shared risk investments. Crowdfunding offers excellent return rates, minimal risk, professional management of assets, and the opportunity to diversify investment portfolios by allowing small contributions to numerous different assets across geographic markets and asset classes. This investment strategy offers a combination of the best benefits of traditional investing forms.

While there is little necessity for contributing to management responsibilities, you are afforded greater frontend control in the selection of projects that you choose to participate in. Depending on the structure, whether debt or equity interest, of the investment that you select, you may have various tax advantages in the form of deductions for expenses and loss, and capital gains treatment of proceeds.

Abundant Opportunities

Choosing an appropriate real estate investment vehicle as an accredited investor can be a difficult, but also rewarding decision. With the numerous investment options available to you as an accredited investor, there is a solution that fits your needs and objectives. Carefully consider how each will affect your level of risk, return, and tax liability. Consult with qualified financial advisors, tax professionals, and legal experts for advice that it is relevant to your situation.