To use real estate as an alternative investment, clients needn’t be limited to REITs or REIT funds or private partnerships.
Some forms of real estate investing are truly outside of the mainstream. With tax liens or tax deeds, for example, investors pay someone else’s outstanding property tax bill, hoping for interest income and perhaps outright ownership of the real estate. Another tactic is to engage in what’s known as private money lending, advancing funds to home buyers with loans secured by the property.
TAX LIENS, PRIVATE LENDING
Jason Hull of Hull Financial Planning in Fort Worth, Texas, has looked into such ventures and has come away with misgivings. “Tax liens and deeds have the potential to be decent investments,” he says, “but you're competing against a large crowd of bidders, including professionals with deep pockets and probably better property information. If someone wants to buy a tax lien or tax deed, they must check the property out. Many of the properties are abandoned for a reason.”
Hull, who has attended tax lien or deed auctions in three states, tells of attending one in Virginia where neophyte buyers obtained a lien on a property that was a former gas station and needed environmental remediation. “They were completely unaware of the situation,” he says, “and were stuck with a worthless lien.”
As far as private money lending is concerned, Hull points out that it’s vital to do the same due diligence on the property and also look closely at the borrower. “If a bank won't lend to someone,” he says, “I have serious doubts that the average note investor is going to have superior information about the borrower. Furthermore, once the note is satisfied, you have to find another note to invest in, so there is reinvestment risk.”
What does that leave? Buying homes as rental properties. “If you can find a desperate seller,” says Hull, “you have the opportunity to skew the odds in your favor. Making an all-cash offer to a desperate seller and being able to close in seven days gives you a very strong negotiating position, allowing you to buy real estate at a discount.” A desperate seller, according to Hull, might be someone facing a lost job, a job move, or a family situation forcing the owner to get out of the house as soon as possible.
Hull also mentions buying properties from banks after a foreclosure, which is similar to buying from a desperate homeowner. “Banks don't want to hold properties,” he says, “because they are liabilities on the balance sheet.”
Describing himself as a fan of residential real estate as a part of a diversified portfolio, Hull says that rents generally go up with inflation and the tax benefits can be helpful. “Rental properties managed by a motivated and skillful property manager can provide passive income,” he notes. Hull adds that if you buy property away from home, you may be able to take a trip to go see your place once a year and deduct some of the cost.
However, owning rental property is not strictly a financial commitment. “You have to be prepared for the human side of the investment,” says Hull. “I had a tenant die a couple of weeks before Christmas last year, leaving a wife and three kids. There's a fine line between compassionate but fair and emotional and financially risky. Advisors with experience can provide a good sounding board for clients who have a significant real estate portfolio as well as a guiding -- and often restraining -- hand for those who are looking to get started.”
Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.