A Peek Inside My 7 Figure Real-Estate Portfolio: 2019 Quarter 1 Update
Updated: Sep 20, 2023
2018 wasn't a fun year for traditional investors in public stock markets. But my real-estate portfolio happily hummed along with a healthy 8.76%+ return.
Note: this is an older version of this article series and there is another, newer update now available. Click here to view the master index which contains a link to the latest and greatest update (as well as all of the older updates). (Usual disclaimer: I'm just an investor expressing my personal opinion and not a registered financial advisor, attorney or accountant. Consult your own financial professionals before making any financial decisions. Code of Ethics: We do not accept any money from any sponsor or platform for anything, including postings, reviews, referring investors, affiliate leads or advertising. Nor do we negotiate special terms for ourselves in the club above what we negotiate for the benefit of members.). Everyone always asks, "What's in your portfolio, Ian, and how's it doing"? Well here's the very detailed answer. I've been disclosing this since I started doing this series in 2017, and now it's time for an update. First I'll give you some important background with a quick summary of my risk profile and preferences. Then I'll talk about what's changed since the last update. And finally I'll dig into the details of each individual investment. (Note: while I call this my "real estate portfolio" it's technically my "alternative investing portfolio" because there's a tiny bit left in direct lending. And I intend to get into more alternatives this year).
About me
First, I am a retired serial-entrepreneur and rely on my investments to completely support myself and my family. So I'm an extremely conservative investor. Preservation of capital is #1 for me. So what I do may not be appropriate for someone who's more aggressive or speculative. At this stage of the cycle, I'm thinking defensively about the next downturn, and all investments have to leave me feeling okay after I pound them with recession-level stress tests. (More about my method is in "The Conservative Investor's Guide to Picking Real Estate Investments"). Someone who's not as concerned about a downturn, will be much more aggressive than me.
Also, I like investments that are quick and slow. "Quick" means short-term investments like hard money loan funds with short lockups of one year or less. And "slow" means long-term equity investments (7+ years) with low leverage, long-term fixed rate debt and conservative underwriting that I intend ride through and beyond the next downturn. And I hold lots of cash to perhaps take advantage of distressed situations when the downturn comes. I also completely avoid the value-added, highly leveraged investments with 2-5 year floating rate debt which are 95% of the offerings on crowd funding platforms. They're a much better match for someone who's more aggressive than me. (see "My Real Estate Investment Strategy: Part 1").
My portfolio
My wife and I share financial decisions and have seven figures invested in "alternative finance". This is almost all in real estate but a little in peer to peer (now down to less than 0.01% of the portfolio). We had an 8.76%+ annualized return for the trailing 12 months. This was awesome compared to the stock market losses in 2018. It's also down from the 9.3% I reported in 2018 Q1. It turns out it's mostly because I got a nice one-time boost back then from an opportunistic real estate development syndication (which yielded 160%). I wasn't comfortable repeating that risky strategy again, because the cycle has only gotten later. So I'm fine with the slightly lower return in exchange for significantly lower risk. I also had more vacancies in my residential rental portfolio to deal with than the previous year. This was expected because last year was exceptionally good. On the plus side, I was able to further self-liquidate almost all of my poorly performing Lending Club and Funding Circle portfolios. I can't wait until they're 100% gone and can give them both a huge, "Good riddance!" How it breaks down Here's how it's invested by category (note Lending Club and Funding Circle are now < 0.01% so they no longer are visible in the graph):
...and by sponsor/investment:
And here are the individual 12 month returns of each investment.
What's behind the scenes on this? Here's the details on each one...
1) Residential rental properties (50.5% of portfolio). Return: 7.8% (income only)
This is by far the biggest part of my real estate portfolio. I follow the core-satellite approach to risk. A huge, conservative core lets me feel comfortable taking more risk on smaller, satellite portions. Residential renters tend to be more stable and longer term than multifamily/apartment renters, which I like. I target working class neighborhoods with affordable rents (to maximize the renter pool, and align myself with the long-term trend of a growing lack of affordable housing). I also pick neighborhoods that are low in crime and properties that meet my yield and other minimums. These were purchased with no debt, which I believe hardens them extremely-well against a severe downturn. More aggressive investors may prefer higher projected returns by taking on leverage instead. Previously I had enjoyed better than expected returns here because repairs and vacancies were much less than projected. I didn't expect this to last, and sure enough it didn't. These have reverted back to the averages. But overall I was still very happy. The 7.8% return only includes what it made in income. And as an extra bonus, due to a hot property market, the price has appreciated over 10%. Since I intend to buy-and-hold I didn't include this in my returns. If If I did, I really got a 17.8% return and my overall portfolio was alot higher too. But I will calculate this if and when I sell the properties and realize the gain. 2) Short-term 1st position debt (25.2% of portfolio): Return: About 9.5%. This is my 2nd biggest strategy. First position debt is the safest part of the capital stack, and short-term allows me to possibly liquidate quickly if conditions change. (Here's a three-part article on how I do due diligence on hard money loans.) About 60% is in BroadMark Capital Fund 1 and 2 (averaged 11.4% return over the last year). It has a 65% loan-to-value maximum, a good uncured default rate (less than 2%), no leverage, and only loans in non-judicial states. It does do construction loans, which have added execution risk over other types. So I balance that out with a second fund that doesn't do any construction. About 40% is in a hyper-local acquisition/rehab hard money loan funds called Arixa Capital Secured Income Fund. (It averaged 7.35% return over the last year). They target 60 to 65% loan-to-value maximum, a very good < 1% uncured default rate, non-judicial states and no leverage. Doing this meant accepting a lower overall yield than Broadmark. But I feel the diversification protection is well worth it. (If you'd like more details on all the things I look for in evaluating a hard money loan investment, check out this three-part article series.) 3) BroadStone Net Lease (NNN leases) (9.5% of portfolio): Return: 12.7% total (6.45% income, 6.25% price appreciation). The next largest part of my portfolio is invested in a triple net lease (NNN) fund called Broadstone Net Lease Fund. A triple net lease is a lease in which the tenant is responsible for almost all expenses (maintenance, taxes, etc.) and the landlord's responsibilities are very minimal. The leases lock the tenant in long-term for 15 to 20 years with built-in escalations. So it makes for a much more predictable income stream than a typical real estate investment that has much shorter leases. The Broadstone fund specializes in recession resistant and Amazon resistant industries like medical, fast casual restaurants, industryal etc. It has full-real estate cycle experience, low leverage at 40% LTV, has an investment grade rating and generates healthy income and price appreciation. Last year it returned a generous 11.2% and this year's 12.7% was even more nice to see. 4) MG Properties Group (5% of portfolio): Return: 6% income = 6% total. I added money to this over the year and am in 4 properties with this sponsor (in 2 different funds). MG Properties is one of those very rare sponsors that appears to have gone multiple cycles without losing any investor money. They do multi family value-added, using moderate leverage, and high skin in the game (10 to 33%). They also are one of the few to implement a full-featured TIC 2.0 1031 exchange pipeline, which allows taxpayers to defer all taxes indefinitely. This is a long-term 7 to 10 year hold, and on exit I intend to 1031 exchange into a follow-up investment with MG (to defer capital gains). Ideally, I would like to hold a position with them forever, and when my wife and I pass away, pass it on to our son (who would inherit it on a stepped-up basis, and also not pay any capital gains). See this article on "How to Invest in Passive Real Estate Without Paying a Penny of Tax (Legally): Part 2: "Defer, Defer and Die"". 4) Peer to peer (<0.01% of portfolio). Return:4%. I made great progress liquidating my least favorite part of my portfolio, and it's almost history. I used to be a huge cheerleader for both Lending Club and Funding Circle. But over the years, I've grown increasingly unhappy with the quality of the underwriting and the annoyance of the "tax inefficiencies". My returns have dropped from the high 9% in early years, to under 5% last year and 4% now. I'm concerned with what will happen if we have a downturn and not hanging around to see what happens. So as I described in this article, I've been liquidating this portion. What's next? So what will I be doing next? Since I'm concerned about a potential downturn, I'm going to be adding investments in alternative asset classes that aren't directly tied to the business cycle. These include litigation financing and life insurance settlements. Since many of these are intended for institutions and have sky-high minimums ($1 to $5 million), I'll be cooperating with others in the private investor club to aggregate our investments together and get in at a much lower minimum ($25k). Also, I'll continue to look at MG Properties deals in the new year and continue the hunt for similar sponsors. I'm also hunting for more conservative short-term debt funds to diversify into. As the cycle ages, I may re-balance my current hard money loan portfolio and put more in lower execution risk rehab/acquisition loans and less in higher execution risk construction loans. I'll continue to watch the local single-family house market and if prices fall and get more reasonable then I will add to my position there. In the past I have said I would like to buy a local multifamily property in Tampa directly with no debt. But after several years without finding a deal that made sense to me, I think I'm too late. So I'll wait until prices (hopefully) reset in the future. Also, I'll continue to liquidate my peer to peer holdings. Cash is King I also have an almost-embarrasingly large amount of cash waiting for new opportunities that may arise after we go through the next downturn. Contrary to popular belief there's no guarantee that real estate prices will fall. So I'm not counting on it. But I feel that most likely there will be some sort of bargains to be had someplace. Ultimately, we'll see. I don't actually hold my cash in a savings account, because the returns are ridiculously low (many times less than 1%). Instead, I invest it in five year CDs with a low penalty for breaking them, and which currently are around 2.8%-3%. To minimize the penalty fees, I break up the money into a bunch of little CDs and only liquidate what I need (so I only get penalized for that amount). For example, if I wanted to do this with $100,000 of cash, I would break it up into five CDs of $20,000 each. Then if I need $20,000 in cash I would break just one of them, pay a modest couple months interest penalty on that alone, and continue to draw full interest on the others. UPDATE: Taxes I've been asked to talk about the tax treatment of the different items in my portfolio. This can sometimes get complicated, so many people skip thinking about it. However, doing that can lead to expensive mistakes. So I think a smart investor should always think about the after-tax return of an investment when looking at it. At the same time, minimizing taxes isn't my first goal. Yes, I put a lot of time and thought into making sure that I minimize my tax burden as much as possible. But if forced to choose between minimizing taxes and preservation of capital/reduction of risk, I'll choose the latter every time. Someone coming from a different risk tolerance and financial situation might feel very differently. Or to put it another way: I'm usually fine with losing a few percentage points of projected after-tax return if gives me extra safety and protection of principal. So you won't see me loading up 100% my portfolio in the most tax efficient investments possible. My situation I live in Tampa, Florida and am lucky in that I have no state income tax. (We do have a sales tax but it applies to purchases and not to income). I also have a relatively small percent of my portfolio in a tax-sheltered self-directed IRA. So, I've saved it for other investments that have much worse tax treatment than real estate. But if you're in a different situation, your self directed IRA or solo 401(k) can be a good way to save on taxes. (See "How to Liberate Your IRA / 401k to Invest in Real Estate") My portfolio tax breakdown:
Residential rental properties:
This is taxed at passive income rates. Due to depreciation, distributions were 35% shielded from taxes last year. I expect to get even more shielding this year with the new tax laws going into effect which give an additional 20% deduction for certain real estate investments.
Short-term position debt: This is the 2nd least tax efficient portion of my alternative investments portfolio (and the worst of my real estate investments) because there is no depreciation. So there is no shielding from taxes. However, both funds should be able to take advantage of the new 20% deduction in the tax law for next year. So that will help.
Broadstone net lease: Distributions are 1099-DIV dividends and taxed as such. This was 42% shielded from taxes last year, due to the depreciation. Again, the new tax law should give me an additional 20% in shielding this year.
MG properties group: Distributions are 100% shielded from taxes. Additionally they have traditionally given their investors the option at the end of the holding period to do a 1031 exchange into a new property. This defers paying back depreciation and paying capital gains. An investor can repeat this over and over and effectively delay paying taxes forever. Even when the investor dies their heirs inherit it on a stepped-up basis and don't have to pay the taxes either. (See "How to Invest in Passive Real Estate Without Paying a Penny of Tax (Legally): Part 2: "Defer, Defer and Die".
Peer-to-peer: This is the worst of all my alternative investments. First, there is no depreciation like in real estate to shield anything from taxes. Second, I actually end up paying taxes on phantom gains that I never really realized, because of the tax and efficiency associated with the loans that have losses. Theoretically I'm supposed to get those back but it can be years before it happens. All in all, this is a huge mess and yet another reason that I have deliberately exited from all of these.
