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The Laurex Process:
Client Consultation
Passive Real Estate Investments
By Don Konipol
Many investors are turned off by real estate because they
do not have the time or inclination to become landlords and property
managers. Both of which are in fact, a career in themselves. If the investor
is a rehabber or wholesaler, real estate becomes more of a business rather
than an investment. Many successful real estate "investors" are
actually real estate "operators" in the real estate business.
Fortunately, there are other ways for passive investors to enjoy many of the
secure and inflation proof benefits of real estate investing without the
hassle.
LIMITED PARTNERSHIPS
Limited partnerships are a way to invest in real estate, without incurring a
liability beyond the amount of your investment. However, an investor is still
able to enjoy the benefits of appreciation and tax deductions for the total
value of the property. LPs also can be used by landlords and developers to
buy, build or rehabilitate rental housing projects using other peoples money.
If you are seeking passive real estate investments, or have the ability to do
a project and are willing to do the work, but need to raise capital, the
concept may be right for you. The primary purpose of LPs is to limit investor
liability to the amount of their investment. But LPs allow the "pass
through" of all the property's tax benefits to the investors, and also
unlike corporations, their profits are only taxed once. They allow
centralization of management, through the general partner. They allow
sponsors/developers to maintain control of their projects while raising new
equity.
Who makes decisions in a Limited Partnership? The terms of the partnership
agreement, governing the on-going relationship, are set jointly by the
general and limited partner (s). Once the partnership is established, the
general partner makes all day to day operating decisions. Limited partner (s)
may only take drastic action if the general partner defaults on the terms of
the partnership agreement or is grossly negligent, events that can lead to
removal of the general partner.
Who owns what? Ownership interests of the Limited Partnership are split
between the limited and general partners according to a negotiated formula.
Limited partners can buy up to 99 percent ownership of profits/losses and
cash flow (excluding fees to the general partner). The general partner
retains the 1 percent or more remaining ownership of profits, losses and cash
flow (plus any agreed upon fees). The limited and general partners split any
profits from sale or refinance of partnership assets. The split generally
provides an incentive to the general partners who may receive up to 50
percent of profits.
Partner's Rights: The specific rights of each party are negotiated in the
Partnership Agreement. In general, the general partner has the right to make
all the day-to-day and development decisions, to determine how much cash to
distribute to the limited partner (s) versus how much to hold in reserve, and
to assess possible sales proposals. The limited partner's rights are to be
informed of operating conditions: to approve a sale or refinancing; and to
remove the general partner for gross negligence or breach of contract.
The General Partner's Obligations: The general partner must complete the
project as proposed, must manage the partnership and the business as agreed
upon in the partnership agreement. and must, generally, guarantee any
additional funding needed to complete the project (repayable with interest)
In addition, the general partner oversees construction, leasing. property
management. and maintains the books and records of the partnership. It must
submit periodic reports to the limited partners (s) on the project's financial
condition and status, including analyses oŁ the property's sale potential.
The general partner may not withdraw without the approval of the limited
partner.
TRIPLE NET LEASED COMMERCIAL PROPERTY
Exchange Into Management-Free And Headache-Free Ownership: Are your real
estate investments giving you a management headache? Are you tired of tenant
complaints and property destruction? As a real estate investor, are your
goals security, predictable partially tax-sheltered income with an inflation
hedge, if so, then commercial triple-net lease property is an excellent
vehicle to create wealth through real estate.
This real estate investment product requires little or no management, has
little risk, and produces monthly income from lease payments. The lease
agreement can also provide the opportunity for rent increases as a hedge
against inflation.
What Is A Triple-Net Lease Property? Over the past several years, owning
commercial property under a triple-net lease arrangement has emerged as a
highly popular and effective strategy in real estate investing. A triple-net
lease property is an investment where one owns real estate (land and
building). Leases to a tenant for a 15-25 year term, who agrees to occupy the
property, operate their business on the premises, pay rent and all the
property operating expenses (taxes, maintenance, and insurance) with the
opportunity for rent to increase over time as a hedge against inflation.
How Does This Differ From Owning Other Investment Property? Unlike owning
duplexes, apartments, land, or an office building, owning a commercial
property under a triple-net lease agreement to a business tenant is a passive
investment (management and headache-free). In most real estate investments
such as mini-storage facilities, apartments, and office buildings you as the
property owner must perform property management duties, and pay operating
expenses. You rent the property, collect the rents, refurbish the premises,
pay the property taxes, insurance premiums, maintenance, accounting, legal,
and other operating expenses. Whereas, under a triple-net lease arrangement
the tenant agrees to perform all these functions for you as the owner of the
property in return for a long-term lease agreement.
With a passive real estate investment, such as owning commercial property
under a triple-net lease arrangement, the tenant operates its business in the
location. As the owner of the property, you do not have to contend with
monthly renters and operating expenses. This type of real estate investment
is passive, similar to owning stock in Sears, you receive the dividends or,
in this case, lease payments. Further, these types of commercial tenants are
positive business renters. Unlike apartment renters who tend to abuse the
property and then move out leaving the owner to refurbish and find new
renters, commercial tenants have a vested business interest in seeing that a
location is well maintained and attractive to customers. As a result, there
is an economic incentive to enhance the owner's property over time.
Some Examples Of Commercial Triple-Net Leased Property
If you drive through the business district of any city or town you will see
commercial triple-net lease properties: for example all the major restaurants
such as; Burger King, Taco Bell, Kentucky Fried Chicken, Pizza Hut, the
automotive after-market such as; Goodyear Tire, Pep Boys, Jiffy Lube, retail
outlets such as; Toys R Us, K-Mart, and Home Depot to name a few. Most of the
real property occupied by these companies are owned by real estate investors
and leased to these companies under a triple-net lease arrangement.
What Are Some Advantages Of A Triple-Net Leased Property
There are several advantages. First, the monthly lease agreement provides a
very predictable, long term income stream to the property owner. Second,
since there are no property expenses (taxes, maintenance, or insurance) to be
deducted, the income stream is not impacted by future increases in property
operating expenses. The property owner (investor) can enjoy a rental income
stream, without property management or property expenses.
Subject to the credit worthiness of the tenant and the terms and conditions
of the lease agreement, the investor can enjoy a high degree of security and
should expect to have additional rental income over time as the inflation
hedge feature of the lease agreement comes into play.
Can a Triple-Net Leased Property Be Used To Complete A Real Estate Exchange?
A triple-net leased property can be an excellent replacement property in
completing a real estate exchange transaction. Many real estate investors
dispose of their management intensive properties such as apartment buildings,
duplexes, and office buildings, hoping to find management-free properties
producing long term, predictable income. If you are thinking of disposing of
your business or investment-held property, would like to "Pay No Capital
Gains Tax" and reinvest into a management and headache free property,
the purchase of a triple-net leased property through a real estate exchange,
can be just what the doctor ordered.
PRIVATE MORTGAGE NOTES AND TRUST DEEDS
In this environment of low interest rates and uncertain returns, you can
still find opportunities to earn high yields and obtain large gains. The
answer lies in understanding and investing in alternative investments. These
are investments that are not offered by the wire houses or broker-dealers or
mutual funds. In fact, these investments will seldom appear on the radar
screen of your financial planner or investment advisor. The alternative
investments that I specialize in are private mortgage notes. Carefully
chosen, they can return 14-18% annually to the passive investor with
relatively little risk, making them ideal for any investor needing more
income or a safe haven from a possibly overvalued stock market.
If you're retired or saving for retirement, it's likely that your stock-laden
portfolio looks a little less invulnerable than it did a couple of years ago.
It's possible, too, with interest rates on bonds, money market funds and bank
CDs at all time lows, that you're counting on a fixed income that doesn't
fully meet your needs.
"If only I could increase my monthly income without depleting my nest
egg," you think, "and without losing sleep over the stock
market." Well, there is a way to make this happen: by investing in trust
deeds, or private mortgages notes, or investment partnerships that specialize
in investing in these debt instruments.
Private Mortgage Notes
Simply put, private mortgage notes, commonly referred to as trust deeds in
the western states, are short-term loans made to real estate investors
secured by the value of the real property as collateral for the loan.
Investors who invest in private mortgage notes or trust deeds typically earn
a 12 to 18 per cent return, paid out monthly, with a minimum investment of
just $5,000 and relatively low risk. As a result, they are able to enhance
their lifestyle significantly without threat to their principal, or build a
large nest egg, safely, in a relatively short period of time.
When you invest in a mortgage loan or note, you are in essence buying a
mortgage secured by real estate. You receive fixed monthly payments from the
borrower based on the terms of a promissory note.
You can invest in trust deeds on your own, lending your money directly to a
borrower. But it wouldn't be advisable unless you have the time and expertise
to evaluate property and to screen out borrowers, and know your way around
the legal maze of real estate transactions. Or, you can invest in trust deeds
through companies that specialize in this type of investment.
By far the biggest attraction of investing in private mortgage notes is their
high yield. Borrowers, often real estate investors, are willing to pay
interest rates of 12 percent and higher because they need a quick short-term
loan to purchase or refinance a property without the hassles and red tape
they may run into at a bank.
Or sometimes borrowers may not qualify for traditional financing at lower
rates because of minor credit problems or liens against the property. Or the
property may be too small or located in an area that makes conventional
financing difficult.
Your protection against default is the property that secures the promissory
note. That's why it is so important to invest in trust deeds (notes) with a
low "loan-to-value ratio."
In other words, the loan should be only for a certain percentage of the
appraised value of the property (and you must use a reliable and experienced
appraiser). As a guideline, investors should seek loan-to-value ratios no
higher than 70 percent for single-family homes, 65 percent for apartments and
65 percent for commercial and industrial developments.
One risk of private mortgage notes is lack of liquidity - you typically can't
get your hands on your principal until the loan is paid off. Trust deed loans
often are for a year or two.
Another risk is the possibility of default and foreclosure. True, you are
likely to recover your money eventually and even make a profit from the sale
of the foreclosed property. But in the meantime you may go months without
receiving any interest payments.
That said, trust deeds available through reputable and experienced firms
offer an attractive combination of risk and reward.
But what happens in a recession, particularly one in real estate? If you
believe property values are going down 10 percent, you are still protected by
having claim to property assessed at a higher value than the loan amount. Of
course, if you believe property values are going to go down 50 percent, then
you are not protected.
Article Provided by:
Don Konipol
Managed Mortgage Investment Fund, L.P.
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