Wealth Tip: Understand that as risk in investments increase the less control you have.
I was talking with an investor friend of mine a few days ago and we got on the subject of private placement memorandums (PPM’s), which are often used to raise money for real estate deals. In essence, a PPM is a formal way a group of investors can find passive money partners for a real estate deal (or other type of investment opportunity.)
We spent a good half hour talking about our experiences working to get our net worth actively earning higher rates of return for us and I’d like to summarize several of our key insights in the hope they you can leverage your returns safer using our insights.
First, you must always compare investments within the SAME risk category. No good comparing the return of a CD (say 5%) with the return from a PPM (projected to be 15-20%) because the CD is virtually no risk (although you lose liquidity potentially) and the PPM may have high or medium risk (or less) depending on the investment itself.
Yet we both have seen too many investors make this apples to oranges comparison to their detriment. I’ll have more on this in the months ahead, just keep reading future week’s Wealth Tips eLetters.
Next, cash flow deals where money is regularly being paid out tend to be much safer than capital gains deals. For example, an apartment complex where you are regularly paid a 8-10% return (with an equity stake for down the road) is usually much safer than an apartment deal where you are buying an empty property at a low price with the intention to fix up, fill up, then resell. Now both are potentially good investments, but they really can’t be compared to each other because their risk characteristics vary too much.
When money is being paid out monthly or quarterly not only are you immediately recouping some of your investment, but much more importantly there is a lot less that tends to go wrong with those type of deals (provided you have done your due diligence on the leadership team and deal itself). And if a problem does arise, you’ll find out about it so much sooner than in a cap gain deal where the general partner or “founder” who is managing the deal could hide the problems for months or even a year or longer.
While no one wants to hear bad news, it is always better to hear that bad news sooner.
This same concept applies to real estate notes that you may invest in. For example I have several first and second mortgages that I own where I’ve lent money to investors to buy real estate. Some are interest accruing, others are interest paid monthly. The interest paid monthly is LOWER risk to me than the interest accruing, all other things being equal.
For me, I get 10-12% interest on the monthly medium term loans and get 15% accruing on the medium term loans that my interest keeps adding up. Which is better? It depends on what you want, just invest with your eyes wide open. (Side note: if the loans were for short term (less than 12 months) I would require a higher return for both types of loans, the key is that I get a premium of 3-5% on the loan for the extra risk of letting the interest accrue.)
We spent a good half hour talking about our experiences working to get our net worth actively earning higher rates of return for us and I’d like to summarize several of our key insights in the hope they you can leverage your returns safer using our insights.
First, you must always compare investments within the SAME risk category. No good comparing the return of a CD (say 5%) with the return from a PPM (projected to be 15-20%) because the CD is virtually no risk (although you lose liquidity potentially) and the PPM may have high or medium risk (or less) depending on the investment itself.
Yet we both have seen too many investors make this apples to oranges comparison to their detriment. I’ll have more on this in the months ahead, just keep reading future week’s Wealth Tips eLetters.
Next, cash flow deals where money is regularly being paid out tend to be much safer than capital gains deals. For example, an apartment complex where you are regularly paid a 8-10% return (with an equity stake for down the road) is usually much safer than an apartment deal where you are buying an empty property at a low price with the intention to fix up, fill up, then resell. Now both are potentially good investments, but they really can’t be compared to each other because their risk characteristics vary too much.
When money is being paid out monthly or quarterly not only are you immediately recouping some of your investment, but much more importantly there is a lot less that tends to go wrong with those type of deals (provided you have done your due diligence on the leadership team and deal itself). And if a problem does arise, you’ll find out about it so much sooner than in a cap gain deal where the general partner or “founder” who is managing the deal could hide the problems for months or even a year or longer.
While no one wants to hear bad news, it is always better to hear that bad news sooner.
This same concept applies to real estate notes that you may invest in. For example I have several first and second mortgages that I own where I’ve lent money to investors to buy real estate. Some are interest accruing, others are interest paid monthly. The interest paid monthly is LOWER risk to me than the interest accruing, all other things being equal.
For me, I get 10-12% interest on the monthly medium term loans and get 15% accruing on the medium term loans that my interest keeps adding up. Which is better? It depends on what you want, just invest with your eyes wide open. (Side note: if the loans were for short term (less than 12 months) I would require a higher return for both types of loans, the key is that I get a premium of 3-5% on the loan for the extra risk of letting the interest accrue.)
posted by David Finkel at 4:50 AM
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