In the May Issue
- 4 Basic Real Estate Concepts Every Investor Should Know
- How to Find the Best Real Estate Investment Opportunities
- Opportunity in Small Balanced Real Estate Funds
- 6 Factors to Consider When Choosing a Fund
4 Basic Real Estate Concepts Every Investor Should Know
In our previous newsletters, we’ve introduced several in-depth, real estate topics that will help you build out a lasting, high-return investment portfolio.
This month we are bringing back four fundamental concepts that every investor (seasoned or new) should know in order to make smart, ROI-minded investments. With high stock market volatility, it’s important to stay knowledgeable on real estate investing in order to have reliable alternative investment strategies apart from the stock market.
The concepts we’ll discuss include:
- Investing or Speculation?
- Return on Time (ROT) vs. Return on Investment (ROI)
- Investing for Cash Flow vs. Investing for Appreciation
- How to Find Opportunities in Real Estate
We’ll provide definitions, examples, and best-case scenarios with each concept to better your understanding of foundational real estate investing principles.
Let’s start by looking at value investing vs. speculation.
Concept #1: Value Investing vs. Speculation?
If you have ever been to Vegas, you know gambling and how quickly you can lose your money. When it comes to investing, every good investor understands investing should never be a gamble. Many speculative investments present a tremendous opportunity, but they carry a very high degree of risk to the invested money.
So how does speculation compare to value investing?
In the investment world, speculation is investing in projects with a high degree of risk with potentially significant returns. Speculation should be looked at as effectively a form of gambling. Examples of speculative investments include investing in BitCoin, high flying technology, and biotech stocks. Most speculative investments have little or no cash-flow.
These investments are often times referred to as trading systems (or progressive systems) that work in the short run, but there is potential for catastrophic risk… There are plenty of successful day traders, but if you are a classic or value investor, these types of investments should not come from your primary investable capital.
In comparison, value investments, typically, have strong cash-flow, and very limited down-side.
At TF Management Group LLC, we prescribe to the same investment philosophy as Benjamin Graham and Warren Buffett. We seek out safe investment opportunities with reasonable rates of return. We’re not in the business to gamble; instead, we’re here to find opportunities that generate growth & income for our members, following value investing methodology of the above mentioned investment giants.
Concept #2: Return on Time (ROT) vs. Return on Investment (ROI)
More often than not, investors make the mistake of only looking at the return on investment (ROI) when scouting out investment opportunities. They fail to realize that investments also require time… and time is money in this business.
Some investments might look promising on paper (high returns), but they require large amounts of time on the back-end and drain your personal time to manage the investments.
High ROT + High ROI = Your Ideal Investment
The most valuable investments require no time and generate strong returns. These types of investments can be hard to come-by, but they do exist.
So how do you know if an investment is worth your time? Let’s take a look at the example below.
You’re presented with an opportunity that would cost you an initial investment of $100,000. The projected ROI is $10,000- a 10% return. However, this project would require 100 hours of your time.
If you calculate your hourly “wage” ($10,000/100hr), you make $0/hr. You generate a 10% return on paper, but when you factor in ROT, it’s a net gain of zero.
Numbers can be misleading when they fail to factor in ROT. Determine what your time is worth (maybe $100/hr, $50/ hr, etc.) and find money-making opportunities for you.
Concept #3: Investing for Cash Flow vs. Investing for Appreciation
Many investments will have elements of both cash flow and appreciation. Rather than two distinct kinds of returns, it’s more commonly viewed as a spectrum.
Looking at both ends of the spectrum, investors who require, or want, a reliable stream of income should focus on strong cash flow investments; investors who want to build long-lasting wealth, and don’t have the need for current income, should look at appreciation heavy instruments. There are also people in the middle, who prefer both current income and appreciation over time, who should consider balanced (Growth & Income) opportunities.
*Note: By knowing your investment goals, you can more easily determine which investments are best for your portfolio.
Many real estate assets generate stronger cash flow than market-leading dividend paying stocks, but the real appealing factor is the appreciation that can tag along with the cash flow.
2 Types of Appreciation
Appreciation is an important factor in any real estate investment because it can significantly increase the value of a project. There are two types of appreciation: natural appreciation and forced appreciation.
Natural appreciation occurs as a result of inflation (market rising in a given area). However, it’s important to note that natural appreciation can be negative (if markets go down).
The more valuable of the two is forced appreciation, which means an increase in value due to actions taken by the owner. This type of appreciation is usually the result of value-add work that takes place on a specific property.
*Side-note: Value-add includes any kind of improvement to a property that adds value such as renovations, build-outs, etc. These improvements often result in increased cash flow.
Natural Appreciation + Forced Appreciation = Total Appreciation
The best type of projects have a strong cash flow with high forced appreciation. Natural appreciation one year could sit at 6% whereas the forced appreciation could be 20%, 30%, or even 40%.
When we look for investments, we look at forced appreciation more so than natural appreciation because when a project has a good forced appreciation, high returns are much more promising.
Concept #4: How to Find Opportunities in Real Estate
Like any business, real estate is subject to market changes and conditions. When the market hit all-time lows after the 2008-2009 crash, there were a lot of opportunities out there. It was easy to find a good deal if you still had capital available to invest.
Today, however, is a different story. Most investors have rebounded which means there are now more people looking for deals, and the “easy hanging fruit”, most lucrative opportunity, has been picked. Good deals are harder to come by, and typically, best marketers/ operators have a strong advantage in finding them.
We are now back to the basics of real estate deal finding: it’s all about looking for seller distress, circumstances, access to deal flow through marketing, networking, and most effective operations.
3 Ways to Find the Best Deals
Like we mentioned, finding the best deals today require new strategies and approaches than in the past. Long- term, value-add projects require a new level of marketing and expertise.
There is nothing fundamentally wrong with buying real estate at retail value as long as you have a great mortgage. This strategy is a great long-term play because you don’t need to do anything other than make the initial investment and stay passive for years.
At TF Management Group LLC, we invest in these types of projects… BUT with strong value add (with forced appreciation), not retail deals. We prefer long-term with 3-5 year horizon and good cash flow to start. Most projects we do have an exit strategy, but Warren Buffett says it best: own the investment perpetually, especially if it’s strong.
If you’re looking to invest in these types of projects, here are 3 different ways to find them:
- Market for deals yourself (You need to establish credibility and develop marketing capabilities)
- Work with good marketers who have established, reliable marketing businesses and are able to find the best deals
- Invest in established funds that do the work and deliver passive returns to you
It’s important to first understand your goals as an investor and find projects that fuel your goals. Let’s take a deeper look at the 3rd option above: investing in funds.
Opportunity in Small Balanced Real Estate Funds
Adding a small balanced real estate fund to your investment portfolio removes the heavy-lifting of finding great deals, researching market conditions, and taking risks. If you are new to the real estate world, it can be hard to know what is a good opportunity.
In contrast to large REITs, small funds typically generate higher ROI and ROT by entering value-add projects earlier. Smaller funds are much more nimble with a faster response rate in their underwriting and deal-making processes.
So how do you choose which fund to invest in? Let’s take a look at 6 different factors you should consider before saying yes.
How to Choose a Fund
1. Security of the investment
Ask yourself these questions when exploring funds: What is their general investment model? What do they invest in? How do they make sure their investments are reasonably secure? There is a big difference between a ‘secure investment’ and a ‘guaranteed investment.’ Guaranteed investments generally have a low yield and are backed by either the government or possibly a fraudulent entity. Secure investments come from the management team’s experience and track record.
2. Return on investment
When looking at ROI, it’s important to remember there are two components, cash flow and appreciation, and how much ROI comes from each. Other aspects to consider are the projected return based on the financial model and the fund’s historic return. Past results are indicative of a fund’s future performance.
Liquidity in a fund comes from three different forms: income the fund generates, fresh capital raised, and sale of assets. Short-term projects generate high levels of liquidity versus long-term projects.
Every fund charges fees (management fees, performance fees, etc.). It’s important to note how much money the manager is making. (i.e. Avoid funds with high fees and low returns.) With performance fees, the higher the fee, the more incentive a manager has to perform.
5. Quality of Deal Flow
The kind of deals a fund invests in should not be taken lightly. Ask the fund managers these questions: “Where are your deals coming from?”, “How do you get your deals?”, “How many deals have your turned down?”, “How many deals do you invest in that generate higher levels of return”, etc.
6. Close-ended Fund vs. Open-ended Fund
There is no right or wrong strategy when it comes to these two different types of funds. Close-ended funds have a period of time when they raise capital and then they close and write those investments until the exit start. They start selling assets, liquidating, and paying back investors the principal. *The income is paid along the way and on the back- end.
Open-ended funds continue to raise capital, make new investments, collect and distribute income, exit investments and re-invest the money. They are also known as “evergreen funds” because they provide ongoing flexibility. The Tempo Opportunity Fund LLC is an open-ended fund.
As small balanced funds increase in number, it’s important to do your research before jumping head first into one. Those six factors will help guide your research and decision-making process when looking for a fund.
There are other factors and questions you should know before investing into a fund. I have written a short book to help investors understand the top 10 questions any investor should ask before making an investment decision. The book is available on Amazon.com.
When it comes to real estate investing, the opportunities available are plentiful, and you can often create your own. If you want to take advantage of great opportunities with strong forced appreciation and current income stream, investing in a small balance real estate fund like the Tempo Opportunity Fund LLC is a great passive investment option.
The concepts explained in this newsletter will help you make the most out of your hard-earned money. It’s time to let your money work for you. If you’re interested in learning more about who we are or investing in the Tempo Opportunity Fund LLC, please contact us. and we’ll be happy to talk with you and answer any questions you may have.
Thanks for reading,
CEO, TF Management Group LLC
This newsletter and its contents are not an attempt to sell securities, nor to sell anything at all, nor provide legal, nor tax accounting, nor any other advice. The presenter is a private lending and real estate fund management business, and the information represented herein are purely for educational purposes and represents the opinions of the presented. Prior to making any investment or legal decision you should seek professional opinions from a licensed attorney, and a financial advisor.
TF Management Group LLC (TFMG) is an investment fund management company that specializes in both short-term debt financing for real estate “fix and flip” projects, and long-term “value-add” equity deals.