Airbnb? Charter schools? Unusual real estate strategies

Published
  • June 26 2017, 4:06pm EDT
Wait a minute — Airbnb as a real estate strategy? Charter schools?

That’s right. Helping your clients who want to invest in real estate can go beyond buying a home, a REIT or a vacation property to include some unusual and innovative strategies.

But never forget that real estate has its own set of rules.

“The market is extremely fickle,” cautions Michael Martin, principal and founder of Marius Wealth Management in New York. “Properties are illiquid and investors can't be emotionally attached."

Asset allocation, risk, tax liability, income needs and the ramifications of owning an illiquid asset all must be thoroughly vetted when discussing real estate investments with clients.

If a client is willing to take the plunge, here are some intriguing approaches wealth managers are currently employing.

Wait a minute — Airbnb as a real estate strategy? Charter schools?

That’s right. Helping your clients who want to invest in real estate can go beyond buying a home, a REIT or a vacation property to include some unusual and innovative strategies.

But never forget that real estate has its own set of rules.

“The market is extremely fickle,” cautions Michael Martin, principal and founder of Marius Wealth Management in New York. “Properties are illiquid and investors can't be emotionally attached."

Asset allocation, risk, tax liability, income needs and the ramifications of owning an illiquid asset all must be thoroughly vetted when discussing real estate investments with clients.

If a client is willing to take the plunge, here are some intriguing approaches wealth managers are currently employing.

Airbnb

How it works: One of Martin’s clients in Denver bought two luxury recreational vehicles to rent to Airbnb customers. They’re in a trailer park just outside the city, and the client is a model host; he leaves maps of the city, puts in fresh flowers and makes himself available by phone or text.

In the winter, the client moves the vehicles to Vail, Colorado, home of the popular ski resort.

The client bought two Grand Design Solitude Fifth Wheel vehicles for $70,000 each. He is financing 80% of the purchase at 4% simple interest (a type of interest applied to automobile and short-term loans).

Upside: Denver is booming, and demand for accommodations is high.

After adding the $14,000 down payment to the annual financing costs per unit and dividing that number by the net annual income of approximately $37,000, the client achieved a return on his investment of about 48%, according to Martin.

Risks: The RVs are not appreciable assets, and if there is a market downturn, there is no guarantee of rental income. What’s more, the client’s business depends on Airbnb, which could mandate a reduction in rates. “His fate is in someone else’s hands,” Martin says.

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Unlocking home equity

How it works: “We analyze the equity in a client’s home,” says Lois Basil, principal of Basil Financial Group in Chicago. “If it is less than 50% leveraged, we recommend thinking of ways to unlock that real estate equity. This approach is markedly different than what is in the financial press, where the advice often is to prioritize paying off your mortgage.

“While not having a mortgage may make sense for some people, we have found that always having a mortgage is a sound and tax efficient strategy,” Basil says.

“Our goal when working with clients is to minimize their tax liability. People often misunderstand that much of their income in retirement is taxed at ordinary income rates. We want to work to make sure our clients are taking advantage of every available deduction to reduce their taxable income.”

For example, Basil Financial Group will even recommend 30-year mortgages for 80-year-old clients. “Their retirement income is still being taxed at ordinary income rates, and we want them to keep more of their money,” Basil says.

Upside: The strategy reduces taxable income. For most clients, their home is their largest asset. “Having your house illiquid does not pay for health care, does not fund education and doesn’t buy groceries,” Basil says.

What’s more, mortgage interest rates are declining after a post-election spike.

Risks: There might not be enough income to pay the mortgage. It’s also possible the value of the real estate will go down, property taxes will rise and unexpectedly large home-improvement repairs will be needed.

“The biggest problem we have with this strategy is overcoming clients’ objections based on the psychological freedom they have that comes from not having a mortgage,” Basil says. “Sometimes, emotions can’t trump a sound financial rationale.”

Charter Schools

How it works: Summit Trail Advisors, a wealth management firm in San Francisco, has partnered with American Infrastructure MLP Funds to buy around 50 buildings housing charter schools in 13 states over the past two years.

Clients from other independent firms can also invest. American Infrastructure is a private equity fund that charges a 2% management fee and 20% of profits above and beyond an 8% preferred return to investors.

The fund hopes to take the portfolio of schools public in an IPO, says Tom Palecek, a Summit Trail founding partner. “To get there, we need to acquire enough schools to where the aggregate of the portfolio income is in excess of around $100 million,” Palecek says.

Upside: Investors were collecting an 11% yield in June while the partnership continued to add schools.

If an IPO proceeds and the stock rose in value, investors could “stand to make a substantial amount” from share price appreciation, Palecek says. If the stock did indeed gain, he estimates the yield could drop to 6% to 8%.

Risks: Charter schools in the portfolio need to keep seats full for years to come, have high test scores and demonstrate “really great management and operations,” Palecek says. Anything less could mean problems.
A regulatory change in charter school funding at the federal or state level could also spell big trouble.

Private Partnerships

How it works: While there are thousands of real estate fund managers whom advisers can work with, “it takes time and a dedicated effort to find managers whose strategies are most suitable to meet clients’ needs and goals,” says Derek Newcomer, director of investment research at Beacon Pointe Advisors in Newport Beach, California. “The adviser needs to ensure that a client [is qualified and willing] to invest in an illiquid investment strategy such as private real estate.

“Some managers have very high minimums,” Newcomer explains.” We have been successful in negotiating minimum investment sizes for our clients so that we can obtain greater adoption from a wider universe of clients.”

Newcomer’s firm, Beacon Pointe Advisors, places clients in partnerships with such firms as Kairos Investment Management, Southwest Value Partners and Buchanan Street Partners, which invest in a wide variety of properties, including office buildings, multifamily properties, industrial properties and retail assets.

An internal committee at Beacon Pointe determines a client’s appropriate asset allocation, usually no more than 10%, before investing in a partnership, Newcomer says.

Investment managers typically charge a 1% to 2% management fee on either committed or invested dollars, as well a performance fee of 15% to 20% after investors have received their original dollars invested and an 8% to 9% preferred return.

“Some funds are structured differently,” Newcomer says, “so it is extremely important to understand how fees are generated and what the fund pays out to the manager as fee income.”

Upside: Distribution of income: Beacon Pointe targets approximate total return combining income and profit to around 12% to 15% over the life of the fund.

Risks: Investments could be illiquid for up to 12 years.

“Fractured management teams can lead to trouble, particularly when you are in a long-duration life fund that can last 10-plus years,” Newcomer says. “Poorly managed assets can lead to increasing costs and decreasing income-generating capabilities.”

The manager may also utilize too much debt when acquiring a property, become too reliant on one tenant or concentrate holdings in one geographic region. What’s more, a partnership may collapse as a result of fraud, disagreements within management or other reasons.

“Advisers should thoroughly review the fund offering documents to fully understand what the consequences of such an incident would have on underlying investors,” Newcomer says. “Certain clauses within the offering documents will outline what would happen should such an event take place.

“There may be arbitration clauses, mediation, or assets may be placed into a liquidating trust,” he says. “Investing with the right management team that has a long history of working together successfully can help to minimize such an event.”