When it comes to real estate investing we tend to focus on equity, but it’s important to explore different investment options to maintain a diversified real estate portfolio. This month, we decided to venture a little outside of our norm and explore the debt side of the deal. Keep in mind, there are always two sides to a coin in real estate. Every leveraged real estate investment contains an equity investor and a debt investor.
The debt investor may be the bank, or it can be an individual. The type of real estate investment as well as the current position within the investment lifecycle dictates who the debt investor is. This factor can change several times throughout the lifecycle of a real estate deal.
As a debt investor, you want to know where you are positioned within that specific investments lifecycle. These types of details will help you better analyze the risk and return you want to expose yourself to.
TCI had the opportunity to interview Ray Sturm, CEO of AlphaFlow and co-founder of RealtyShares.com this month. AlphaFlow has developed a unique investment platform for the individual that is interested in being a debt investor.
During the interview, Ray discusses real estate crowdfunding and loan investing and where it makes sense in your portfolio. AlphaFlow has created a portfolio known as the “Optimized Portfolio”, which allows accredited investors to take a first lien position on a pool of short term loans.
As we discussed, a debt investor needs to know which part of the investment life cycle he or she is investing in. Given that this portfolio is made up of short term loans with an average maturity of 6-12 months, this is a good indicator of where the investor will be positioned in the real estate investment life cycle.
Short term real estate notes, often referred to as bridge loans, (AKA gap financing, interim financing, or swing loans) are mainly used by real estate flippers who need capital to begin construction of their project. These types of loans are common within the flipping industry due to the need of upfront capital before transitioning into a traditional mortgage. Banks tend to stay away from these types of loans given their risky nature.
Lenders need to have a good sense of the market in which they are loaning money. This explains why the majority of short term loans are underwritten by mom and pop lenders. Mom and Pop lenders specialize in their specific market and have a good sense of the risks associated with their loans. Their expertise in a given market allows them to analyze deals much more thoroughly than a national bank, thus creating the opportunity for high returns and relatively low risk.
As an investor you have to understand the implications of bridge loans. Bridge loans offer a higher yield because they carry a higher default risk. However, these loans are collateralized by the real estate themselves, so in the unlikely event of a default, the investor is partially protected by the asset that backs the loan.
Liquidity and real estate aren't often associated in a positive way. Real estate investments have always been regarded as a relatively illiquid investment but sites like AlhpaFlow have figured out a way to change this. Liquidity is achieved through the short-term maturities on these loans. Investors may receive their principle investment back in as a little as six months.
As with any investment, always perform your own due diligence when investing your hard-earned money. Becoming a debt investor isn’t for everyone but it may be a great addition to your portfolio. Click here to listen to our interview with Ray.
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