eCourse – Syndication Due-Diligence for (LPs) Passive Investors

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7) Other Investment Options that Are Syndicated

eCourse – Syndication Due-Diligence for (LPs) Passive Investors 7) Other Investment Options that Are Syndicated

But what about taxes?

If you’re a passive real estate investor (net worth greater than $500,000 or making over $150,000), it’s essential to understand the tax implications and benefits of investing in a private investment fund/syndication/private placement.

Also, thanks to the 2017 tax reform, taxpayers who earn less than $157,500, or $315,000 for a married couple, can deduct 20% of the income they receive via pass-through businesses from their overall taxable income.

Each investor receives a K-1 tax form at the end of the year, reporting the investor’s allocated share of these income, expense, gains, and losses items for inclusion in their tax returns. As general rules:

  • An investment fund's profits and losses are allocated to investors on a pro-rata basis unless there is a special allocations of income, expenses, gains, losses, etc. as agreed upon in the partnership agreement.
  • Profit distributions (including preferred returns) from income that is connected with the fund's trade or business are taxed as ordinary income. However, this regular income can be offset by the partner's allocated share of deductions and depreciation.

NOTE: If a partner receives a distribution from the partnership that is above the partner’s share of the fund’s income as reported on the K-1, these distributions will be considered a return of capital.

Tax Basis

Tax Basis (Capital Account) – A partner’s original basis in his/her partnership interest begins with the original capital contribution, and then over time, taxable income and additional contributions will increase the basis.

While any distributions considered a return of capital is not taxable; distributions, depreciation, and expenses lowers the basis (i.e., original cost) of the partnership interest, which will affect the amount of capital gains realized when the interest is sold or liquidated.

Going into deals getting a whole bunch of Bonus Depreciation (Passive Activity Losses or PALS) to offset future sales and passive gains/cashflow is what we call the "Simple Passive Cashflow Gravy Train". In 3-7 years when a deal is sold you will have to pay the capital gain and depreciation recapture but that is why you should be going into multiple deals.
Insider Tip
from Lane

You only went into TWO DEALS!

Tax Basis Example:

 

DISCLAIMER: If you’re considering investing in a private fund, we recommend you consult your tax advisor for a complete discussion of the tax factors of passive investments. Likely your CPA does not understand this stuff or thinks its illegal… which is why they are still stuck in the day job… let us know if you need a referral to a good tax professional.

  • Initial Investment

    An investor partners with one other guy 50/50. The partnership makes an initial capital contribution of $1,000,000 (initial tax basis will be $1,000,000).

  • Fund Generates Revenue

    The fund has generated $400,000 in annual revenue, $200,000 in operating expenses, and has allocated $100,000 in depreciation over the life of the investment.

  • Taxable Income

    Total taxable income amounted to $100,000 ($400,000 - $200,000 - $100,000). The investor's share of income that income is (50% of total) $50,000 distribution payments of the total $100,000.

  • Ending Basis

    The partner's ending basis in the partnership will equal $450,000 as outlined: If the investor receives $500,000 for his partnership interest from a sale or liquidation, that will result in capital gains of $50,000 ($500,000 - $450,000).

In most syndications there will be 50-120 investors. The best method is to breakdown your percent share of the deal. Start with the total capital raise (say $6M), if you put in $120,000 that is 2% of the total. Don’t forget to factor in the GP carried interest portion. So on a 70% LP / 30% GP split deal your 2% goes down to 1.4%. Now you can simply multiply 1.4% to all deal level returns and depreciation losses to get your individual share.

Syndication Structure

These investments are typically organized as partnerships in the form of LPs (limited partnerships) or LLCs (limited liability companies). Investors are treated as passive partners for tax purposes.

Most investment funds prefer the partnership tax structure over the corporate structure to avoid double taxation, to allow for the fund’s income to be taxed at the investor level, and to provide for the flow-through treatment of income, expenses, gains, and losses.

This structure allows you to compound 100% of the fund’s proceeds for years, as long as you do not distribute the gains outside of the fund.

For instance, let’s say you are investing in a syndication where the sponsor is purchasing a fully occupied apartment building and holding it for cash flow:

Tax Advantages of Multifamily Real Estate

NOTE: I am not a CPA, tax attorney, or tax expert so do not rely on it for tax, accounting, or legal advice. Please consult a licensed professional before making complex tax decisions. 

There are 5 main benefits from multifamily real estate:

  • Depreciation
  • Cost-Segregations
  • Passive Income Tax Treatment
  • 1031 Like-Kind Exchanges
  • Death

Depreciation

Depreciation is probably the best tax benefit. Capital spending and maintenance usually comes from after-tax dollars which some investors may be reluctant to spend. The government offsets this by letting investors take a deduction against their current income of 1/27.5 (3.6% of the building’s value at purchase) each year. 

Although buildings have practically a limitless useful life, the government is allowing you to treat the property as if it will become obsolete in 27.5 years. Regardless of the age of the property, the depreciation clock resets every time the property is sold.

Example: If you purchased a property for $1,000,000 and the land is worth $100,000 you can take 1/27.5 of $900,000 or $32,727 from their current income each and every year. 

 

Cost Segregation

While the building may depreciate in 27.5 years, the government considers the useful life of items on the property (appliances, fixtures, etc.) to be 7 years or less. Which is why having a cost segregation study on properties with a value over $1,000,000 is worth undertaking to separate these items from the building to get even more tax savings. 

Check out my article on cost segregations

Passive Income Tax Treatment

Unless you’re a “real estate professional” your income generated from multifamily real estate will be considered passive income which are taxed at lower rates than income taxes. Appreciation will be taxed at capital gains tax rates, which are still lower than income tax rates. 

Syndications kick off Passive Losses and that allows you to pay less taxes especially if you can combo Real Estate Professional status to lower your ordinary income. This is where you get on the Simple Passive Cashflow Gravy Train. Invest for more, pay less taxes, and more to invest... its a great thing.
Insider Tip
from Lane

1031 Like-Kind Exchanges

The depreciation deduction previously mentioned is subject to “recapture” when the property is sold. So when the property is sold the gain on the sale is increased by the amount of depreciation deductions that were taken. 

When doing 1031 exchanges the government will allow you to defer those taxes. Your basis in the property is subtracted from the gain on the sale. Your basis is the purchase price minus the accumulated depreciation taken over the investment.

1031s are obsolete with current bonus depreciation laws. It is a good tool for a very rare occasion. Trouble is all these 1031 sales guys are always trying to sell it.
Insider Tip
from Lane

Example: After 5 years you sell that $1,000,000 property for $1,500,000 and you took $32,727 in depreciation every year ($163,635 total after 5 years). 

Basis: $1,000,000 – $163,635 = $836,365

Taxable Gain: $1,500,000 – $836,365 = $663,635 

You are permitted to repeat this process as many times until you die. 

Death

Your death is a tax benefit, because your taxable gains are erased when you pass away. The government assigns a new tax basis to the properties when they are transferred to your heirs. 

However there is a caveat. The capital gains will still be taxed unless investors in a syndicated deal keep their funds in the LLC (the actual owner of the real estate and the only party eligible to do a 1031 exchange). Investors must understand that there are tax advantages during the life of the investment, however they may not be able to defer taxes on the capital gains after the property is sold via a 1031 exchange. 

 

Deferred Sales Trust (DST)

DST’s are known as “seller carry-back” and a type of IRC Section 453 installment. They offer a flexible tax deferral alternative to 1031 exchanges. It’s a complicated strategy that requires a qualified trustee to operate. In short, you as the owner will transfer the asset to a dedicated trust. When the property is sold, the trust will “sell” the asset to a buyer and act as a note holder. The buyer will make agreed upon payments (called an installment sales contract). The only capital gain that will be recognized will be the portion of the overall capital gains due from the taxpayer’s sale to the trust (based on the terms of the installment sales contract). 

What is a Security?

Both federal and state securities laws contain a comprehensive list of items that are considered securities by definition, one of which is an “investment contract.” 

Based on U.S. v. Howey, 328 U.S. 293 [1946], the current standard for determining whether an investment constitutes an investment contract—and thus a Security—has been reduced to a four-prong test including:

  • An investment of money
  • In a common enterprise
  • With the expectation of profit
  • Based solely on the efforts of the promoter

A good rule of thumb is that whenever someone raises money from private investors and then makes decisions on their behalf, a security has been created.

Under federal and state securities laws, the sale of securities must be registered with the government as a public offering unless the sponsor or the transaction otherwise qualifies for an exemption from registration.

It doesn’t matter who the investors are (even if their family/friends), if the sponsor is making decisions on their behalf, it’s still a security, unless they are doing a Private Placement. 

Exemptions to Creating a Security

Because registering an offering can be a prolonged and expensive process, many sponsors seek measures to avoid creation of a security altogether. 

Member-Managed LLC or Tenant in Common (TIC) Ownership

A security may not created if all investors participate unanimously in decisions involving the investment, such as in a “member-managed LLC,” or in a Tenant in Common (TIC) ownership.

Private Lender Loan

If a private lender loans money to an investor to purchase real estate using a promissory note and mortgage or deed of trust secured by the real estate, as long as investor funds have not been “pooled” or the note has not been “fractionalized” by combining investor funds to make up the total loan amount, this may qualify as an exempt transaction.

Private Placements

There is an exemption from registration known as a “Private Placement” exemption that allows a sponsor to raise money from people they he or she knows without registering the offering. One such exemption is offered by the federal Securities and Exchange Commission (SEC) under Regulation D (17 CFR § 230.501 et seq.), Rule 506(b). Under this exemption an unlimited number of “accredited” investors can be used, an unlimited amount of money can be raised, investors can come from any state, and state Securities rules are generally superseded as long as required notices are filed.

The Private Placement exemption applies to the sponsor. The sponsor may be called a syndicator, promoter, manager, general partner, etc. However, regardless of title, the exemption generally applies to the issuer, i.e., the person, group or company that is actually selling (promoting) the securities.

In addition to the Private Placement Regulation D, Rule 506(b), most state securities agencies also offer exemptions from registration and there are other federal exemptions available, e.g., Regulation D, Rules 504 and 505; each of which has it’s own specific set of rules. As an example, the rules for a Regulation D, Rule 506(b) Private Placement exemption include the following:

  • The sponsor must not engage in general solicitation or advertising of the opportunity. The sponsor must have a substantive, pre-existing relationship with any investor to whom he or she offers the securities. This is what distinguishes a Private Placement exemption from a public offering, in which general solicitation is allowed.
  • The sponsor must qualify prospective investors as “accredited” or “sophisticated” based on their income, net worth, financial or investment experience, or assistance of their professional financial advisers, before their funds (i.e., “Subscription”) can be accepted.
  • The sponsor must disclose all foreseeable risks of the investment and may not guarantee returns. This is typically done in a Private Placement Memorandum using a format prescribed by the SEC (Guide 5).
  • The sponsor must promptly return all money to investors if the minimum investment amount has not been raised in the time frame specified in the offering documents or if the objectives of the investment are not realized (i.e., the property is not purchased or the company is not opened, etc.).
  • A notice of the sale of securities must be filed with the SEC (Form D) and any states in which securities have been sold. The notices (and applicable fees) must generally be filed within 15 days of the first sale of securities.

Investing with Retirement Funds – Private Placements

Investors can invest their savings or retirement funds in Private Placement offerings. Many retirement accounts allow the account owner to use a third-party administrator or custodian to set up a self-directed individual retirement account (IRA) or self-directed 401(k) account. The account owner can direct the custodian to release his or her retirement funds to purchase private placement interests, interests in a limited liability company or limited partnership, etc.

What If The Sponsor Doesn’t Comply With Securities Laws?

Failure of the sponsor to comply with the Private Placement exemption rules may subject the investment to unnecessary legal exposure, which could impact the viability of the investment. The sponsor could be subject to substantial civil and criminal penalties for the sale of unlicensed securities. Regulatory agencies or other creditors could force liquidation at a disadvantageous time, or the sponsor could spend investor funds defending charges or paying fines.

Furthermore, a sponsor who neglects to comply with the law may be less likely to comply with the provisions contained in the offering documents or may not understand his or her fiduciary obligations to the investors.

A syndicator who fails to follow securities laws puts the entire investment at risk.

If you are an investor contemplating investing your private funds or self-directed IRA funds in an investment opportunity that you believe is a security, conduct your own due diligence and ask questions of the sponsor to determine whether the sponsor is following the rules of any applicable exemption, and whether the sponsor has hired a securities attorney to assist with preparation of the offering documents and compliance with the myriad securities laws.

Do Your Due Diligence Before You Invest!

When deciding whether to invest a portion of the assets of a qualified profit-sharing, pension or other retirement trust in the Company, a fiduciary should consider whether: (i) the investment is in accordance with the documents governing the particular plan; (ii) the investment satisfies the diversification requirements of Section 404(a)(1)(c) of Employee Retirement Income Security Act of 1974, as amended (“ERISA”); and (iii) the investment is prudent and in the exclusive interest of participants and beneficiaries of the plan. 

PLAN ASSETS – ERISA  

Under ERISA, whether the assets of the Company are considered “plan assets” is also critical. ERISA generally requires that “plan assets” be held in trust and that the trustee or a duly authorized Manager have exclusive authority and discretion to manage and control the assets. 

ERISA also imposes certain duties on persons who are “fiduciaries” of employee benefit plans and prohibits certain transactions between such plans and parties in interest (including fiduciaries) with respect to the assets of such plans. Under ERISA and the Code, “fiduciaries” with respect to a plan include persons who: 

  • Have any power of control, management or disposition over the funds or other property of the plan;
  • Actually provide investment advice for a fee; or
  • Have discretion with regard to plan administration.

If the underlying assets of the Company are considered to be “plan assets,” then the Manager(s) of the Company could be considered a fiduciary with respect to an investing employee benefit plan, and various transactions between Management or any affiliate and the Company, such as the payment of fees to Managers, might result in prohibited transactions. 

A regulation adopted by the Department of Labor generally defines plan assets as not to include the underlying assets of the issuer of the securities held by a plan. However, where a plan acquires an equity interest in an entity that is neither a publicly offered security nor a security issued by certain registered investment companies, the plan’s assets include both the equity interest and an undivided interest in each of the underlying assets of the entity unless:

  • The entity is an operating company or;
  • Equity participation in the entity by benefit plan investors (as defined in the regulations) is not significant (i.e., less than twenty-five percent (25%) of any class of equity interests in the entity is held by benefit plan investors). Benefit plan investors are not expected to acquire twenty-five percent (25%) or more of the Units offered by the Company. Management of the Company intends to preclude significant investment in the Company by such plans. Employee benefit plans (including IRAs), however, are urged to consult with their legal advisors before subscribing for the purchase of Units to ensure the investment is acceptable under ERISA regulations.

Tax FAQ’s

Can I invest using my retirement funds?

Yes, you will need to roll over your existing retirement funds (401k's, IRAs, etc.) into a self directed IRA account (SDIRA). In a SDIRA you can choose what you want to invest in and have the account custodian invest on your behalf. You will need to provide the custodian with copies of the legal documents (PPM, operating agreement, and subscription agreement). All returns from the syndication must go back into the SDIRA, and not into any other accounts (i.e. personal). 

When does selling interests in an LLC constitute the sale of securities?

Once an investor purchases interests in an opportunity it is considered illiquid. However, it is possible to sell interests/liabilities via a private sale (typically a firesale transaction).

 

We see many people try to avoid securities laws by saying they are doing "joint ventures" when, in reality, they are selling securities. Selling interests in a Manager-managed LLC with members contributing capital and a few key people managing the company would constitute the sale of "Investment Contracts," which are securities. Selling interests in a Limited Partnership with the limited partners contributing capital and the general partner managing the company would also constitute the sale of Investment Contracts.

 

One way to avoid selling Investment Contracts is with a Member-managed LLC or General Partnership structure in which "all members are responsible for actively generating their own profit," and all are responsible for management of the company, which could include opening and closing bank accounts, contractually binding the company, etc.
 
 
A Member-managed LLC might be feasible with 3-4 members who know each other very well and have identical objectives, but when larger groups are involved, it rarely happens. What actually happens is that a few members actively manage the deal while the rest are not actively involved in management. In that case, it doesn’t matter if the company is Member-managed, because certain members will attest that they didn’t participate in management and therefore will likely be deemed passive investors. If the deal is ever scrutinized by a securities regulator (or one of the investors’ attorneys), it will likely be deemed to have been the sale of securities without following an exemption (which requires proper disclosures and SEC/state securities notice filings).
 
 

In our experience any more than 5 people in a Member-managed LLC is a recipe for disaster as they can’t agree on how things will be done (too many cooks spoil the supper…), so it creates dissension, stress, and in the worst cases, litigation.

Can you explain what tax savings there are to investors that receive a K1?

Check out the webinar for best explanation. Bonus depreciation which is not really more depreciation, but it is front-loaded in the beginning years. So if you believe in the time value of money and how it's better to have those savings today… it’s a big deal. We will cover this in an educational section in this webinar and how the Cost Segregation is used to support the accelerated depreciation. I did a couple of quotes to do a cost segregation and I will include those examples as well. Of course, talk to your own Legal Professional.

I was unable to declare my SFH rental property 'loss' in my taxes last year due to having too high an income (AGI). Is cost segregation treated differently, so that I would be able to apply that to my taxes

Your passive losses should be accumulating. Personally I am walking around with a few 100k of passive losses so when I do realize a gain I do what I did in 2018 and use some passive losses. See below.

I wanted to use my funds from my SEP IRA which is currently in a qualified intermediary trust. What is the UBIT tax? Will I be subject to that on this deal? Also, should I set up an LLC that then loans the money to their LLC? How can I structure this for tax and liability benefits?

[Note: From CPA and not this is NOT legal or professional advice]: When you invest in a business (syndicate = business) with your IRA, the IRA will be subject to UBIT (unrelated business income tax) and UDFI (unrelated debt financed income).

For our purposes, UDFI is produced when an IRA uses debt to purchase real estate. Essentially, the portion of the property’s income considered UDFI is based on the percentage of rental income derived from debt.

For example, Property A is purchased for $100,000. You put down 25% of the purchase price as a down payment and finance the remaining 75% with a traditional mortgage from the bank. The property produces $10,000 in net income for the year. $7,500 (75%) of the net income is considered UDFI and is subject to UBIT.

There is a deduction for the first $1,000 of income subject to UBIT. Income subject to UBIT over $1,000 is taxed at trust rates. For 2017, trust tax rates start at 15% and max out at 39.6% after just $12,400 of income subject to UBIT.

UBIT is paid by the IRA account. If for whatever reason UBIT is paid directly by the taxpayer, the amount paid is considered a contribution to the IRA.

I’m trying to decide if one is better than another for tax purposes. Is there any difference in how the UDFI will apply for these: 1) SD IRA 2) SEP-IRA 3) Solo 401K 4) SD IRA (operated as an LLC) so this one is confusing... My LLC owns an LLC (syndication) which owns a property

 The solo 401(k) is not subject to UDFI but is subject to UBIT. The IRAs are all subject to UBIT and UDFI. Note that generally the passive income flowing back to you is very low and the as a result we don't see a huge UBIT tax.

Another idea would be to take a debt position (lending) rather than equity. The interest you would receive is free of UBIT and UDFI tax.

(This suggestion of a "debt" position or note investment with the SEP IRA to avoid UBIT and UDFI tax is a creative one... but it’s a very low chance of happening because it’s just too complicated and honestly not worth the effort from the syndicators side. It’s a very similar case of to a Tenant-In-Common (TIC) arrangement where an investor has 1031 exchange funds and wants to parlay that money into a syndication. It’s possible but from the syndicator’s prospective it's a lot of unnecessary work when you can just raise the funds the traditional way. Caveat: if you are bringing in a huge amount of money say 50% of the raise then that might tip the scales in your favor. In the real world, I just spoke to someone who did a TIC and brought a serious percentage of the total raise into a deal. They said they were lucky and the lead told them that it was not worth it and they would never do it again… and to consider it a personal favor.

Other Investments You Might See Our There….

Land Use Restrictive Agreement (LURA)

When a property is under a LURA agreement, the owner exchanges some rights of the land use for future tax credits. The restrictions are usually a maximum rent that can be charged for a unit and requiring that some or all units be made only available to households who’s combined income is below a certain percentage of the average median income. 

One example of this is when I was looking into a property that had a LURA on the land for 30 years. It limited the rents being charged at the property to 60% of the median household income for the area. Not saying its a bad investment but once a property has been low income or more than 10-20% of their tenants on government assistance the property develops a negative sigma (aka the place you get your drugs from). I personally don’t invest in these types of projects (pun intended) but one could make a tremendous amount of money if they are willing to take this risk. The same can be said for Opportunity Zone projects.

 

Check out my article on LURA's

Investing in Hotels

Read the info page here.

0:33 Why Consider Hotel Investing

12:40 Different Types of Hotels

17:01 Mid Tier Example Hotel

17:22 Strength of Hotel Investing

22:26 Weaknesses of Hotel Investing

25:03 Metrics | STAR Report in Hotel Investing

33:06 Competitive Advantage of Hotel Investing

Investing in Shopping Centers – Triple Net (NNN)

Read the commercial shopping center primer here.

Value add apartment investing can mean higher returns but it can also mean more risk than needed. This can be especially be true for large value-add projects with less than stabilized rent rolls (less than 90% occupancy) and recourse bridge loan debt. Many client under 1-2M net worth will need to grow their net net-worth in these 12-17% IRR deals however clients over 2-4M net worth who have reached Critical Mass. A triple net shopping center is a great way to sustain legacy wealth with very little headache. Plus you can be a general partner for tax reasons (750 hour active participation rule) with very little actual effort.

Post Pandemic Update – I have generally stayed away from this sector but if purchased at the right cost basis any investment makes sense.

Value-Add Leasing Strategies

Below are multiple value-add strategies to employ when investing in Shopping Centers:

Filling Vacancies

Leasing Vacant Spaces

The easiest way to add value is to lease any vacant spaces, which increases cash flow and, ultimately, NOI/ value. However, not all tenants add equal value for Shopping Centers. Some tenants might just be a placeholder to fill a vacant space, but in retail leasing the other key is do they attract other quality retailers that will pay higher rents? Retail tenant selection becomes vital to adding value for the Shopping Center.

Retailers want shopping centers that can produce the highest sales for their company. And, the higher the sales a tenant does, the more they can pay in rent! So when evaluating a property to acquire, we look at the area demographic history and trends, sales reports, existing tenant mix, market dynamics, design/layout of the property, current rent roll, historical financials, and other capital market conditions that could impact our value add strategy.

Analyzing the Rent Roll - Negotiating Leases

By simply looking at the rent roll, we can find a way to add value to the asset. For example, we have a 5,000 sq ft vacancy next to a 10,000 sq ft space that is leased by a low-quality retailer at below-market rents. The low-quality tenant’s lease expires in 12 months, and we know there is a quality hardware store looking for 15,000 square feet in the market. You could negotiate a Landlord favorable “as is” (no tenant improvements or tenant allowance) 10 year lease to occupy the entire 15,000 SF for $6.00 per square foot rent which would add $90,000 in income and $1,125,000 value at an 8% capitalization rate ($90,000 annual rent/.08 cap =$1,125,000). That’s a lot of value creation and leases your vacant space.

Bringing in a “Desirable Tenant” 

Let’s say we reached out and could attract a desirable tenant like Old Navy, however, we would need to give them a larger tenant improvement allowance of $50.00 per square foot or $750,000 (15,000 SF x $50 PSF) total for their construction. Old Navy will do more sales volume and attract more people to the shopping center, which will raise renewal rents and the probability of existing tenants renewing. Additionally, Old Navy will attract other desirable tenants that previously wouldn’t consider leasing from our property. 

One strategy to combat the high tenant improvement allowance, we would amortize the tenant improvement allowance over the tenant’s lease term ($750,000/10 year lease = $75,000; $75,000/15,000 SF = $5.00 PSF/year *simplified for illustration purposes). Now your rent is $11.00 per square foot ($165,000 per year) instead of $6.00 per square foot for the Hardware store (in the “filling vacancies” example). 

Old Navy will also be valued at a lower cap rate of 7%, so your new value creation is $2,357,143 ($165,000 annual rent/.07 cap rate = $2,357,143 in value). After looking at all the options, who wouldn’t take the value from the Old Navy lease? However, slumlords take the easy, low hanging options all the time, which creates more Value-Add opportunities for us. 

Convert Gross Leases to Net Leases.

Another way to add value through leasing is converting “Gross” lease structures (Tenant favorable) to “Triple Net” leases (Landlord favorable). When renewing existing leases, we always try to shift the risk of expense increases back to the tenant who is getting the benefit of the services associated with those expenses. Even if we cannot get them to a full NNN lease, we will at least shift them to a “Modified Gross” lease where the tenant pays the increases from an established base year. 

Again, lazy Landlords will accept gross leases just to get a deal done, avoid confusion/hassles, and save a few $ on legal fees. Which, in the long run, will cost investors thousands of dollars. 

Let’s say gross leases discount $15,000 of potential NOI at an 8% cap rate. $15,000 annual losses/.08% = $187,500 in lost value. It all adds up.

Reducing Expenses Wisely To Maintain Service Levels.

Reducing expenses is another way to add value; however, you will not get as much value as leasing. We always rebid service contracts, appeal real estate taxes, and reduce payroll where prudent. Defined benefit pension plans can be replaced with SEP/IRA’s. 

Strategically replacing outdated equipment and fixtures with energy-efficient lighting and HVAC (where the landlord is responsible for energy costs or replacement) can also increase your bottom line. Reflective TPO white roofs and adding extra insulation during a reroof also dramatically decrease energy costs. 

If you neglect the property, most Landlord’s will be required to spend more on capital expenditures. More money in capital expenditures (roof replacement, HVAC replacement, not negotiating vendor contracts) equals less cash flow to investors. Additionally, if you save more money for your tenants, you can push renewal rental rates, which impact your NOI = VALUE.

Selective Renovations Can Revitalize A Shopping Center

Simply spending a lot of money on a new facade will not automatically translate into additional rents or an increase in value. That is why we judiciously weigh the cost to the benefit of renovations and redevelopments. Less expensive and high impact upgrades to appearance can include paying to replace tenant signs, adding pylon signs with tenant identification, adding, replacing and improving landscaping, seal coating and new striping, replacing existing lights with LED lights decreases electric bills and increases light in parking lots.

We find the biggest bang for the buck is renovated or increased landscaping, which softens hardscapes and creates an inviting atmosphere. Along with LED lights making the parking lot and common areas brighter and safer, it reduces expenses. Plus some utility companies subsidize the cost of retrofit and there are great tax credit programs.

It is much more expensive to perform facade renovations, and even demolition of existing buildings to reconfigure and build new for quality tenants.

Developing Outparcels is Turning Pavement In To Gold.

An outparcel (sometimes called Pads or Out Lots) are the buildings closest to the street that come most commonly in the form of fast food (Quick Service Restaurants/QSR), banks, small strip centers, and drug stores but can be an amazing array of service and retail tenants that benefit from high visibility or the need for a drive-through (drive-thru). 

With cars getting smaller and ride-sharing apps, parking requirements have been reduced over the past five years. So converting that sea of asphalt in front of the shopping has made a liability a key asset in driving value and cash flow. Even if there are existing out parcel buildings, you might be able to squeeze in an additional outparcel or two (maybe even an ATM or Billboard in the side/rear of the center). 

This is usually accomplished by getting the zoning approval, and subdividing the property so that the parcel pays it’s own taxes. It also sets up the property for another value add strategy if done properly. The outparcel can be developed through a number of methods. 

You can execute a Ground Lease with a tenant and have them be completely responsible for constructing and maintaining the building. You can also complete a Build-To-Suit whereby you contract with a tenant to build their store to their plans and specifications, and then they take delivery of a fully completed building and start paying rent. 

You can also build a single tenant or small strip center on “spec” (speculation and lease the space as it is completed).

Selling Off Outparcels is Buying Wholesale and Selling Retail.

Another excellent way to add value is parcelization. Subdividing a larger property into smaller parcels or putting every outparcel building on it’s own tax parcel gives you the property owner the ability to sell off those parcels separately.

Our strategy is to arbitrage the lower price per square foot and higher cap rates between larger multi-tenant shopping centers. There is a larger investor pool looking for smaller stabilized Single-Tenant Triple-Net leased properties than there is for larger, higher-priced multi-tenant properties. 

Some of the reasons for this are: lower price point is easier access to commercial real estate, and Single Tenant NNN’s have much fewer management hassles. With single-tenant triple-net leased deals, one of the major decisions is do you want your rent check mailed or sent via ACH directly to your bank account.

Life Settlements 

What is a Life Settlement?

A life settlement is the sale of a life insurance policy to an investor in exchange for a lump sum payment. The amount received by the policy owner is less than the death benefit, but more than it’s cash surrender value of the policy.

The investor maintains the policy – paying all policy costs and/or premiums. Thus, the investor receives the death benefit upon the demise of the insured.

A life insurance policy is a saleable asset no differently than a home or automobile.

Life Settlement Deal

 Why Would Someone Want to Sell Their Policy?

There are many reasons why a policy owner may no longer want or need to retain their life insurance. Below are some common scenarios:

  • The Need for Cash

    They may need to pay for healthcare/long-term care, supplement their retirement, purchase a retirement home, fund grandchildrens’ educations, or check off items on their “bucket list”

  • No Longer Needed

    Their spouse has passed away, their children/heirs are self-sufficient, or the changes in the federal estate/tax laws.

  • Increased Policy Premiums

    The life insurance policy premiums have become too expensive due to the age of the insured, improper funding, or lack of policy performance.

For whatever reason, the owner of the policy realizes that they can turn their life insurance into a living benefit and receive a lump sum payment that they can utilize in their remaining years.

Below are the pros and cons of Life Settlements:

Pros 

  • Attractive Returns

    Double digit interest rates with no loss of principle.

  • Fixed Dollar Return

    The dollar yield to insured’s life expectancy is known before the investment.

  • Non-correlated Asset

    Returns are not tied to external factors such as the stock market, interest rates, housing market, or political environment (low volatility). In other words... No Market Risk.

  • Quality Asset

    Policies are backed by America’s oldest and most financially sound life insurance companies.

  • Regulated Industry

    The life settlement industry is regulated in 45 states.

  • Invest with Retirement Funds

    Custodial accounts are available to convert your current qualified retirement plan.

  • Win-Win Opportunity

    Life settlements are win-win opportunities because both the buyer and the seller come out on top.

  • Your Success Doesn't Depend on Someone Else’s Management Skills

    This might be the biggest reason your financial adviser isn't talking to you about life settlements. Once you invest in life settlements, there aren't really any more decisions to be made, other than whether you want to expand your life settlement portfolio or sell to other buyers. The only variable for which you have to account is time.

Cons

  • Longevity

    The insured may exceed their life expectancy.

  • Feature Item 2

    The funds will be tied up in the investment until the policy matures.

  • Credit Risk

    There's a possibility that an ‘A’ rated life insurance company would not pay a death claim.

How Long Have Life Settlements Been Around?

In a 1911 Supreme Court ruling in the case of Grigsby vs. Russell, Justice Oliver Wendell Holmes Jr. ruled that life insurance contracts can be sold as an asset.

The Life Settlement market has been in existence for 20 years and is a top alternative investment.

“Viatical Settlements” became popular in the 1980s due to the influx of HIV/AIDS diagnoses. A viatical settlement refers to a terminally ill person with a life expectancy of 2 years or less.

“Life Settlements”, or “senior life settlements” refer to an elderly or unwell senior with a life expectancy of 3 to 15 years.

How Can I Participate in a Life Settlement?

Why Haven’t I Heard of Life Settlements?

Most financial advisors are not aware of alternative investments. If he/she works for a brokerage firm, the types of investments sold are limited to what the brokerage firm offers. 

Some financial advisors are not allowed to participate in alternative investment options. 

In addition, due to their broker-dealer restrictions, they do not have an understanding of the market due to their lack of participation. Wall Street does not want you to know about a little known asset class known as life settlements.

More Info - Life Settlements

Note Investing

The mortgage note is an IOU that can be purchased at a discount in the right situation. Performing notes are when the borrower is current on payments and non-performing is when the borrow is late or in default. 

Many investors higher than $1M net worth who have realized that owning actual rental properties are not scalable look for ways to be active. Investing in notes can be a great option for the “tinkerer”, you don’t even need to get your hands dirty interacting with tenants and there’s minimal travel involved.

Due to the COVID19 pandemic and volatility in stock prices there has been an increase in demand from investors who are ditching the equity markets and going into hard assets such as real estate, especially turnkey rentals.

Some are going as far as owning the notes on these properties to collect a predictable income stream of 10-13%. I personally try to stay on the equity side if I believe in the deal, but debt deals/lending can be a good play for more conservative investors (see below for more info). And it is idea of retirement account investing.

More Info - Life Settlements

Types of Notes

Based on the legal ownership structure and municipality there are two types of notes:

Notes & Mortgage

Lender is the first Lien Holder on the Property, the Buyer is the Title Holder

Land Contracts

Lender is the Title Holder, the Buyer is making payments until paid off.

How to Invest in Mortgages?

Should the borrower default, the lender may exercise their rights as spelled out in the mortgage document.

Trust deeds, deeds of trust, and mortgages have similar wording, and have a few differences, but serve mainly the same purpose.

These loans can be bought and sold just like any other commodity. If someone were to buy at “face value” they would be paying the loan amount remaining at the agreed upon interest rate for the remaining term. Buying at a discount means that you purchase the note for less than the face value, thereby increasing your yield.

There are two loan documents created when a person borrows money to purchase a home: 

Promissory Note

A promissory note is evidence of a promise to pay a debt and is signed by the borrower.  The terms “loan” and “note” are often used interchangeably with “promissory note.”

Security Document

A security document, such as a mortgage, is a document that is recorded at the county showing that the borrower pledges the property as collateral against the loan. The type of security document varies by state and can be a mortgage, deed of trust, or trust deed.

Investing in Mortgage Notes vs. Real Property

Similarities

Collateral

The underlying collateral for a note is the building and/or land itself. You should value the underlying collateral of your note investment as if you will own the property (because you just might). Typically you can use online resources like Zillow or Redfin to get a range of value, to get more accurate you would order a broker price opinion (BPO) to have the property valued against other local properties. Ideally you want the value of the collateral to be higher than the unpaid principal balance of the note. Why? Because if you have to foreclose you want to make sure that after all legal and liquidation expenses, you capture at least your original investment. Return of capital is more important than return on capital!

Title

Just as you want clear title when purchasing a home, so too is the case when investing in a note. For new notes, you will obtain a lender’s policy to insure your note will record in the desired lien position. For existing note purchases, you will want to review the existing lenders title policy to ensure that it is transferrable.

Insurance

Note investors should make sure the borrower has appropriate insurance for the collateral and that the note investor is listed as the Mortgagee on the Evidence of Insurance certificate issued by the insurance company. When listed as a Mortgagee on the insurance policy, the insurance company knows to issue a check to both the Mortgagee and the Borrower. In addition, if the policy is changed or canceled, the Mortgagee is notified and can take corrective action. If the borrower does not have hazard insurance then you as the lender should originate Force Placed Insurance at your expense so that should the home be destroyed you can at least recover your original investment and expenses. FPI can be added to the borrower's account as a "recoverable cost" if you follow the procedures required by the CFPB.

Differences

Lien vs. Ownership

The first difference is the most obvious. The real estate is not owned by the note holder: the note holder has a lien position against the real estate. If the borrower breaches the terms of the loan agreement, the lien holder can foreclose upon their interest and acquire title to the property.

Borrowers vs. Tenants

Note investors manage their borrowers, and real property owners manage tenants. Both tasks can be outsourced. Note investors may outsource the collection tasks to a servicing company just as real estate owners can outsource rent collection and upkeep to a property management company.
As a note holder, your main responsibility is to collect the payment and make sure taxes are being paid and insurance is current.

Taxes & Leverage

When purchasing real property it is typically easy to find 60-80% financing from a bank or private lender. Leverage is more difficult to obtain for note investors. Although it is possible to obtain a loan against a note investment (hypothecation), it is far less common and reserved only for the highest quality investors, and usually at above market rates. Most note investors should assume that they will be required to pay cash for a note or find a "money partner" to fund the acquisition.

Also, when owning real property the landlord has some great tax advantages such as depreciation, loan interest, and passive income that is taxed at a lower rate. The note investor does not receive these benefits, since a note is considered personal property and is taxed at ordinary income rates. Because of this, note investing works well with a Roth IRA or self directed IRA since the income and growth is tax free.

Credit Underwriting

When making a decision on a note investment, the borrower’s credit and capacity to make regular payments, is equally as important as the value and quality of the collateral. The process of evaluating the borrower’s credit and ability to pay is called “underwriting” the loan. Individual investors should set standards for their borrowers in accordance with their own appetite for risk.

Document Underwriting

Not only should an investor underwrite the borrower, but a full review of the loan documents should be made. At a minimum, the review of the note, the Deed of Trust (or Mortgage), any previous assignments, allonges, lender title insurance policy, servicing notes, and payment history should be completed. If any gaps in chain of assignment are found, that could cause problems should a foreclosure be needed and a borrower could challenge the validity of the note if any defects/gaps are found.

In purchasing real estate, there is typically a purchase agreement and a Deed. The purchase agreement details the terms of the purchase and the deed is recorded to put the public on notice of the new owner, and that the transaction closed. In a note purchase, there is also a purchase and sale agreement which spells out the terms of the note purchase, but instead of a Deed, the instrument that is recorded is called an Assignment Of Mortgage or AOM. The previous note holder is assigning the beneficial interest of the note to the new note owner with a notarized AOM and once that document is recorded on the county records, the new note holder is now the lender of record.

Foreclosure

When a note investor is not paid, foreclosure is the final recourse. The process of foreclosure varies by state and may be judicial or non-judicial depending upon how the state statutory scheme is set up.

Foreclosures may require substantial upfront fees paid to attorneys and/or trustees and can be a stressful process for a note investor to undertake. The risk of foreclosure is directly related to the quality the note investment and the quality of the borrower. Good quality borrowers are as important to note investors as good quality tenants are to real estate investors. Generally loss mitigation tactics should be deployed to work with a borrower to get them back on track for the payments. It can be a long, time consuming process but will pay off in resumed income on the note.

Buying Notes – Example

The concept of “buying at a discount” is fundamental to note investing. Let’s look at an example to illustrate the point.

If we were to buy a $100,000 note at face value of $100,000 and it is paying 7% interest on a 30-year term, our return would be 7%.

As a note investor, we don’t pay face value, so we discount our purchase offer. If we were able to buy this loan for 60% of the unpaid balance, or 60 cents on the dollar, the return on our money would be 13% instead of 7%.

Considering that banks are paying roughly a whopping .2% (that’s right! 2 tenths of 1 percent) on deposits, this strategy multiplies our earnings to returns that few can show.

Buying discounted notes is a powerful way to increase our passive cash flow (or, “mailbox money,” as we call it). These high returns are why the distressed and discount note space is so attractive to us as private investors.

***I don’t invest in notes because I don’t get the passive losses from the investment

How to Vet Note Deals

Below is an example spreadsheet of all the above criteria:

Why Do Banks Sell Their Notes?

Banks and GSE’s (Government Sponsored Entities like Fannie/Freddie Mac) are not good at owning Real Estate and foreclosing. They profit on the spread, which is the difference between the rate at which they lend money and the rate at which they borrow.

Due to government regulations (that would take up several pages), when a borrower defaults on a loan, the lender must reserve a significant amount of money to service that loan.

When this happens, that money is no longer available to lend and costs the banks the profit that they could have earned.

With the huge volume of defaulted loans in the past half dozen years or so, lenders have found it more lucrative to sell the notes at a discount than to take them through to foreclosure.

Avoiding lengthy and expensive foreclosures (the length and expense vary by state) is one of the many reasons selling loans is a viable option for lenders.

 

We as investors benefit by being able to work out the loan with the borrower in a variety of ways.

How can we help the homeowner?

When we purchase a note, we are buying the payments as well as all the original rights that are spelled out in the documents. These rights include the right to modify or change the loan with the permission of both parties, and the right to renegotiate or foreclose.

In most cases, your returns are higher when you successfully work with a borrower to return them to the path of on time payment rather than foreclosing.

When the borrower has returned to paying on time and has done so for six months (this is called “seasoning”), we have the option of selling that loan as a re-performing loan at a higher price than what we paid. This spread is our profit.

 

Other Homeowner Workout Options

Foreclosure Laws – Deed in Lieu

When we cannot work out a solution to get the borrower paying on time, sometimes the lender must foreclose. Foreclosure procedures vary by state; it is important to research them to determine whether you want to purchase notes in particular states.

An alternative to foreclosure is accepting a deed in lieu. A deed in lieu of foreclosure occurs when the borrower hands over the property to the lender to satisfy a loan that is in default. When a borrower agrees to the deed in lieu, the borrower’s credit remains unaffected, which is why this strategy is often preferable to foreclosure.

When a lender takes a property back via foreclosure or deed in lieu of foreclosure, the lender becomes the owner of the property.

Note Exit Strategies

  • Mod and Sell

    Do a simple purchase, modify, markup, and sell. As discussed earlier, when we can turn a non-performing loan into a re-performing loan we can sell the loan for a much higher price than we paid. The “mod and sell” strategy is a very lucrative business model.

  • Title

    Brokering is a method where a note seller wishes to sell a note, and you find the buyer. The buyer tells you what they will pay, and you offer less to the seller. The difference between the sale price and the accepted price is your profit. Brokering is the best way to generate income with no money out of pocket.

  • Selling a Partial

    “Selling a partial” refers to selling part of the income stream of the note. The note holder sells a portion of the payments (usually a set number of payments from the front-end of the loan) to another investor at a price that will result in an agreed-upon yield for the investor. After the investor receives all his payments, the payments revert to the note holder. With partials, you get the best of both worlds–you get your money back so that you can buy another note and at some point in the future, while continuing to receive payments from the note.

Foreclosure Exit Strategies

Foreclosures are inevitable in the note business. Despite our best efforts to avoid them, they will happen, and you will end up with a property on your hands. Remember, you picked up the property for the discounted price of the note. That’s the beauty of dealing in Real Estate-backed notes.

Below are some options, out of many, available to you. As an investor, you will want to put your property to it’s highest and best use. Many factors, such as the local Real Estate market and your comfort-level with being a landlord, go into making this decision. Research the home’s market before deciding on an exit strategy. 

  • Auction

    Investors who want to deal only with paper (“paper” is another word for loan, mortgage, etc.), not properties, want to get out of the house as quickly as possible, usually through a foreclosure auction or trustee sale.

  • Hold and Rent

    A note investor may want the rental income from a property to diversify cash flow. In this case, the investor will keep the home, renovate it, then rent it out.

  • Fix and Flip

    To realize a high profit in the short-term, the investor may rehab the home and sell it at retail. Again, this could be very profitable due to the cost of the discounted note.

Investing in Notes with Your Retirement Funds

 

You can invest in notes from a self-directed IRA, have all the profits returned to the account, and enjoy the tax benefits of the IRA. 

You don’t get the great tax benefits or bonus deprecation like syndication deals but it is great for a tax sheltered retirement account.

Triple Net Deals (where you collect rents and have the corporate backed tenant pay for improvements and maintenance is lower risk but also lower return. Same can be said for Life Settlement investing (no tax benefits). Those sectors are considered more "endgame" investments. If you are under $2-4M net worth you will likely need to invest in higher risk reward profile deals. I honestly think you can't beat the risk reward profile of stabilized multifamily buildings with a little bit of value add.
Insider Tip
from Lane

Oil & Gas

The popularity of oil & gas investing has risen primarily due to tax deductions (offset active W2 income) and to the government subsidizing exploration for oil and secondarily for harvesting the oil

Most people (environmentalists included) do not realize that petroleum-based NOT only the gas in your car’s tank, most plastics are made of petroleum:

  • Umbrellas
  • Bicycle Tires
  • Solvents
  • Curtains
  • Mops
  • Roofing
  • Toilet Setas
  • Deodorant
  • Basketballs
  • Golf Bags
  • Perfumes
  • Refrigerant
  • Paint
  • Hair Coloring
  • Ice Cube Trays

It’s important to note that petroleum has no substite, oil and gas is a commodity so there is limited supply and high demand

Oil and Gas Article

Investing in Oil & Gas

Pros

There are significant tax benefits investing in oil and gas — specifically to owning a producing oil and gas well. A few of the tax benefits are:

Tax benefits

The structure of the oil and gas investment will dictate the amount of tax benefit. For example, a drilling program could result in 75%-100% write off against your active income in the year that you invest.

Cashflow from producing wells or royalty interest can have a 10%-15% yearly depreciation allowance.

Cash flow

Certain oil and gas investment types can provide consistent cash flow, similar to real estate. One good well can pay you for passive income decades and produce exponential returns.

Diversification

Apart from the tax write-offs, investing in oil and gas provides diversification of your portfolio, and can be seen as a hedge against inflation.

Cons

Despite all the wonderful pros of investing in oil and gas, it is important to take note of some of the cons.

Volatility

As you’ve seen in the news, the price of oil can be very volatile. Since oil is a global commodity with many other countries also producing it, global tensions can directly affect its price.

This could directly affect any cashflow producing investments because your cash flow is directly tied to the price of oil and gas.

Large Barrier to Entry

Depending on the type of oil investment and size of the project, it can be a big barrier to entry financially; it can cost hundreds of thousands to millions of dollars to drill a single well.

Environment

There is potential for large liability issues if there is a spill caused by one of your oil and gas wells.

Credit Underwriting

When making a decision on a note investment, the borrower’s credit and capacity to make regular payments, is equally as important as the value and quality of the collateral. The process of evaluating the borrower’s credit and ability to pay is called “underwriting” the loan. Individual investors should set standards for their borrowers in accordance with their own appetite for risk.

Document Underwriting

Not only should an investor underwrite the borrower, but a full review of the loan documents should be made. At a minimum, the review of the note, the Deed of Trust (or Mortgage), any previous assignments, allonges, lender title insurance policy, servicing notes, and payment history should be completed. If any gaps in chain of assignment are found, that could cause problems should a foreclosure be needed and a borrower could challenge the validity of the note if any defects/gaps are found.

In purchasing real estate, there is typically a purchase agreement and a Deed. The purchase agreement details the terms of the purchase and the deed is recorded to put the public on notice of the new owner, and that the transaction closed. In a note purchase, there is also a purchase and sale agreement which spells out the terms of the note purchase, but instead of a Deed, the instrument that is recorded is called an Assignment Of Mortgage or AOM. The previous note holder is assigning the beneficial interest of the note to the new note owner with a notarized AOM and once that document is recorded on the county records, the new note holder is now the lender of record.

Foreclosure

When a note investor is not paid, foreclosure is the final recourse. The process of foreclosure varies by state and may be judicial or non-judicial depending upon how the state statutory scheme is set up.

Foreclosures may require substantial upfront fees paid to attorneys and/or trustees and can be a stressful process for a note investor to undertake. The risk of foreclosure is directly related to the quality the note investment and the quality of the borrower. Good quality borrowers are as important to note investors as good quality tenants are to real estate investors. Generally loss mitigation tactics should be deployed to work with a borrower to get them back on track for the payments. It can be a long, time consuming process but will pay off in resumed income on the note.

How to Invest in Oil and Gas

Invest in Oil Stocks

Here are a few companies you could buy stock from that are doing the deep well drillings:

Exxon Mobil (XOM)
Chevron (CVX)
ConocoPhillips (COP)
British Petroleum PLC (BP)

Unfortunately as we know investing this is not direct or project specific projects and you won’t get the tax benefits. 

Direct Participation Program

If you are an investor who wants to take a more “hands-on” approach to oil and gas investing, consider taking a look at an oil and gas direct participation program (DPP). DPP’s are designed for people to invest directly in oil and gas production and exploration.

It is a type of investment that allows the investor to gain the benefits of the cash flow and tax advantages for the investment.

DPP’s require a substantial amount of due diligence by the investor and can have varying levels of risk.

In a DPP, you actually own a percentage of interest and assets of the operating company — what’s known as working interest. You have all the advantages of owning a percentage of an oil company without having to set-up the company, manage the day to day operations or be an expert in the oil and gas space.

If your investment is profitable, the DPP’s are generally passive investments and can result in steady cash flow.

 Types of Direct Participation Programs

There are different types of Direct Participation Programs you can be involved in:

Exploratory Drilling Program

This is a “high risk, high reward” type of investment and is the riskiest type of program.

This is when an operating company structures a deal to explore a new area for oil. Usually, new wells are drilled in areas that have no previous activity or drilling.

While there is a chance that the exploratory wells could hit a lot of oil and could result in insane returns, there is also the possibility that the well is a “dud” and produces little or no oil.

In exploratory programs, your investment is usually 75% to 100% tax-deductible.

Developmental Drilling Program

This is the most common type of DPP. Normally an operating company is looking to drill more wells in an already proven area.

Since there are already producing wells and historical trends in these areas, the chance of drilling a “dry hole” is much less — but again, nothing is guaranteed.

These types of drilling programs are usually chosen by investors who want an immediate tax write-off against income in the same year.

The tax benefits can yield 75% to 95% write-offs.

Based on steady or increasing oil prices, this type of investment can also yield a steady cash flow.

Working Interest Program

This is when the developmental wells have already been drilled and are already producing.

Usually, other working interest owners are looking to cash out and sell their interest to another investor. This is similar to buying real estate that is already generating a rental income.

There are no major tax advantages with this type of investment, apart from the depreciation allowed on the assets.

Re-work Programs

Re-work programs are not as common. Re-working programs normally involve operators taking already producing wells which have low production rates, and “re-working” or revitalizing them.

This normally involves:

  • cleaning the well
  • drilling into new zones
  • re-stimulating (fracking)
  • making casing or tubing repairs
  • These types of investments can be risky because it is not guaranteed that the well production rate will increase or will result in substantial production increase with this rework.

On the other hand, a small investment may result in very large returns on a well or group of wells.

Overall, investing in the correct DPP can prove to be very lucrative, though it is important to note some of the risks associated with DPP’s.

When looking at the DPP options, consider a program that is a combination of both development and working interest ownership — This type of program would hedge your risk, so you can sleep easy at night.

Similar to real estate, your working interest is relatively illiquid because you would need to find a buyer for your working interest if you are looking to cash-out.

Since you are a “part-owner” of the company or project, you can be liable for costs that arise from the project.

For example, if the operating company runs out of the money that was initially raised from all the working interest owners, they can issue a “cash-call” which would result in working interest owners needing to invest more in order to keep the project alive.

This is why it is important to involve an oil and gas attorney before you invest in these programs to ensure you understand all the risks associated with the investment 

It’s also worth noting that if you’re investing in physical wells, then go there and inspect the lease. Talk to the operator. If you can, find locals in the area that know the history of the area and better yet the lease itself.

 

Owning Mineral Rights

Apart from the DPP options we just explored, there is one more option for investing in oil and gas.

This is owning oil and gas mineral rights. Simply put, “mineral rights” mean you own the oil and gas rights beneath the surface.

Mineral rights give you the right to explore (drill) or produce oil and gas on a piece of land. Mineral rights also include the right to lease the land for oil and gas production.

Normally investors can buy mineral rights through an authorized broker, however, the cost to buy mineral rights can be quite high.

Once a person owns mineral rights, they can enter into mineral rights ownership agreements with oil and gas companies.

One of the most common types of ownership is known as a royalty interest. This is when the mineral rights have been leased to an oil company for oil and gas exploration and production.

The owner keeps a certain percentage of the revenue when the operator starts producing oil and gas. A royalty owner does not bear any costs associated with drilling or operating the wells.

This type of ownership provides a very lucrative passive income for investors, however, good mineral rights deals are not very easy to come by.

Other common investment opportunities of the wealthy consist of the following:

Solar 
Short Term Rentals
This helps to qualify as an active participant in a portfolio to qualify as a real estate professional for tax reasons
Websites
These are NOT real investments

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