July 29, 2021

JF2522: Limited Partners Exposed | Actively Passive Investing Show

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Travis Watts: Welcome, Best Ever listeners. This is Travis Watts. I’m your host of the Actively Passive Show. I have a very exciting episode here today called, What Do Limited Partners do for a Living? This is actually a blog post that got put on joefairless.com, that Theo Hicks wrote, and I just thought, “Hey, this would be a great little solo episode to do,” since I myself am a limited partner. And I’ve been asked number of times what’s a day in the life, but more importantly, I just thought, the fact is, you guys, I have worked with thousands of investors over the years, literally through numerous companies in numerous roles. A lot of limited partner investors, people investing in private businesses and companies and real estate – they also prefer to be private. So you’re not getting a lot of people like myself and a few others out here in the industry that are speaking out about what this is all about; why we do it, how it works, who’s behind the scenes.

So I thought this episode, we’re going to expose these people, these people like myself. I just felt like it’d be a good topic, both for active and passive investors to tune into, and I just kind of want to share some things that I’ve learned with you guys.

So I want to start out just by talking about those who qualify, first of all, to invest in apartment syndications or real estate private placements in general, they’re required, usually, just typically speaking, to have a certain net worth threshold or a certain income threshold to be able to qualify to do these types of investments. So we’re just talking about wealthy individuals. However, I want to point out a couple misconceptions about that here in a minute.

So most of these, by the way, these private placements, they’re a limited partnership or an LLC structure. But generally, what you have is a general partner or general partners, and then you have limited partners; and limited partners like myself, we are the investors. You may have anywhere from one to thousands of limited partners in one of these structures, depending on your business plan and what you’re doing.

But the common misconception, and I had the same misconception, by the way, back in 2014/2015, before I really dove into investing this way, is that I thought you had to be a special kind of person, a special kind of entity; you had to be a savvy Wall Street executive broker, a billionaire, hedge fund manager; this is who was buying up all the apartments nationwide. It’s just not true. In fact, it couldn’t be further from the truth, and we’re going to talk about the most common type of passive investor limited partner here in just a second. But I’d be willing to bet that there’s somebody in your network, excluding yourself if you’re already an investor, who invests privately in real estate or who invest in private placement offerings. So it may not be made public, this may not be a thing that people put on their LinkedIn profile, but the fact is, a lot of people, individual main street accredited investors are investing this way.

Let’s talk about the different types of people who are limited partners. And I want to start with the most common type that blew my mind when I figured this out… But it’s just your everyday W-2 employees. This was me; I had a high paying job, I worked in the oil industry, and I was a W-2 worker, and I invested passively on the side. This was just a place to park some extra capital that I had that I didn’t need to live on and I didn’t want to put it in 401(k)s and IRAs, and stuff like that. So there’s a lot of people, and we’re going to talk about it in a minute, who fall into a W-2 category. I’ll give you the most common types of industries, too; if you’re active, you may want to look at finding people in these particular sectors. But this is the most common type of person, your, what I call, an everyday retail accredited investor, who maybe they’re already putting some money into a 401(k) and their IRAs, and maybe they’ve done what they can do, and now this is just a place to park some extra capital, and they meet the SEC’s definition of being an accredited investor, for example.

But I do want to point out right here, you do not have to be an accredited investor to participate in all types of offerings. So I’m not going to dig into the weeds in this episode, Theo, and I’ve covered it in previous episodes, but there’s 506B offerings, there’s Regulation A offerings… So definitely if you’re not an accredited investor just yet, look into other ways you could possibly invest in real estate private placements.

So with that, here’s some of the common industries I’ve come across through investor relations and other roles that I’ve held, speaking with thousands of investors; typically what I see the folks investing as limited partners are physicians, medical professionals, dentists… Technology is a huge sector – that’s kind of vague, but engineers, etc, highly paid salespeople, oil and gas executives, that was the industry that I came from, commercial pilots, Fortune 500 CEOs, vice presidents of big companies, attorneys, professional athletes… These are just some common sectors.

What you’ll see here is the general philosophy, I think, if I had to break it down myself, is that you work actively on your highest and best potential; that could be something you’re passionate about, that you love, or something that pays you the most amount of money, whatever it is (everyone’s got a different take on that), but then you invest passively into real estate. It doesn’t always make sense to get out there on the weekends and be a fix and flipper and come back to the office Monday and work seven days a week. So real estate takes a lot of time commitment, as I’m sure everybody listening knows, in one way or another, and even if you haven’t invested yet in real estate, actively investing in real estate, self-managing, finding deals, underwriting, education, building teams – it can easily turn into a full-time gig.

So the second group of people that I want to talk about are small business owners. Simply put, self-employed individuals who’ve scaled a business to the point where they have revenue in excess, or value of the company that allows them to invest in these types of offerings.

So for those familiar with the story of Robert Kiyosaki, the author of Rich Dad Poor Dad, and CEO and founder of the Rich Dad Company – his story, according to Robert, is that his rich dad taught him to, one, start a business and make sure it’s a cash flow producing business, then take the cash flow that the business produces and put that into real estate that also cash flows. And then you take the real estate cash flow, and you just continue the cycle; you take that and you either buy more real estate with it, or you buy other income-producing assets, or gold or silver or oil and gas, whatever it is that fits your model. But the point is cash flow to cash flow to cash flow. It’s kind of a never-ending cycle of cash flow and tax advantages.

So I love that model, and a lot of people use it. Examples of small business owners that I’ve ran into at least that invest this way, people who own construction companies, landscaping companies, restaurants, franchises, healthcare companies, sales companies, technology companies… You get the point; it’s any company really, but those are the most common categories that I run into.

Break: [07:50] to [09:51]

Travis Watts: Self-employed business owners, if you’re not familiar, are heavily taxed. In fact, depending on the competency of your CPA, they often pay the highest taxes possible; all the self-employment tax and all the other tax that everyone else pays. So, real estate’s always been a very attractive asset class for people in high tax brackets and high tax situation. So small business owners certainly fit the bill there, and they’re busy running their business, they’re busy, again, working actively at their highest and best in their own active company. They don’t have the time, nor do they have the desire in a lot of cases to go be active in real estate as well. It’s a whole new venture, a whole new journey, a whole new skill set; a lot of people don’t want to do that. So these real estate private placements, being a limited partner can certainly add a lot of value to small business owners.

Third type of limited partner is retirees; retirees who have retired from their W-2 job or their 1099 job if they were a contractor of sorts, or have sold their business. Now they invest passively, because they’re retired; they’re done working, they don’t want to work. My dad falls into this category. My two first mentors in the passive investing space fall directly in this category, I’ll share with you their story. Two individuals when I first met them in their 60s and 70s, they had sold their businesses in the mid-1990s and came into a lot of money, that they never really anticipated coming into; that wasn’t really what their plan was when they got started building a business. But sometimes equity happens. So what do you do? All of a sudden, when you have multiple millions of dollars. Well, they decided for themselves; they were going to become investors. They weren’t going to go blow it or buy the big houses and fancy cars or whatever. They decided to self-study, and a lot of what they invested in for the last 20+ years has been multifamily real estate.

So I was talking to them about their experiences, about the risks, the pros, the cons, how was 2008/2009, the turndown… And I really learned a ton from these two gentlemen; but basically, they’re retirees. It depends on how you frame it, right? They are full-time passive investors, but they are also technically retired. So I guess it’s whatever you want to deem them. I would call them retired just solely because of their age; I don’t know how they self-identify, but…

Next category are professional full-time passive investors. These are individuals, they use their own money to invest in apartments syndications, REIT stocks, private businesses, self-storage, mobile home parks; the list goes on and on. I fall into this category. I wouldn’t call myself retired, it just feels weird to say that and everyone gives you a funny look if you were to say that… So a lot of people wonder, how do you get to this level? How do you achieve the FI, the financial independence?

And it’s worth mentioning again in this episode, I’ve covered it in other episodes, but disclaimer – I’m not a financial advisor. I’m not a financial planner, I’m not a CPA. I’m not telling you what to do. I’m going to share with you what I did and what I continue to do today, that has worked for me. And if it works for you, that’s amazing. If you don’t want to try it, don’t try it. But I call it the 8% rule. It’s quite simple. I’m a cash flow-focused investor, mostly multifamily apartments, but other asset classes as well that produce cash flow. So here’s how the 8% rule works – you’re basically looking for approximately an 8% annualized cash flow. Now, I have some investments, admittedly that do less than 8% and I have some that do more than 8%. So what I’m looking for is an average annualized cash flow of 8% as a limited partner.

So let’s run the math—$625,000 invested at 8% annualized is $50,000 per year. So you might say, “Well, $50,000 per year, that’s not enough, I need $100,000.” “Okay, $1.25 million invested at 8% annualized is $100,000 per year.” You say, “No, I want $200,000.” You keep doubling it, $2.5 million invested; you get the point. So that’s what I do.

Now, equity, I exclude that from my strategy. It’s usually there, I’m investing in things that both produce cash flow and have equity upside, so hopefully it’s going to go up in value over time, but I don’t bank on it. That’s just my personal take on it. If it’s there, it’s there. If it’s not, it’s not. I’m a cash flow-focused investor, I turn that into my income. So for what it’s worth, that’s my 8% rule. So again, if it works for you, that’s awesome. I’m not telling you what to do.

I’ve used this example before, people have asked me, “If you had to start all over again from scratch and you had $50,000, what would you do?” I probably wouldn’t be a passive investor, to be honest with you. Because 300 bucks a month isn’t life-changing. It doesn’t allow me to leave my job. It doesn’t allow me to switch to part-time work. It doesn’t allow me to retire. It doesn’t allow me to travel the world. It doesn’t allow me to do much; it’s $300 per month.

So I would instead focus on being an active investor and working my highest and best doing other things until I had more of a net worth to go put to work, to where I could actually get these six-figure annualized incomes out of my investing, is what I would do. So again, there’s not many of us full-time passive investors that are being public about this. I want to share this with you guys because it’s not some “get rich quick” scheme. It’s not some fantasy land idea. You might be starting with $50,000 invested and getting $300 per month, but then you have $100,000 invested and $700 or $800 a month, and you just keep building and building and building until you’re at the point where you have that flexibility to move to part-time work or retire or whatever it is for you. Travel more, spend more time with family, everybody’s different, everybody kind of has their own take on that.

The next category I want to cover is general partners, or I call them real estate professionals. So these are people who actively invest in real estate and we’ll use the general partner example first, it’s often ideal for them to invest in their own apartment syndication. So if I was a general partner, I want to put my own capital into my own deal as a limited partner as well. So I’m both a general partner and a limited partner. Why? It’s an alignment of interest. If I was doing that, and I was out trying to raise capital and get interest into my own deal, then I could say, “Look, I have my own money in this deal. If I lose money and you lose money, I go down with the ship, just like you. So I believe in this deal. So I’m going to put (whatever) 100k of my own money right here with you.” So that would be from a general partner perspective.

Now from a real estate professional perspective – let’s talk about that. These are people investing in real estate actively, but also doing passive deals on the side; we’ll discuss why here in a minute. But think about fix and flippers – there’s only so many fix and flips you could be doing at any given time, because you only have so much time, energy and resources to give. So if you’re doing let’s say three fix and flip simultaneously and bouncing around and self-managing all that, well, you could also be passively investing in other people’s deals, to help build your cash flow up as you’re generating that kind of income.

Buy and hold landlords – I mentioned my dad owns single-family buy and hold rentals, loves it, but also knows he doesn’t want to have say double that many rentals, because he’ll be too busy. He’s retired and he enjoys being retired; he doesn’t want to go back to work and be a landlord. So again, he does a hybrid mix; he self-manages a certain amount of his portfolio and then he invest passively in other deals to scale up his income.

Short-term rentals can be a lot of work, can be somewhat passive, depending on the strategy and business model that you’re using, but either way, it’s a way to scale. Real estate developers, real estate agents, commercial brokers, mortgage brokers, lenders, property management companies – there’s so many firms and people actively in the business who passive investing can have a lot to benefit, too. And those are the most common types that I run into.

So, again, so what are the reasons? Diversify your investments. Well, usually when you’re active, you’re specializing on one niche, one sector, sometimes in one market. So this is a way to diversify a little bit. If you’re a developer in Texas, that’s great. That’s your highest and best, you understand the Texas market or the particular city there, but might you want to put some money in Georgia or Florida or Arizona or the Carolinas? Maybe, just for the sake of diversifying, maybe. Scalability – we already talked about it. You can only do so much with your time and energy. So scale your cash flow by investing passively, no matter what you’re doing actively.

Break: [18:22] to [20:30]

Travis Watts: Last but not least – this is a huge one – real estate professional tax status. Man, this is huge. A lot of people are investing, either solo or with a spouse, to claim real estate professional tax status, which means—and I’m not going to dig in the weeds, I’m not a CPA, so please reach out to licensed advice, another disclaimer here. But basically, if you’re active in a real estate business and you’re spending the majority of your time on it, but then you’re also investing passively and you’re getting these K-1 tax forms with these passive losses from depreciation and all that, you can actually offset potentially your active income with your passive losses if you can claim real estate professional tax designation on your tax return.

So the importance of finding a competent CPA that works with real estate individuals is understated, it’s just a must. If you’re going to be serious and you really want to save money, and you really want to excel in this industry, you just have to find a proactive CPA firm that will do strategy with you, that will think through, that isn’t just saying, “Send your info at the end of the year and I’ll take care of it”, but it’s saying, “Hey, in 2022, here’s some things that you might think about, some pivots we can make, some things you might want to purchase for your business. Some ways you could restructure this or that.” These are the types of CPAs that you want to look for, or tax strategist for that matter.

So with that, as I always say, “You do you.” I have said that in the last four or five episodes, I feel like. But “you do you” meaning find your passion, find your highest and best earning potential, spend your time and energy there and at least be open-minded to passively investing. And it doesn’t have to be a limited partner and real estate, private placements; it could be in the stock market, it could be in buying publicly-traded REITs or whatever it is for you. But this is the only way to really get scalability. I think most of us desire to retire one day, whether it’s in our 50s, 60s, 70s. At some point, we don’t want to be swinging hammers and logging in and punching a time clock 9-5. At some point, you want that freedom, I would say, in general. And this is the way you start creating it, rather than relying on the government and hoping you get some bailouts or pensions or whatever. Maybe far down the road, this is a way to make the reality real and make it tangible and make it now, and make it an option for you to create what I always talk about as time freedom. And to me, that’s the ability to do what you want, when you want, as much as you want with your time, and this is created through passive income, through passively investing. That’s really the only way to get there, because again, you’re freeing up your time. So anything you’re doing actively is the opposite; you’re tying up your time, you’re spending your time, you’re exchanging your time for money. This is the exact opposite.

So I encourage everybody listening, if you’re not already on the journey, start the journey to creating your own passive income and time freedom and retirement. So thank you all for tuning in. I’m Travis watts, your host of the Actively Passive Show. We will see you next week.

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