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The Massive Potential and Pitfalls in Notes for Self-Directed Investors

2021 May Be the Best Year Yet for Private Lenders…If They Are Careful by Tom Olson When speaking with self-directed investors who are considering acquiring turnkey rentals in their retirement accounts, I always make sure to tell them that a slightly more “creative” option might better suit their needs. Without losing the benefit of holding a real estate-related asset, they can invest with a far greater tax advantage if they buy or originate well-considered private loans. This is also true for investors looking to diversify their portfolios. Last year was definitely a year for diversification, and many real estate investors, self-directed and otherwise, decided to expand their portfolios to include real estate-secured private loans. There are many reasons to love having this type of loan in your self-directed IRA or 401(k). A few reasons are: They are extremely low maintenance. They are often even more secure and low risk than turnkey rentals. A borrower will almost always prioritize real estate-related debt over other debt obligations, making a private note extremely predictable even when the economy is volatile. Furthermore, when you are using a self-directed retirement account to make these loans, you can be extremely creative with the terms of the loan. This represents nearly unheard-of potential for self-directed investors to buy and sell private notes. However, that creativity has led to some new pitfalls in the asset class as well. Case Study: Why This “Great Note” Might Not (and Maybe Should Not) Sell With more investors, self-directed and otherwise, moving into the private lending space, there are more notes available for purchase and sale. It might surprise you to learn that many investors do not originate their private loans but instead buy them from other investors. As you can imagine, this can be complicated if you are just getting started in the space. Here is a real-life example I recently observed of a note that could have gone really wrong for someone: The “deal” came from a Facebook post wherein the note-seller was attempting to sell an active land contract. The original note balance was $71,500, and the unpaid principal balance was $67,272.27. The note had an interest rate of 9 percent, and the estimated market value of the collateral property was $125,000. The note was “performing,” meaning the payer was paying monthly and on-time. When the seller posted his ad along with the notice that he wanted a full, cash payment for the note and that he wanted to sell at face value ($67,000), the forum erupted with jokes and other commentary. People started “bidding” on the note, starting around $10,000 and nudging the bid upward in increments of a dollar. There was a lot of hilarity, until a local investor quite seriously posted that he wanted to buy the note and did not understand why everyone was laughing at the proposal of paying $67,700 to get 9 percent interest on that loan. At that point, I knew I had to respond before that investor potentially fell right into a pitfall with his hard-earned retirement capital. Here is what I told him: First, most note investors want to earn 10-12 percent a year on their investment, which means most investors probably do not want to pay face value for single-digit yields. Second, there are three things to consider when you are buying a private note if you plan to either keep the note performing or attempt to reinstate it: 1)  Who is the borrower? Vet a potential borrower the same way you would a tenant unless you want the collateral property. Too many investors vet borrowers far less than they would tenants. A good note for sale will have a credit report and other information about why the loan was made. Not all notes will have this information, and you need to decide if you are willing to take the risk on the deal even though you might end up owning the property if the borrower defaults. Once you make this decision, vet the property the same way you would any other real estate deal. 2)  What is the quality of the asset? Sometimes private lenders will take on a risky deal because they are fine with foreclosing and ultimately owning the asset. However, this process can take longer and be more expensive than you might think. Make sure your strategy will accommodate the value of the asset and the potential cost of holding it. Get an appraisal and quotes for repairs if appropriate before makingan offer. 3)  How solid is the paperwork? You can never assume that you are buying a note with good paperwork. Have an attorney review the terms of the note and confirm that it protects the lender’s interests and holds up under the Dodd-Frank Wall Street Reform and Consumer Protection Act that was passed in 2010. If the paperwork is not solid, some investors will buy the note anyway, but they tend to insist on a discounted price because weak paperwork weakens the asset. Ultimately, I do not know for sure if the note-seller ever made a deal or not. However, I did learn several things from that post and subsequent commentary: There are still a lot of opportunities on social media if you can look past the political “garbage.” There are still a lot of people doing real estate deals on Facebook. Creative real estate is still alive and well. The opportunity mindset will make or break investors in 2021. Make sure you are willing to be creative and dedicated to making sure your creativity is optimized to generate returns for your portfolio. 

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Jacksonville, Florida

The City “Where Florida Begins” Remains a Bright Spot in 2021 by Carole VanSickle Ellis In 1901, Jacksonville, Florida, earned the dubious title of “home to the third-largest urban fire in the United States” when The Great Fire of 1901 sparked from a kitchen chimney, ignited a fiber factory, and destroyed a full 146 city blocks. The fire wrought about $15 million in damage ($2 billion today). Despite the fact that the fire left more than 8,600 residents homeless and the biggest attraction left in the area was an ostrich park, the southeastern city rebuilt with determination. The following day’s newspapers declared, “A Greater Jacksonville is in Sight,” and a number of prominent architects including Henry John Klutho joined forces to help rebuild. Six months after the fire, the city hosted the Florida State Fair. Fifteen years after the fire, the resultant boom was still going strong. Today, the self-proclaimed city “where Florida begins” continues in the tradition of turning negative events into positive results, and this is true for its real estate market as well as the broader economy. “The real estate market in Jacksonville remains a bright spot,” wrote Roofstock contributor Jeff Rhode in his 2021 forecast for the city. “The city’s business-friendly and pro-development policies strengthen the economy and create opportunities for both workforce and small-business creation.” A Prime Position for Recession Resistance and Economic Stability Sitting just north of the boundary between the Floridian peninsula and Continental North America, Jacksonville, Florida, has long benefited from a prime position in the U.S. import and export trades. Thanks to its two deep-water ports, the Jacksonville Port Authority and the Port of Fernandina, Jacksonville has been able to attract and retain international business from direct servicers to and from Asia, Europe, Africa, South America, and the Caribbean. Although the shipping and logistics sectors are affected by economic volatility, the presence of ports like those in Jacksonville inherently creates recession-resistance in the local economy because American consumers still need access to essential products. The city has long been dedicated to maintaining its competitive edge in this sector, and Jacksonville’s regional economic initiative estimated in 2019 that “for every $1 invested in deepening [the ports], $24 will be returned to the economy.” That year, a single harbor-deepening project created 15,000 new jobs. Of course, access to deep-water ports is just one geographic advantage in the Jacksonville market. Others include a pleasant, subtropical climate that makes outdoor living an enjoyable option most of the year and no state income taxes. Although Jacksonville has long been considered an emerging tertiary market getting ready to boom, the 2020 COVID-19 pandemic lit the fuse in the local housing market. For many urban dwellers, the relatively “wide, open spaces” in Jacksonville that allow for high square footage and ongoing development make the area nearly irresistible. “The pandemic has caused mind shifts in what people want in their lifestyle and their home,” observed Melanie Green, communications director for the Northeast Florida Association of Realtors. She noted that many buyers are looking for more room to accommodate remote work and virtual school as well as “a yard and more space for the kids”. Jacksonville’s relative affordability makes it an attractive relocation destination as well; the city’s overall cost of living is lower than both the state of Florida and the national average. Pro-Business in the Face of Pandemic-Related Challenges The state of Florida and Jacksonville’s city government both have shown a dedication to keeping the real estate industry running during the pandemic, making the area attractive to investors who want assurances that their projects will continue in the event of another shutdown. While nothing is ever guaranteed, precedent indicates this trend should continue. In 2020, the state’s governor, Ron DeSantis, declared residential and commercial real estate both essential services. The state also declared “construction sites, irrespective of the type of building,” essential. Although not every city in Florida accommodated this classification, Jacksonville did so, keeping its builders, housing providers, and contractors in business throughout the worst of the nationwide shutdown. This pro-business approach kept Jacksonville’s unemployment rate below the national average for the duration of 2020, and that trend also appears likely to continue in 2021. When unemployment spiked in April of last year after a near-total national economic shutdown, Jacksonville’s rate was 11.2 percent, compared to nearly 15 percent nationwide. By December 2020, unemployment had fallen below five percent, compared to nearly 7 percent nationally. “Reopening efforts boosted the local labor force as well as hotel occupancy levels,” wrote Yardi Matrix senior associate editor Timea-Erika Papp in the Yardi Matrix Jacksonville Report for Fall 2020. She noted Amazon is also adding jobs in the area, saying that the company’s plans to add another 500 jobs in its $106 million Imeson Park fulfillment center slated to open later this year is “further underpinning the metro’s path to recovery.” Poised for Growth from Every Angle Conventional real estate investing wisdom states that if a market has a growing population, positive job growth, and a diversified economy supported by employers in growing industries like I.T., healthcare, and finance, then that market represents a great deal of potential for real estate investors. In Jacksonville, all of these indicators meet the parameters for future market growth. According to Forbes, Jacksonville currently ranks 22nd for best places for businesses and careers in the United States. The city was ranked 26th in the nation for job growth as well. Expansion Management magazine routinely lists Jacksonville as one of the “Hottest Cities in America” for business expansion and relocation, and BizCosts.com named Jacksonville the third least-expensive city in which to launch a corporate headquarters. WalletHub chimed in, ranking the city 12th in the country on its list of “Best Large Cities to Start a Business” in 2019. “In Jacksonville, the availability of jobs is set to increase by 42 percent in the next 10 years,” said Marco Santarelli, CEO of Norada Real Estate Investments. “A wise move by investors in the Jacksonville real estate

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2021 Real Estate Investing Outlook

A Perspective on Single-Family, Multi-Family, and Commercial Assets by Erica LaCentra Despite still being in the midst of a global pandemic, real estate investing is booming. The Single-Family Rental space in particular is primed for continued growth in 2021. Record-low mortgage rates and lack of inventory continue to drive demand for housing. Couple that with the mass exodus from major cities to the suburbs because of the pandemic, and the industry is seeing spikes in housing prices across the country which has made it unaffordable for many potential buyers. This means more and more people must continue to rent as homeownership is now beyond their reach. The Single-Family Rental space is undoubtably having its moment, but that is just a portion of the big picture. As we head into another year where there is still a lot of uncertainty, how is the rest of the real estate investment industry fairing and what trends lay on the horizon? How Will Home Prices Fair? Home prices skyrocketed in 2020 and it no doubt continued to be a sellers’ market. As we saw the year close out, home prices ended “7.6% above where they were in 2019” according to the realtor.com national housing forecast. However, the question that remains on everyone’s mind is, will the growth continue in 2021, and if so, for how long? From all current indications, the answer is yes, strong growth is expected to continue for home prices in 2021. The median national home listing price grew by 15.4% over last year, to $346,000 in January 2021, based on data provided by realtor.com. Pent-up demand for homes is not slowing down any time soon and there is still no easy answer for how to increase supply in the market. Even as the supply of new home listings has increased since the beginning of the pandemic, it has not been nearly enough to curb the sharp home price increases that we have seen throughout the country. Many are banking on an increase in new construction starts, renewed interest in home flipping, and finally, an end to the government moratorium on single-family foreclosures to finally remedy the issue of inventory as we go into the spring. The current prediction is that 2021 will display a bit more normalcy than we saw in 2020 with the typical seasonal listing, buying, and selling patterns emerging and inventory increasing in the Spring as we have seen in previous years. From there, inventory levels are expected to continue to improve throughout the fall and into the end of the year as the vaccine is more wide-spread and people can get back to the way things once were. Maybe then we may finally see home prices start to level out. New Construction and the Reemergence of Home Flips Builder sentiment in the single-family space remains high in 2021 due to a growing desire to address the insatiable demand for homes with new construction. While Dodge Data and Analytics estimates that “total residential starts are expected to rise 5% in 2021”, starts for single-family housing are estimated to “rise 7% in 2021, to $254 billion, the highest since 2007”, according to Engineering News-Record.  And this statistic is not a fluke. The National Association of Home Builders also projects continued growth in the new construction space, with an estimated “6% increase in single-family housing in 2020, followed by a nearly 3% jump in 2021 and a 2% uptick in 2022”, which is all very good news. However, even with this projected growth, the industry will still be below the production levels needed to keep up with the rising demand for housing. There has been such an immense backlog of projects that had to be put on hold due to the pandemic that it will be challenging to make up for lost time. This is where new construction coupled with renewed opportunities in the fix and flip space will benefit the industry. For a combination of reasons, it is no surprise that over the past year home-flipping activity dropped. With limited buying opportunities in a highly competitive market, inexpensive homes were in short supply. However, investors that were able to find those opportunities, were able to make hefty profits. According to ATTOM Data Solutions, “the gross profit on the typical home flip nationwide (the difference between the median sales price and the median paid by investors) rose in the third quarter of 2020 to $73,766—the highest amount since at least 2000”. These high returns on investment will continue to make the flipping space very attractive to savvy investors as long as they can keep finding properties.  How Will Commercial Real Estate Fare? Commercial real estate was probably the segment of the market that was hit the hardest by the pandemic, and at one point the industry was questioning if it would ever recover. However, it seems like commercial real estate is starting to recover and there are positive indications that hard hit areas will be able to bounce back in 2021. For example, with employment starting to rebound there is hope that the multifamily space will come out of the pandemic unscathed as an increase in housing demand for workers returns. There is also optimism for the office sector as vaccine distribution has started and it looks like employees will be able to return to work versus solely working remotely in the near future. While many companies will have to adapt now that they know workers can be efficient while working remotely and offer more flexibility, there will still be a need for physical office spaces which is good news for this area of the market. Finally, one of the more interesting trends that is starting to emerge which should prove extremely beneficial for commercial real estate, is adaptive reuse of currently unoccupied or unwanted commercial real estate. This practice of taking spaces like unused retail or defunct hotels and renovating them into something useful rather than demolishing and redeveloping the space is starting to get traction. Companies

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Trust Deeds: The Unsung Hero of Alternative Real Estate Investments

The Risks, Rewards, and Strategy Options by Stephanie Fryar Trust Deed investing has been around for decades, offering private investors a myriad of opportunities to invest in real estate development and provides benefits such as diversification, capital preservation, and historically high yield returns. And yet, it still receives little merit and remains one of the most underutilized alternative forms of real estate investing in an IRA.  Private lending, such as through Trust Deeds, is unfortunately marred by dark periods of predatory lending practices, as well as the misconception that they are reserved for borrowers with bad credit and the exceedingly wealthy who can afford the risk to lend to them. There are two important factors that the general public fails to acknowledge. The first is that, because of the housing bubble of 2008, the government cracked down hard on the lending industry. To this day it is one of the most highly regulated industries on both the state and federal level. Second, there are companies, with years of experience, offering opportunities in fractionalized investments like Deeds of Trust. This essentially breaks down the capital barrier and makes them passive investments for their clients. The big picture is that Trust Deed investments are highly regulated, have shorter hold periods, lower investment minimums, offer capital preservation, are generally passive, and deliver a fixed income, making it an ideal investment to deploy for a long-term investment strategy. One may be wondering, what are the risks because every investment has them? For Trust Deeds it is liquidity, which is due to the fact that you are unable to cash out on your investment before the loan matures. You must wait for the borrower to pay it off, and there is the risk of the borrower defaulting on the loan. If the borrower defaults and the property must be taken back through foreclosure and then sold to recoup investor principle, this process can take time. Mitigating Risk Common strategies to mitigate this risk include diversifying Trust Deed investments across multiple borrowers, regions, and property types (commercial and/or residential). Low investment minimums and shorter turn-over time make it easy to maneuver through the real estate market which is essential when you are utilizing retirement funds to invest. In a Self-Directed IRA account, the interest income from Trust Deeds will compound tax-deferred or tax-free (depending on the account), and with enough foresight, their ability to generate a fixed income can also be used to help bridge the income gap during retirement years. The primary problem that many retirees face is how to replace the income they used to earn from their job. Sources of income from pensions, social security, disability, and income properties may still not be enough; and, unfortunately, not a lot of thought is given to creating a strategy on how to effectively use the retirement assets once we reach those latter stages of life. Imagine if you could take $120,000 from a retirement account and generate $1,000 per month of income in perpetuity without spending a dime of the $120,000. Sounds too good to be true, right? Let us look at two scenarios side-by-side. In Scenario One, a couple years before retirement you roll-over $120,000 into a Self-Directed IRA from another qualified account to invest in Trust Deeds; but like many you think it is prudent to pay-off a large chunk of debt, i.e., credit card debt or your home loan, which amounts to $40,000. You find a company that offers annualized returns of 10%. You may run into a default or two down the line, but because of the low investment minimum your portfolio is diversified across multiple Trust Deeds. While the defaults work themselves out, the others are still performing and providing an income. As you get older it is no secret that your expenses may increase for things such as healthcare, which accounts for increased distributions as years pass. In Scenario Two, all factors remain the same except you opt to not pay-off your debts right when you retire so you maintain your full principal amount of $120,000.  Now let us look at how the numbers play out in Scenario One and Scenario Two in the charts below. The difference between the build-up in Scenario Two vs. the draw-down happening in Scenario One is rather shocking! You can see the potential that Trust Deeds present if you have the wherewithall and the ability to maintain (you cannot discount the unexpected) the integrity of your principal amount. Now as you get into your latter years and would like to place your retirement savings in something with a smaller risk profile (ergo a smaller return), then you are that much farther away from completely draining your account. This could be a boon if you are planning to leave a legacy. Performing Due Diligence Finding the right Trust Deed investment company that will suit your retirement portfolio needs is key. As with any investment, proper due diligence and research is essential before making a commitment with any company. When you are performing your research and comparing different companies, there are a few questions that you can ask yourself that could help you narrow down your options: How passive do you want this investment to be? This is important because not all Trust Deed investment companies will provide the same level of service. If you are comfortable with potentially being more hands-on with the investment, then you could consider companies that will just broker the loan and then leave the servicing of the loan entirely up to you or with the help of a third-party servicer. If you are retired or at a point in your life where you do not need the chance of an extra commitment, other companies will provide all services needed for the life of the loan, leaving the investment very passive to the investor. What is your threshold for risk? Trust Deeds can be offered in first, second, third, etc. positions. If your Trust Deed investment is not in

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