3 Of The Worst Ways To Invest In Real Estate

By on October 2, 2015

In times of real estate booms, investors can get so caught up with the fear of missing out that they become receptive to any way possible to buy a ticket for the ride. People, especially novice investors truly believe that no matter how much money they lose, they can make it all back with the appreciation.

It doesn’t help that everyone at work and in social circles seem to be making a killing by taking on investing positions that will be classified as lunacy in a normal progressive market.

Typically, the average investor will only have 1 method of stocking up with properties. That is to get a conventional mortgage to leverage on his considerable down payment. There is absolutely nothing wrong with that. And that is enough for anyone to hitch a ride on a booming real estate market.

The problem is that when prices are rising so fast that new investors feel a fear of missing out, people start to explore alternative methods to put their money into real estate bets. Then they buy into stuff that they don’t fully understand. That’s the logic in an illogical market.

If you have somehow reached that stage where fancy investment opportunities for real estate start to look attractive, then here are 3 types of structures you want to be wary of.

1) Real estate focused hedge funds

When you see the word hedge associated with any form of investing, you think about things that are supposed to guard your investments. You hedge your bets.

But the reality of how hedge funds work is that the beneficiary of the hedge is the fund manager instead of the investor. This is because when the fund loses money, the loses will be incurred by the you alone. And when it does make money, the fund manager takes a cut from it at roughly 20%. These types of arrangements effectively take the risks out of the managers, and instead transferred all to you.

The people at the top of this industry makes at least double digit millions each year. If they are making you a lot of money, you could possibly turn a blind eye to their huge management fees. Everything works great when everyone is partying to the bank. But when markets go south, you will be scratching your head as to how you got involved in the first place.

2) Limited partnerships

Limited partnerships sound like a basic business structure that you are pumping your funds into. But they are anything but that if you don’t do your due diligence checks.

Promoters, brokers, and financial consultants travel all around the world to promote these vehicles to a global clientele. You would think that if their real estate opportunities are so attractive, they would hardly have time to travel just from the tidal wave of interested prospects in the home country.

But alas, a huge amount of their buyers tend to come from overseas investors who have little knowledge of the environment the investment operates in. On top of that, the middlemen get such an obscene amount of commissions per sale that you wonder how can anything be left for the investment itself. This is why you will never get a straight answer when you ask about their commission fees.

The really unscrupulous project operators then use the harvested funds to pay themselves huge salaries while indulging in office furniture made of gold. All in the name of operating expenses. If you are really unlucky, they might even use the money to fund their travels to get more international investors on board.

The worst part of such investments is that they are illiquid. You won’t be able to cash out anytime you want. So even if you have seen the value of the assets plummet by 50%, there won’t be a proper process to exit. You are pretty much stuck for years until the partnership is liquidated.

3) Time shares

On paper, time shares look like the ultimate dual concept. Because properties can both be a home and an investment, time shares exploit this usability to it’s advantage.

They do this by allowing investors to pool up their funds sort of like a group buy, and purchase an apartment within a multi-unit development (often resorts). In the case of a resort, investors will be able to “book” a week or two each year for their own use so that they can enjoy the resort themselves. At the same time, the project owner will then pay you a rental or a promised return annually.

The irony is that if you do the numbers and calculate how much the unit actually costs, you might find that you can fully buy a nearby apartment for yourself at half the price. In fact, many investors expect this. But the draw of time share is the low capital outlay.

If the resort becomes a winner, there is a secondary market for you to sell your share at a profit. But most of the time, prices are lower on the secondary market. This also means that if you really must buy time shares, the best place to buy them could be the resale market.

I personally know people who lost their whole investment from time shares. Resorts get built half-way and the builder runs out of funds to continue construction. Resorts could also flop badly causing operators to abandon it completely. Be careful when making a decision on these things.

A good alternative

Because the market generally suffer from bright shiny object syndrome a lot of the time, investment vehicles that have lost the excitement of being new lose publicity. One of which is REITs.

REITs are very attractive vehicles to get invested in real estate without having to get involved. They are basically many properties being bundled into a fund. The big ones are then listed in the money markets giving you an ease of liquidity. Avoid those that are privately held to avoid liquidity issues.

Most REITs are managed by big corporations and packed with high valued commercial assets. Managers are usually very focused on making their REITs grow. There are also those that are focused on niche markets. You have to read up their prospectuses to learn what you could be buying into.

Overall, it definitely looks to be more assuring as an alternative ticket into real estate to me.



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