An Ignoble Experiment: WCI December Real Estate Newsletter — How Your Real Estate Investment Can Go to Zero

Welcome to the Monthly White Coat Investor Real Estate Newsletter!

Thank you for being a member of the WCI Real Estate Opportunities Group! We hope you find the enclosed information and introductions helpful. Remember that we have a financial relationship with each company listed in this email, you generally need to be an accredited investor to invest, and you are still responsible for any necessary due diligence. Consider these to be introductions, not recommendations. This newsletter should be the first step in your due diligence process, not the last one.

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Today's Topic: How Your Real Estate Investment Can Go to Zero

Many real estate gurus have gone bankrupt over the years. Sometimes, it feels like half of the authors of real estate investing books have lost it all at some point in their careers. The story is usually the same: too much leverage (debt). People learn about leverage and get really excited about what it can do to help them achieve financial freedom relatively quickly. "The more leverage the better!" they say. "Other people's money!" they say. The problem with leverage is that it works both ways. Just like you can double your money by putting 20% down and having the property appreciate by 20%, you can lose your entire investment by putting 20% down and having the property drop in value by 20%. In fact, as a direct real estate investor, it's entirely possible to lose MORE than your entire investment. Imagine putting 20% down and then having the property value drop by 50%. You still owe the entire mortgage.

Time heals most wounds in real estate. However, for time (appreciation) to heal your wounds (drop in value or unexpected expenses), you have to stay in the game. The way to stay in the game is to have positive cash flow. The way to have positive cash flow is to put down more money, reducing the largest expense of real estate investing, i.e. the mortgage payment. It would be extremely rare to have negative cash flow on a paid-off rental property. Even if your property drops in value, you can just hold on to it until it goes back up in value, so long as you can still pay that mortgage payment and other expenses, either from cash flow on the property or some other source of income. However, even a doctor's income can only carry so many properties that create negative cash flow.

One benefit of being a passive real estate investor (i.e. a limited partner in a syndication or fund of syndications) is that your loss is limited to your entire investment. However, you still have your entire investment at risk. Sometimes the equity in a leveraged property goes to zero, and the equity investors are wiped out. Although rare, sometimes those higher in the capital stack (preferred equity and debt investors) lose principal too. If that property is the only holding of a syndication, the equity investors lose all their money. If that property is one of a dozen in a real estate fund, the result is much less catastrophic, but there is still a loss of value. If an entire portfolio or fund is over-leveraged and/or poorly managed, it can all be lost.

On two separate occasions, I (Jim) have lost most or all of the principal in a passive real estate investment, and I know some white coat investors have invested alongside me in both of those investments. It absolutely does happen and it hurts, both psychologically and financially. While neither partnership is completely wrapped up, some preliminary lessons can already be drawn.

The first episode was a result of fraud. Basically, the sponsor (aka operator or manager) of the syndication violated the terms of the partnership and used the value of the apartment building owned by the partnership as collateral for a separate loan. Then, he defaulted on the loan. While the sponsor ended up going bankrupt and being criminally prosecuted, the investors (including me) really didn't have any financial recourse. While the platform I bought the syndication through formed another partnership with additional equity to try to save the deal, their current best estimate is still that I'll lose 100% of my equity in the deal.

The second occasion was with a company/REIT that sponsored The White Coat Investor for a year or two up until the beginning of 2023. While the company has been very transparent about what's going on, that doesn't do much for the disappointed investors facing serious loss of capital. One of them complained:

"I will lose a lot of money on this investment. Of course I knew that I could suffer up to a 100% loss but viewed it as a distant possibility, as I did when I underwent hernia surgery. The operative consent form mentioned the possibility of death, but I trusted the surgeon to keep that probability minimal . . . It is one thing to invest in crypto, which has no intrinsic value, just what people believe it is worth. This investment was in houses, which have intrinsic value. If they are not giving the houses away for free, then how is it possible for investors to have a 100% loss?"

As explained above, it is possible (and actually not even that hard) to lose 100% of your investment due to leverage. They are currently estimating a loss of 75%-100% of the capital from this investment. What happened? Well, really the same old story. There wasn't enough cash flow to service the debt.

The capital stack started with debt, but one problem was that the debt for the REIT was mostly variable, not fixed. As you know, interest rates have gone up about 4% in the last year or two, so this dramatically increased the cost of the debt. After the debt, there was some preferred equity. However, the managers of the REIT gave the holders of the preferred equity a call option, and as rates rose, they exercised the option. Finally, there were a fair number of assets in the REIT (build-to-rent homes) that were not yet cash-flowing assets, further straining the available cash flow.

The REIT could no longer cover its operating costs from cash flow, much less service the debt and give the preferred equity holders their money back as quickly as they wanted it. So, it began to sell assets (single-family homes in this case) to raise cash. As you know, when you're desperate to sell, you don't get very good prices on what you're selling. That has been the case so far as the REIT tries to sell homes quickly enough to stay in business, make the now increased debt payments, and keep the preferred equity wolf away from the door. While this hasn't all wrapped up yet and probably won't for another year, it appears that the debt holders will likely get their money back, the preferred equity holders should get most or all of their money back, and the equity holders (like me) will lose most or even all of their money.

Lessons to learn from this debacle for direct real estate investors and fund managers include:

Use less leverage.
If you're going to use variable-rate debt, make sure you can afford the worst-case scenario.
Don't give call options to debt or preferred equity holders. Raise more equity and put more down (i.e. less leverage) instead.

Lessons to learn for passive real estate investors include:

Diversify, diversify, diversify.
Invest at the minimum amount until you know a sponsor well and have evidence that they manage their business well. The shorter the track record, the less you should be willing to invest.
Understand where you are at in the capital stack.
Understand the leverage used by the syndicator or fund manager. How much leverage? How much of it is variable? Is there preferred equity or mezzanine debt too? Does anyone have a call option they could exercise?

Real estate investments can and do go to zero. This is one reason why private real estate investors generally must be accredited investors. The technical definition of an accredited investor is simply an income (of $200,000 single or $300,000 with a spouse) or a net worth figure (of at least $1 million). I think you should not only meet both standards but double them. The idea is that an accredited investor is wealthy enough to lose their entire investment without it affecting their financial life AND be capable of evaluating the merits of an investment without the assistance of advisors. If both of those do not apply to you, private investments that require accredited investor status are not for you, no matter how much FOMO you feel looking at projected (or even actual) returns or how much you want to feel "sophisticated" or that you're "playing with the big boys." Risk is real and investing is more about risk control than it is about returns. Caveat emptor!

Recently Published Articles That Relate to Real Estate

Check out these recent articles and podcasts that relate to real estate from across the WCI Network:

Current Real Estate Opportunities

DLP Capital (Multiple Funds)

DLP has been around for a long time and treats investors better than any similar company we know. Their investments are straightforward, easy to understand, and profitable. They even pay preferred returns before they receive their management fee, which is unique in the industry. DLP has five funds: 2 equity funds, 2 debt funds, and a notes fund. DLP has agreed to lower that minimum to $100,000 if you go through the links in this email and/or tell them you're coming from The White Coat Investor. Jim is invested in the Debt and Equity funds with DLP.

To learn more, watch the DLP Capital Webinar.

Check Out DLP Today!

MLG Capital (Multiple Funds)

MLG Capital is a real estate investment firm, founded in 1987. Focused on serving accredited investors, investment advisors, family offices, and more. Each of the MLG Private Funds target to acquire a geographically diverse portfolio of 25-30+ commercial real estate assets across several key U.S. markets.

Since its inception, MLG Capital and its associated entities have had active, exited or pending investments of nearly 35 million square feet of total space across the United States, inclusive of more than 30,000 apartment units, with exited and estimated current value exceeding $±4.7 billion.

MLG Private Fund VI is now open for investment.

To learn more, watch the MLG Capital Webinar.

Check Out MLG Capital Today!

Southern Impression Homes (Turnkey Homes)

Southern Impression Homes is the parent company of one the most successful Build To Rent Ventures in the United States. They specialize in helping individual investors build successful rental portfolios in high growth, landlord friendly markets in Florida. Focused on new construction homes in desirable neighborhoods designed to maximize landlord profit with better inventory, less tenant turnover, lower maintenance and repairs and a better overall growth strategy for both rents and values. Their system provides full-service in acquisition, building, construction, property management and ongoing client support and education. Most clients come to SI Homes looking for an alternative to the stock market because SI's strategy creates ongoing cash flow, real estate appreciation and an excellent hedge against inflation. For the right investor, their system delivers amazing results to help overcome those issues quickly and completely.

To learn more, watch the Southern Impression Homes Webinar.

Check Out Southern Impression Homes Today!

Origin Investments (Funds and Syndications)

Origin Investments helps high-net-worth investors, family offices, and registered investment advisors grow and preserve wealth by providing best-in-class real estate solutions. They are a private real estate manager that builds, buys, and lends to multifamily real estate projects in fast-growing markets throughout the US.

Since their founding in 2007, they have executed more than $2.8 billion in real estate transactions and their Co-CEO's have invested more than $60 million alongside their investors. Their performance ranks them in the top decile of private real estate North America-focused fund managers by Preqin, an independent provider of data on alternative investments.

Origin is currently accepting new investors for their open QOZ Fund III and IncomePlus Fund, which seek to provide tax efficiency, enhance portfolio yield, maximize growth, and minimize portfolio volatility. Also their affiliate partner, Origin Credit Advisers, offers the Strategic Credit Fund ¹, a private credit Fund open to qualified purchasers. ² The Strategic Credit Fund's objective is to provide a consistent stream of risk-adjusted income with capital protection.

1) This Fund is offered by Origin Credit Advisers, LLC, an SEC-registered investment adviser. For information on Origin Credit Advisers privacy practices, please see their privacy policy.
2) A qualified purchaser is an individual or a family-owned business that owns $5 million or more in investments, not including a primary residence or any property used for business.

Check Out Origin Investments Today!

Wellings Capital (Fund)

Wellings Capital seeks to help accredited investors passively protect and grow their wealth through investing in self-storage, mobile home parks, RV parks, and more throughout the country. Over 700 accredited investors have invested in Wellings Capital funds, which aim to provide value to investors in four primary ways:

Instant diversification across private real estate asset types, operators/sponsors, geographies, properties, and strategies
Extensive, professional due diligence on operators and properties
Access to deals and operators
Better terms

Their sixth fund, the Wellings Real Estate Income Fund, is accepting new investors with a $50,000 minimum investment. The Fund only accepts new capital when properties are identified, so all capital is called up front.

Check Out Wellings Capital Today!

37th Parallel Fund II (Fund and Syndications)

37th Parallel has been doing multi-family syndications for years. Since their inception in 2008, they've completed over $1 billion in multifamily transactions while maintaining a 100% profitable investor track record. Their Income and Total Return Fund II is now open for investment. This $40M-$80M fund has a $100,000 minimum. Fund II is focused on acquiring and improving 200-plus unit Class A & B apartment complexes in 13 markets across Texas, North Carolina, South Carolina, Florida, and Georgia. Capital will be called as needed to acquire properties with a goal to have all investors' capital called within 12 months. Their goal is to begin liquidating or recapitalizing fund assets in seven to eight years from inception. Fund II has two share classes - Class A (Current Income) and Class B (Total Return). Class A shares have a 9% annual preferred return and first access to cash flows from operations but capped upside. Class B Shares have a 7% annual preferred return and second access to cash flows from operations along with an initial 80/20 split. Jim is personally invested in Fund I, and we have negotiated a $500 fee discount for you if you go through our links. If you prefer individually choosing which properties you invest in, 37th Parallel still does individual syndications too at a $50,000 to $100,000 minimum investment.

Check Out 37th Parallel Fund II Today!

Mortar Group (Syndications)

Mortar's approach to investments is simple. We are a vertically integrated firm with an experienced team that delivers consistent returns. Specializing in multi-family real estate, Mortar has been the driving force behind over 30 distinctive and successful developments in prime and niche New York neighborhoods since 2001. We leverage over two decades of experience in architecture, development, and asset management to build value and minimize risk for both investors and the residents who live in them. Our winning combination of high-returns and risk-adjusted strategies has led to an excellent track record of investment success.

Check Out Mortar Group Today!

EquityMultiple (Real Estate Platform)

Offers equity and debt investments to accredited investors. Equity Multiple is very transparent and invests alongside its investors in every deal, which is unique for a real estate platform. Since it has skin in the game, I expect EquityMultiple to be a little more conservative with its due diligence. Its volume is not as high as some companies, but perhaps that is a reflection of the higher quality of the deals that do show up. Jim owns a syndication purchased through Equity Multiple. Minimum investments are typically $5K-$20K.

Check Out EquityMultiple Today! (Management fee waived on your first investment when using this link)

AcreTrader (Real Estate Platform)

AcreTrader is an investing platform that makes it easy to buy shares of farmland and earn passive income. US farmland has historically outperformed most asset classes, with almost no correlation with the stock market. Further, it has experienced positive returns during economic downturns. Unfortunately, buying and maintaining farmland directly is extremely difficult, which has prevented most investors from participating. AcreTrader makes it easy to place direct investments in farmland and handles all aspects of administration and property management. AcreTrader carefully reviews each farm, selecting less than 1% of the total parcels considered, then places each farm offering in a unique legal entity and offers shares to investors through its online platform. See AcreTrader's current offerings to view what is available today! Minimum investment is $10K.

Check Out AcreTrader Today!

Fundrise (Private REIT Provider)

Fundrise offers REITs and funds to non-accredited investors. It now has 7 REITs/Funds with various focuses, including income, growth, and various geographic areas. Minimums are the lowest we've seen, just $500. Jim has invested with Fundrise in the past, although that was before they started this REIT.

Check Out Fundrise Today!

CrowdStreet (Real Estate Platform and REIT)

CrowdStreet is the premium provider of online commercial real estate investment marketplace, technology and professional services. Investors can directly access institutional-quality commercial real estate offerings with CrowdStreet's online investing platform. CrowdStreet's REIT provides investors with easy access to a diversified portfolio of growth-oriented private commercial real estate projects from multiple sponsors through a single fund managed by CrowdStreet Advisors. This is a portfolio of 20-25 private commercial real estate projects selected by CrowdStreet. You can invest with lower minimums ($25K) and expenses than traditional private funds. The REIT election allows for simple 1099 tax reporting instead of multiple K1's.

Check Out CrowdStreet Today!

We hope you find these monthly newsletters helpful. We appreciate your feedback, both positive and negative, about the real estate opportunities you learn about here and elsewhere.

Jim and Brett

Jim Dahle, MD, FACEP
Founder, The White Coat Investor

Brett Stevens, MBA
COO, The White Coat Investor