Real Estate Investing Online Part III: Tips, Tricks, Caveats and Final Considerations

Parts I and II of this series on online investing in real estate deals discussed the basics and what to look for in these deals. Now, let's talk about the little details that make all the difference and not obvious when one is just starting out.

K-1s and minimum investment size: opposing forces

In almost all cases when investing in real estate online, one will be a member of a partnership for tax purposes, as a limited partner. As such, you will receive a schedule K-1 at some point and you'll need to file that with your tax returns. Just like investing in MLPs or some commodities ETNs.

So far, so good, right? No big deal?

Except that if you use an accountant to file your taxes, many of them will charge you per form (or equivalently, per hour). That means that for every new RE deal you invest, you could be paying $50-$100 or more to file your taxes. And if your investment size is as small as say, $1000 on a deal that pays say 8% annually ($80 per year), you could be keeping just $30 of these $80, minus the tax you owe once you pay your accountant.

So, just keep in mind that very small investments sometimes are not worth the trouble at tax time. If you do taxes yourself, this is less of a concern, but still, it's one more form to file and it will take some of your time, which could be better spent doing something else other than tax.

Multiple States, Multiple Headaches

Online deals are great because one can diversify and invest in a state across the country from where one lives, thus hedging bets about local economies and the RE market across the US. However, this very diversification comes at a cost: tax preparation costs again.

Each state has a different requirement for when one should file, even if you're not a resident of that state. For example, Oregon has a low threshold of just $4,600 of income per year for married couples. If you earn money from an RE deal in Oregon, you will be liable to pay taxes there even if you never set foot on the state.

Filing tax in multiple states is not only a headache, but it's more cost too as a CPA will have to research that state's laws. Even if you use software like TurboTax, you will incur the cost of filing with a new state. So, keep that in mind when choosing to invest and when deciding the minimum amount of your investment.

Oh, and, of course, you're liable for the taxes due in that state. So, make sure you factor the state tax rate into your required returns before you invest.

Luckily, there are five happy states that won't require you to file anything because they do not tax personal income: NV, FL, WA, WY, and TX. But then again, check with your tax professional as things change and I'm not a tax specialist.

Finally, consider your tax consequences when you invest in national or regional funds. These are funds that invest all over the US or in a given broad region like mid-west or east coast.

Get familiar with capital calls and dilution terms

Many operators retain the right to make a capital call -- that is, request more money from investors in proportion to their original investments. Say, if a deal is underfunded or incurs losses or extra expenses not budgeted for, the general partner (GP) may tell the limited partners to pony up more money. And, as is often the case, those who do not put more money in will have their shares of the partnership diluted in some non-linear way.

The dilution can sometimes be 15-30% more than if you simply didn't add more money in subsequent rounds. For example, let's say there are 10 investors and they each put $1000 for a $10,000 deal, and there's a capital call later for another $1000 per investor. Normally, each investor would add $1000 and each would keep their 1/10th of a $20,000 deal. However, with some dilution clauses, if someone does not contribute the extra $1000, their share would not simply go down to 1/20th as you'd expect. It could become 1/25th, 1/30th or less, depending on the dilution penalty clause.

There is also the possibility that a non-contributing member could be automatically given a "loan" from another investor. In this case, some contracts specify that the "defaulting" (non-contributing) member needs to repay the lending member at a rate of interest of X%. This interest will be taken out of the member's distributions or even principal if the distributions are not enough to cover the implicit interest.

These dilutions terms are not very common, but I've seen quite a few of them. So search the documents of the deals for "dilution" and "capital call" and understand thoroughly what you're getting into. I've found that emailing the operator also works and most are willing to explain the terms in more details if you're having trouble with the legalese.

General Partners as Free Riders

Generally, the general partners will invest in the deal some percentage of what they're looking to raise. Obviously, the more they invest the more their interest is aligned with yours. And as I've explained in part II, investing alongside a GP who is also an investor, not simply a fee-taker operator, is a good thing.

Most GPs will invest some percentage. But whose money are they putting up? It could be your own money that they're co-investing with you -- so they're getting a free ride (and probably laughing at you at your own expense).

I explain.

Remember the acquisition fee we talked about in part II? Well, some GPs will openly declare that they will use that fee to make an equity investment in the deal. Meaning: they're charging you what I consider to be a borderline abusive fee to then turnaround and dilute your investment some, just so they can say they're co-investing in the deal. But in reality, they're taking no economic risk in doing so. These operators are just operators, not investors. Don't get me wrong: They might be great operators and they might generate great returns for their investors. I've invested in one such deal and it's working fine. But I strongly prefer when GPs are real investors in deals and are exposing their own money.

Keep in mind you are the Limited Partner

This is common to all deals: you're the limited partner and you have little to no say in how the asset is managed and operated. That's great when things are going well, but it's useful to always think of worst-case scenarios and how you'll recover your money if something goes bad.

Imagine, for example, that a debt deal goes bad. If you have first lien on the property, you may think you're covered: "I take my part of the asset and sell it". Right? However, first lien debt is not exactly like a bank mortgage. First, you don't control the terms. Second, you can't threaten to ruin the borrower's credit score. And most importantly, you're one of many investors so even in cases where you may vote (typically, in case of default you have some limited rights), you still need to reach consensus with other borrowers. So, imagine what other investors will think when the borrower decided to negotiate a 50% haircut. Maybe you don't agree with it, but you may not have final say.

There's not much you can do as an LP. So, choose the operators wisely and don't settle for mediocre returns. There's a reason they need to offer you more than what they would pay a bank for a "normal" mortgage. Make sure this margin is not too thin, because you have limited recourse in case something goes bad.

The sites that offer these deals are not in the business of foreclosing or negotiating with operators when things go south. These platforms may or may not help you, but that's not their business. So make sure you build your own defenses as much as possible in terms of due diligence and margin of safety.

Debt: Repeat borrowers, good or bad?

Many sites offer debt deals these days. You may see borrowers asking for as little as $200k to rehab a house and flip or to buy one or two properties, improve them and rent out.

Many of these operators have been doing this for a long time. Experience is great. But it also could spell trouble: how can you be sure these operators are not over-leveraging themselves and borrowing more than they can handle?

It's true that each deal has its own terms and guarantees. But can a bad deal somewhere else in their portfolio cascade to yours? Typically they're separate legal entities, so you might be protected that way. But often times these debt deals come with a personal guarantee from the borrower -- a line of credit if you will. But this guarantee is often the same one for all deals of an operator. So it's not much of a safety net if many deals go wrong.

Just something to consider. Look at the history of each operator on your platform of choice to have an idea of how much they're borrowing and what they offer as guarantee and whether you think that guarantee is enough of a safety net for all the deals they've listed. More deals is not always better. It can be, but don't just assume it is.

Payment In-kind

This is not a big deal, but some operators reserve the right to pay you "in-kind". Meaning, they will give you the asset(s) instead of cash. One such operator I contacted said it is rare they need to do this, but they reserve the right in case the market is not conducive to a sale.

In most cases, I'd just prefer that the time frame for the deal gets extended instead of receiving the asset directly. But it's a choice the operator will make for you. Again, as the LP, you won't have much say and you'll need to deal with other investors if you're given the asset directly. Just make sure you're okay dealing with it.

Be wary of indirect language, unnecessary complexity and general sneakiness

Most operators are straightforward and most deals are reasonably easy to read if you've read a few of them -- even for someone not versed in legalese like me.

But then there are deals that have hundreds of pages and things that are defined in addendums, appendices or left unspecified or unclear. For example, I've seen deals where there's a hurdle rate for investors, after which there's a catch-up phase for the operator. But the catch-up amount was not specified until later in an appendix. This may be because these deals use template documents or for whatever reason. But I generally prefer a straightforward document that is easy to read and has everything spelled out nicely and up-front. Not in footnotes or appendices.

Another tell tale sign of potentially too much ass-covering language: if the word "fee" appears as many times or more than there are pages in the document.

I can't list all of the things I've seen nor give an exact formula for what unnecessary complexity and sneakiness means. This is something one needs to learn by reading multiple deals. And sneakiness and complexity are subjective and personal things.

Try searching the documents for words that matter to you as an investor: "fee", "dilution", "guarantee", "capital call", etc and read around these sections. Sometimes you'll be surprised by what you find out lurking in subscription documents.

That's all for now. Happy investing.


Real Estate Investing Online Part II: Triaging Deals Online

Last time, we talked about some of the basics of real estate investing online and how I’ve been using online platforms for over a year to generate an income-focused portfolio.

This time, let’s talk about some of the things to look for and be aware of when investing in real estate online.

How investors earn money from real estate deals

Real estate deals online have several dimensions. First, one needs to understand the difference between a loan (debt) versus equity.

Equity vs loan (debt)

Most often, I see deals that are equity deals. This means you’re investing in buying the property advertised. If it’s a rental property (commercial or residential), you can expect to get some income from rents. For rehabs (fix-and-flip), you’ll likely see returns after the property has been sold. Same thing if it’s a new construction. Typically, equity deals have some upside in the end, even if they pay a distribution (say, from rent).

Equity deals also have a downside: if the property fails to generate enough income, you may not get your distribution. And if something bad were to happen and the operator defaults on the bank loan (most equity deals still take out loans with banks to buy the properties), then you likely would not get your investment back.

Debt, on the other hand, is a loan to the entity buying the property that pays a fixed interest but with no upside upon sale of the property. Loans typically offer a higher annual payout than equity investments. Loans also are often structured in a way such that the investor would get his/her money back first in case of default, before the operator and equity investors. Note, however, when making a loan investment, be sure it has a first-lien on the property, before any bank or other investors. Otherwise, you’d be running an even greater risk of loss of principal, which needs to be matched by a higher payout or other risk-mitigating factors.

Bottom line: I tend to prefer to have upside and thus invest in equity deals primarily, but I do invest in debt when it offers a solid return with a decent risk profile -- I avoid debt to buy a single family home for example, but find it more acceptable when doing so as part of a fund or a multi-tenant property.

IRR vs Cash Flow (or Cash-on-Cash)

Internal Rate of Return (IRR) is the annualized return one gets after the property has been held for a few years and then sold. For example, if your share of a property is bought for $1000 and it pays $100 per year in rent for 5 years and is then sold at the end of the 5 years for $1500, the IRR to the investor is the $500 collected in rents (5 years x $100), plus the $500 appreciation ($1500 - $1000), plus the principal back ($1000), annualized over 5 years, for that original $1000 investment. Thus, this means an IRR of 2000/1000^(⅕) = 14.9%

But note that for the first 5 years, the investor did not get these 14.9% every year. So, IRR does not mean money in your pocket every year, even though it’s an annualized rate.

Cash-on-cash is the money in your pocket every year. These are the $100 per year you’d get in the example. This translates to a cash-on-cash return of 100/1000 = 10% per year.

When looking at deals, it’s important to look at both numbers. IRR will tell you what your average return will be. It’s important for it to be a high number, certainly higher than what you could get out of stocks or bonds. I personally look for 15-18% in most cases.

One needs to be aware that a lot of the IRR is due to property appreciation, which is very hard to predict, specially for long hold periods, say over 5 years. So one needs to balance a high IRR with an equally healthy cash-on-cash return. I like to see the two numbers being closer together rather than farther apart, for a balanced deal without a lot of my return coming from hypothetical appreciation. It’s easier to predict cash flow from rents than price appreciation -- though, neither one is guaranteed, of course.

I typically look for cash-on-cash of at least 8% and currently I’ve been looking for even higher returns, given that interest rates are expected to go up soon, which means that in a few years a return of 8% is likely not to be as attractive as it is now that “safe” rates are very low.

But it’s all a balance, of course. A very high and realistic IRR might make up for a relatively low cash-on-cash.

A quick note on another metric, the equity multiple: that is simply your overall return after the hold period and sale of property all combined into one big multiplier of your initial investment. In the example above, it’s 2x, because one would get out $2000 for an investment of $1000 after the hold period. It’s essentially the same information one gets from the IRR, but compounded over time. I’ve trained myself to understand the compounding effect of IRR, so equity multiple does not give me any new information. But it does put things in perspective a little bit. For example, if the equity multiple is 1.2x for a hold period of 10 years, that’s a terrible investment, as one would be getting a total gain of 20% after 10 years. Likewise, the IRR on such a deal would be 1.8%. So, looking at the IRR usually suffices for me.

Bottom line: I typically look for cash-on-cash of upwards of 8% and a believable IRR of 15% or more. These required numbers will go up when interest rates go up.

How deals are structured

Commonly, real estate deals online have a “waterfall” structure of returns. A deal might be structured such that investors get 80% of the returns and the sponsor of the deal (the operator) gets 20%, beyond their own investment.

More commonly though, investors will get 100% up to some preferred return or “hurdle” rate. A typical structure might look like this:

Hurdle Rate
Preferred return


It’s also common for deals to differentiate between cash flows and capital events (i.e. sale of property, cash out refinance, etc).

And sometimes there are multiple tiers of returns, such as this (real) example below:

Hurdle Rate
Preferred return
Tier 1


The example above is interesting because it gives the operator an extra incentive to go beyond that 18% hurdle rate and thus collect a larger fraction of the money to themselves. I don’t mind that, because it means a higher return for me too. Just beware of 50-50 splits right after a low hurdle rate. I’ve seen these deals too.

In real estate lingo, the operator’s split is commonly called the promote. It’s similar to what hedge funds call performance fee. A good return structure is crucial to align investors and sponsors.


If there’s one guiding tenet in all I do when investing and consuming is this: minimize paying fees. Fees not only eat into returns, they potentially create a misalignment of interests between investors and the operators. But not all fees are bad. Let’s discuss them in turn.

Property management fees

Normally, operators charge a property management fee. They are fees paid to a third company or sometimes the operator directly, for making sure rents are collected, the property’s conditions are kept in shape (toilets unclogged, gardens landscaped, etc). Those are necessary, so don’t mind them.

In fact, most operators I’ve studied charge a very reasonable property management fee, between 4 and 5% of rents collected. This is actually why I prefer to join a professionally managed deal online than buy my own property and hire a property manager -- they would cost me 8-10% typically. But seasoned operators have scale and thus their fees are quite reasonable.

Bottom line: Make sure to look for property management fees around 4-5%.

Asset management fees

Now, asset management fees are the ones I don’t like. These are fees for keeping my money, like mutual fund and ETF expenses. I often see them in the 1-2% of assets range. Some operators will charge less and a few don’t charge them at all and at least one I've seen charges a fixed rate.

The reason these fees turn me off (besides eating 1-2% of my returns) is because the operators get paid even when the deal goes south, which is the misalignment of incentives I was talking about. A flat fixed fee is okay, as they need to pay for accountants and office staff. But the work does not become more expensive with extra money. It might be proportional to the number of investors, but not with the number of dollars necessarily. I would not be opposed to a fee on  a sliding scale, where it goes down with higher amounts invested -- which is similar to a flat fee anyway.

Another reason why an asset management is bad is because it is typically beyond paying for the accountants, lawyers and secretaries. Most deals, if you read the fine print, say that the company investing in the property -- most commonly a separate entity than the sponsor itself -- is responsible for all reasonable expenses. So, my understanding is that all the overhead of running the deal is paid by all investors already. This makes an asset management fee just an extra way to compensate the operators regardless of how the investment performs.

Bottom line: Avoid asset management fees like the plague.

One-time fees

Many deals have an acquisition and/or a disposition fee, oftentimes around 0.5 to 1%. These are justified in some cases because these fees are paid to brokers and other companies employed in finding the properties in the first place. However, one needs to inquire operators about these fees, as they’re not always meant to reimburse third parties, but instead are an “incentive” for themselves -- sort of a self-congratulatory high-five for putting the deal in place.

In some cases, these fees are used to fund the operator’s part of the equity in the deal. This means that the operator does not need to put up its own money into the deal. They instead charge an acquisition fee to fund their portion. Think about it: they take your money to fund their participation in the deal, as an equal partner to you, plus their promote. Seems unfair, no? It is.

I believe that the bulk of an operator’s returns should come from their equity investment alongside you, the investor, and in part from their promote. It should not come from auxiliary fees or asset management fees. I don’t expect them to work for free, obviously. But in many cases the entity formed to operate the deal is paying all incurred expenses directly anyway and the sponsor will get its performance fee (the promote) as compensation for working on the deal. A fixed-amount asset fee on top is not unreasonable. This structure of compensation is what I would want for me if our roles were reversed and I was operating one of these deals. Anything else seems greedy and unfair. Several operators follow this approach. Some don’t even charge a promote and instead are equal partners to you. Our incentives are truly aligned, as they should be. Long and prosperous lives to them.

Bottom line: Inquire about the use of acquisition and disposition fees and avoid them if you can. Prefer operators that are investors themselves and are getting their returns from their investments mostly and not from selling you deals in which they have little or nothing at stake.


Real Estate Investing Online - Part I: The Basics

Over the past year and a half, I have been investing in many real estate deals online, via websites like RealtyShares.com and RealCrowd.com. I’ve done quite a few now -- over two dozen -- and I have learned a lot about investing in real estate online. I thought I’d share a few things with my dear readers.

Thus, over the course of the next several weeks, I will write about my experience with these online marketplaces, the nuances of different types of real estate investments and the gotchas and pitfalls to watch out for.

Let’s start with some of the basics first: Why invest in real estate, how to invest online and the differences between two of the online investment sites I use.

Why invest in real estate

I’ve expounded on real estate investing before on this site. Basically, real estate investing has a few interesting properties:

  1. Leverage. It’s easy and relatively cheap to use leverage to acquire properties, via a mortgage. Leverage will increase returns, if properly used.
  2. Income. A property allows one to derive income from, via rents. This is not always true with say stocks, which may or may not pay dividends.
  3. Control. Owning a property outright may allow you some wiggle room to control how much income you derive from it. One typical way of getting more income is by increasing rents when appropriate or by rehabbing the property to make it “worth” more to tenants, thus allowing for higher rents. Owning a dividend-paying stock or a REIT is great, but you ultimately have little control over the dividend.
  4. Tangibility and simplicity. It’s relatively easy to “see” a property and value it through comparables and rental income. This is often not the case with large companies and their complex balance sheets and cash flow statements.
  5. Tax and depreciation.  Oftentimes, the tax treatment on real estate can be constructed in beneficial ways, by taking deductions on the mortgage and depreciation and by using tax laws such as 1031 exchange.

All told, real estate often yields a solid stream of income with relatively low volatility. Of course, there are disadvantages too such as not having as much liquidity as with stocks and bonds and the added headaches of owning a physical structure that decays over time and needs maintenance.

How to invest online

Gone are the days one had to go see a realtor, stop at a bank and at a title company to buy real estate. Now this can all be done online, sometimes in a matter of a few seconds. Sites like RealtyShares and RealCrowd are making these investments very easy to make. Here are the US-based sites that I know of:

RealtyShares.com - Invest as little as $5000. Equity, debt.
RealCrowd.com - Deals starting at $25,000.
RealtyMogul.com - $10,000 minimums.
ProdigyNetwork.com - Manhattan only. $10,000 minimum.

I have first hand experience with the first two, RealtyShares (in which I am also an investor) and RealCrowd. I will describe my experience with them. Both have many similarities, such as in how they present deals. They simplify the selection process by showing investors what they’re investing in. They show pictures and descriptions of the properties, financial terms (returns and fees), and the types of deals they are: preferred equity, equity, debt.

How online sites differ

Despite their similarities, RealtyShares and RealCrowd have big differences too. The biggest one I see is how they trade-off fees for ease of investing.


RealCrowd does not charge investors a fee to invest, while RealtyShares will typically charge 1% to administer the deals on behalf of investors. However, that cost comes with some benefits too, such as not having to deal with various operators and their individual preferences and quirks (see below).

Transparency and Complexity

Investors in RealtyShares don’t need to deal with operators (the companies that sponsor the deals). Everything is done through a separate entity -- an LLC -- for each deal. RealtyShares deals are investments in an LLC that pools money together and subsequently invests in the deals the operators promote. This means RealtyShares is responsible for collecting checks and providing investors with statements and their end-of-year tax documents (typically K-1s). In my experience so far, everything has been standardized with RealtyShares. They make it easy to see my returns with an integrated dashboard and they deposit payments directly to my bank account.

With RealCrowd, payments to the operators and distributions from them need to be dealt individually with each operator. RealCrowd does not track my returns for me. If you invest with only one or two operators, that’s not a big deal. But I have a dozen or so deals with RealCrowd and some operators pay by wire transfers or ACH and some send me checks in the mail. They each require a different way of funding their deals, which must be initiated by me. RealtyShares, on the other hand, will ACH the money to and from my chosen bank account automatically.

Operators on RealCrowd communicate with me directly, which is good for transparency, but it can also be messy as some prefer to call me on the phone, others send email and a few insist on sending me physical letters, making it more complicated to keep track of updates. Also, they each send their tax statements in different ways and at different times. I had three K-1s that were delayed and hence forced me to file for an extension on my tax returns. RealtyShares, on the other hand, sent me all the K-1s on-time and in one fell swoop.

Deals on RealCrowd, however, are more transparent, as one gets to see the exact terms the operator is offering and read all the paperwork associated with deals first hand. Investors also get to communicate directly with operators and have their questions answered from the horse’s mouth. RealtyShares investors are investing in a proxy deal which RealtyShares itself operates, which in turn has terms similar to those originally offered by the operators.

The trade-off here is clear: one pays for standardization and ease of use.


RealtyShares typically has deals starting from $5,000. Sometimes, a few deals can be found for as low as $1,000, especially when deals are near closing and there are only a few spots left.

RealCrowd deals are more expensive, starting at $25,000 and oftentimes minimums of $50k or $100k have been seen.

Deals on RealtyShares tend to close more quickly too which can be good and bad: good because you put your money to work faster. But bad because I’ve seen deals fly-by in a few hours, making it really hard to do my due diligence and read all the disclosures.

My experience so far

I have done about two dozen investments so far. A few more of my deals were on RealtyShares than on RealCrowd, but I invested slightly more money via RealCrowd, given their higher minimums.

I have not noticed any difference in quality of deals between the two sites so far. Deals on both sites have done mostly well and all are functional. No deal has defaulted in over a year that I’ve been investing in them. Most are already paying back regularly. But there are a few deals on both sites that have delayed their distributions more than they had anticipated. I’m not concerned though as complications are part of the process of investing in real estate and all operators have been open about their difficulties so far.

Partial Returns So Far

Total returns are hard to speak of as the exact accounting for depreciation, losses, fees and taxes play a role in computing them. Many deals offer 7-10% cash-on-cash with expected total return after the holding period of around 15-18%. But there are deals offering 12-14% fixed payment with little or no upside. And as I said, some deals are not yet paying, making it hard for me to know exactly what my real payoff will be.

So far, I have gotten about 3% return on all my disbursed dollars -- meaning, I got 3% back from what I’ve paid into deals in 2014, not accounting for any depreciation or tax breaks. That may not sound so great, but many deals that closed in the last 6 months have not yet paid a distribution. If I include only deals that closed in 2014, my partial returns on disbursed cash have been about 4%.

However, if I continue to invest in deals at this rate and they continue to offer the current mix of return -- cash distributions and expected returns upon sale of properties -- I roughly expect a steady stream of about 12-15% returns as some deals close out (sell appreciated properties) and others continue to return cash in the form of collected rents.

I will provide an update on returns by the end of this year to see where things stand.

In the next post, I will talk about things to look for and how I triage investments on these sites. And then after that, I will explain some of the pitfalls to avoid and things to look out for with these deals.

Disclosures: I’m a minority investor in RealtyShares. I’m not authorized to speak on behalf of the company. This is my own opinion as a real estate investor. I was not compensated in any way by any of the parties mentioned here.