 All right, let's let's take a look here. All right. Here is my subject matter today. Is this on? Okay real estate It's really on now Can it be added to a Boglehead portfolio? Should it be added? How should it be added? Let's talk about it. Something we don't talk about a lot first some I am not a financial advisor I'm not an accountant. I'm not an attorney. I'm not licensed to do anything in the great state of Maryland So this is all for your entertainment and information only. I have conflicts of interest I own a for-profit company called the white coat investor. Some of our advertisers are real estate investing companies I'm not going to mention any of those today, but be aware. I have that conflict of interest The only company I'm probably going to mention today is Vanguard, which I have yet to get to advertise with me So I don't have a conflict there Okay, here's what we're going to talk about. We're going to talk about the case for real estate in general Then we're going to talk specifically about the case for private real estate Following which I'm going to present the most important slide in this presentation. I call the real estate continuum All right, first the case for real estate The first reason why someone might want to invest in real estate is because the returns are high Okay, when you're building a portfolio, you want multiple high returning asset classes Maybe you want some lower returning ones as well. So what are we talking about? We're talking about stocks We're talking about real estate. We're talking about small business Maybe some speculative asset classes out there might have higher returns But real estate returns in general are similar to stock returns, but are a little bit more easily leveraged and once you leverage them The returns tend to be higher Second reason low correlations Okay, when building a portfolio again, you want lower correlations between your asset class If they're higher than about point eight, you're not doing a lot of good ad in that asset class at all Correlations of course go from minus one up to one and the lower the better when it comes to building a portfolio For example between us and international stocks. It's anywhere from point five to point nine four with bonds It's almost zero with commodities. It is zero Bonds to commodities actually have negative correlation in comparison Comparing us stocks to us publicly traded real estate investment trust the correlation is about point four or five And if you compare that to private real estate, it's as low as point one seven That's a good reason to invest in the asset class The third reason real estate tends to be very inflation resistant. These are real assets. They tend to go up in value with inflation The value of income of course income property is highly dependent on the rents that you are charging and collecting And so as inflation rises and you can raise the rents then that provides some inflation protection at least in the long run It's also easier to pay back fixed fixed rate debt with Inflated dollars and if you have a bunch of low interest rate fixed rate debt like a lot of people right do right now and Inflation goes up that can be a really great place to be sitting in Real estate also has relatively high cash flow a higher percentage of your return tends to come from income than from capital gains That's not always a good thing, especially if you don't need the income But it can be useful for de-cumulation years and also for replacing earned income during the working years Another great thing about real estate is that it's a little bit easier to add value You're extremely unlikely to add value to your portfolio by studying and picking stocks If you have not learned that yet you will learn it this weekend But all real estate is local an active management has the potential to work better with real estate than it does with stocks You can also boost returns aka earn money by doing the work yourself When something needs to be done that introduces some aspects of a second job Which a lot of people find not very attractive about real estate investing, but it is an opportunity to add some value Another awesome thing about real estate are some tax advantages, which frankly are unfair They're unfair tax advantages. For example, if you sell your home It is appreciated less than two hundred and fifty thousand dollars since you've been in it all that capital gain You don't have to pay capital gains taxes on if you're married it doubles Depreciation basically the government says your house is going to be worthless in twenty seven and a half years The truth is your house isn't going to be worthless in twenty seven and a half years It's overly generous, you know even for businesses. It's like 39 years still overly generous That warehouse is not going to wear out completely in 39 years And then when that depreciation is recaptured at a sale, it's only recaptured at 25 percent for those of us in the highest tax brackets That's a great deal. Take the break at 37 percent pay it back at 25 percent If you get real estate professional status, which admittedly is not all that easy to get or you take advantage If you're doing short-term rentals the short-term rental loophole, you can use passive losses to offset your earned income I know doctors High-powered surgeons whose spouse qualifies as a real estate professional who pay no taxes on their clinical income because of depreciation from rental properties Mutual funds unfortunately can't pass through their capital losses, but a partnership investing in a real estate property can do so You know those depreciation losses are really only losses on paper, but they can pass them through to you Opportunity zone funds are another excellent way that real estate offers some tax advantages Basically allows you to pay less on capital gains that you get from that real estate But the very most tax-efficient way to invest in real estate is to invest directly in properties that you buy depreciate and Exchange rather than sell into another property a bigger property usually and then depreciate some more exchange it into a bigger property and Finally you die without ever selling anything Well, if you never sell anything you never pay capital gains taxes your heirs get the step up in basis of death It's incredibly tax-efficient all that depreciation sheltered income and then nobody ever pays the capital gains taxes So that's one of the cases for real estate of these unfair tax advantages Okay, so we're talking about the case for overweighing real estate because most of you own real estate investment property Whether you like it or not The total stock market index of vanguard owns three to four percent Real estate three to four percent of it is composed of these private publicly traded real estate investment trust However, ninety percent of real estate by dollar dollar value is not Publicly traded. It's not on the stock markets It turns out investors only purchase about 22 percent of single family homes and only three percent of those are purchased by large Institutions, they're not on the markets. It's a completely separate economy from what we're investing in in vanguard index funds If you compare that to non real estate businesses You'll see that there's a few thousand publicly traded businesses in the company in the country But there's 27 million total businesses However, the truth is almost all of those are one-person businesses, you know 21 million of those only have one employee and 80% of profits when you look at non real estate businesses 80% of profits in the country are coming from those publicly traded businesses from stocks That's not the case in real estate So the idea is that if you overweight real estate in your portfolio more than a total stock market index does That's a little more representative of the real economy and real wealth in the country Okay, so enough about real estate in general. Let's talk now about private real estate Okay, what is the case for private real estate as compared to just investing in real estate investment trust that are publicly traded on the stock market Well, you still get high returns. They might not be higher returns as we'll discuss momentarily You get lower correlation and perhaps better risk adjusted returns You may collect an illiquidity premium. You certainly should by theory whether you do or not. It's a different question You may get lower expenses of a lot of these, you know There's a lot of regulation when you were publicly traded on the stock market It costs a lot to comply with all those regulations However, when you're involved in these smaller properties syndications, etc You can have those regulated according to regulation D, which is a much lower barrier as it's upsides and downsides There's fewer regulators looking at it, but it costs less to comply with it So you may have lower expenses in that regard. You're also often investing in smaller properties You know a duplex just isn't going to fit into a publicly traded REIT It's too big. It needs to invest too much money. It's not going to buy the duplex down the street from you That might not be the case with private real estate It tends to be a less analyzed market fewer people picking through it fewer analysts looking at it And of course in these sorts of partnerships or whether you own it directly the depreciation has passed through right to your tax return Okay, but here is where the rubber meets the road 2022 is not a great year for most of us, right? These are my actual portfolio returns from 2022 If you look at my overall return is about minus 10 percent US stocks were down about 16 percent small value did a little better International did about the same small international did even worse Bonds did not have an awesome year in 2022 either and you know I bonds were like one of those rare bright spots Well, if I look at my private real estate compared to my public real estate that year My public real estate got hammered right along with the stock market did even worse minus 23 percent But my equity real estate did about 9% and on the debt side. I did a little bit better than that nine and a half percent To me that goes hey, you know, there's something here Maybe we ought to be looking at this a little bit more closely Those are various hand-selected investments and how they did in that year, you know, someone did quite well But on average, you know about 9% that year So our private returns actually higher This is a good question and the answer is it depends. I think the best answer is probably not on Average, but the risk return risk adjusted returns probably are a little bit better Because they have lower correlation with stocks and bonds once you incorporate it into a portfolio. It may do better But the returns don't actually have to be higher for it still to make sense to invest there All right, so here is a comparison in four sectors of the real estate investing space You know retail and us office and industrial and apartments. We're comparing private and Public okay, so the red line is the REITs the publicly traded real estate The blue line is the private and as you can see it varies a little bit by sector, but more or less It's about the same However, when they look at these things more specifically in studies You'll see a lot of studies that come back with data like this and you'll see here The second thing down there are these publicly traded REITs and they did pretty darn well over this time period Which is about 20 year time period, you know, it's up there 10 and a half 11% ish And if you go down about halfway, you'll see unlisted real estate. This is the private real estate. It did not do nearly as well It's about what 8% Okay, so it was higher in that study for the publicly traded real estate and Numerous other studies have basically shown the same thing, you know time periods are all a little bit different But it's basically the same thing. You'll see that the public real estate did better than the private But then you start looking at studies where they look at incorporating into a portfolio to take advantage of the fact the Correlation is lower and this study from Utah he et al concluded that the optimal portfolios had higher weightings of direct real estate investments as opposed to REITs and that the optimal Portfolios containing REITs are outperformed by those containing direct real estate investments. It's not all about returns If you look at the sharp ratio Private real estate according to Black Creek anyway has delivered better risk-adjusted returns for investors over the last 20 years Once you adjust it for risk and by risk they mean primarily volatility and The reason why is is the correlation is just much lower You see over the last 20 years compared to the 10 years before that the correlation of the stock market With publicly traded REITs has gone way up and it's gone up a little bit for the overall real estate market But not nearly as much. So it's just much lower correlation and This is kind of interesting data too when you look at this You'll see there's a little bit of a lag, you know, because the stock market is marked to market daily it goes down first and Likewise publicly traded REITs go down first and then the private stuff kind of follows it so there's a little bit of a lag there and If only private real estate didn't have such high transaction costs and such illiquidity, you might even be able to take advantage of that This is interesting too once the stock market gets pounded once publicly traded REITs go down more than 20% Compared to their net asset value Then they do much better than private real estate over the next one to three years That's what this graph is showing. So something to keep in mind there All right, enough about private real estate Let's talk about the most important slide in this presentation the real estate continuum and This is what it looks like On the left side, you will see people who are basically real estate developers. They go to the city They get a permit they break the ground. They dig the hole. They build the building. They, you know, they're it's ground up construction And then you move along to the next category. This is fix-and-flip you buy a place It's like the shows on TV and fix it up you renovate it and then you sell it Coming next on the spectrum is short-term rentals. Okay, it's you're kind of running a hotel business here All right, this is Airbnb. This is Burbo, right? People are renting your house for three days or seven days something like that Next to that comes long-term rentals. You still own the whole thing, but you're now renting by the month or by the year After that is a turnkey property Basically, you still own the whole property, but you're not doing any of the work You've hired it all out somebody else finds it. They put the tenant in it. They manage it. They repair it They sell it. They're doing everything. All you do is own it After that we're getting into the more passive types of real estate investing the next couple are available only to accredited investors Meaning an income of at least 200,000 for each of the last two years 300,000 is a couple or a million dollars in investable assets. We're talking about syndicated properties so the idea here is 99 investors go in together and they buy a 200-door apartment complex because none of them can afford it on their own number one and number two You get this, you know Some sharing of expenses a little bit and you get professional management None of those 99 investors are being called when the toilets clog. It's a passive investment to them It's mailbox money that comes in every quarter But you own the property directly and it's a partnership and so the depreciation is still passed to you a Private fund often now structured as a REIT even though it's still private It's just you know 15 or 20 of these you put 15 or 20 of these apartment buildings into one fund And that's what a private fund is and then of course at the far end are the publicly traded REITs that show up in your total stock market index as You move from left to right along the spectrum You will see that you will require less experience. You will have less hassle You will get more diversification and as a general rule you'll get more liquidity However, you're giving up control. You're giving up tax benefits You are paying more layers of fees and you probably All of if all of this is done. Well have lower returns because of that So there's not actually a right or wrong way to invest in real estate But there is a right way and a wrong way for you to invest in real estate You've got to match yourself up on that continuum with what makes sense to you You know if your goal is you hate your job and you want out as soon as you can and you'll do anything to do it The answer might be building an empire of short-term rentals On the other hand if you're like I'm a retiree and I want to play golf for 12 hours a day And I don't want to do any of this real estate stuff the right answer for you might be I'll just take the real estate that's in the total stock market index Or maybe I'll just add a little bit of the vanguard REIT index fund that sort of a thing And everyone else has got to match themselves along that spectrum somewhere Real estate of course is not mandatory. You already own it whether you want to or not Okay, so what we've talked about real estate while optional is a great asset class and often the first alternative That gets added to a portfolio Private real estate may not have higher returns than public real estate, but it does have some other advantages There are lots of different ways to invest in real estate You don't need and you certainly don't want to do all of them. I promise you Make an honest assessment of what you want from your real estate investment before making it But you can invest in real estate without getting toilet calls It is not always a second job if you look at that spectrum all of our real estate investments My wife and mine are on the far right side of that spectrum, you know Some of them are private and some of them are public, but nobody calls us for toilets I assure you and That is not the only way to invest in real estate Real estate investing should not be a get rich quick scheme, but it can be a get rich quicker scheme It's still going to take years, but using some hard work some leverage You actually can reach financial independence earlier most likely doing that and Of course passive income is a great term. It is often not nearly as passive as it looks All right. Thank you for your attention. Let me Thank you