Council Post: Investments In Real Estate: Exploring The Alternatives (2024)

Managing Partner at Perch Wealth, specializing in 1031 exchanges and tax-advantaged alternative investments.

Real estate investing goes beyond the direct purchase of property; in today’s environment, it also encompasses investing in alternative real estate investments. Different from the traditional real estate structure, alternative investments provide a new opportunity for investors to access passive income, diversify their portfolios and often utilize tax mitigation strategies that can potentially help increase overall returns.

What Are Alternative Real Estate Investments?

Alternative investments include all investments that fall outside the realm of traditional investment opportunities—in the case of real estate, alternative real estate investments might include preferred equity offerings, real estate investment trusts (REITs), interval funds or other income funds.

Unlike direct real estate, alternative real estate investments generally require individuals to invest with a sponsor. These sponsors, who range from large financial firms to smaller syndicators, provide investors an opportunity to access real estate investments that are not available in the public market. Some investors find this type of investment not only more interesting but also more beneficial.

Potential Benefits

There is no one-size-fits-all strategy for real estate investors. However, those seeking options may potentially experience the following benefits through alternative real estate investments, or real estate alts.

• Potential Passive Income: Like stocks and bonds, investments in real estate alternatives are passive and many are income-producing; investors can benefit from a potentially steady stream of cash flow.

• Professional Management: Real estate alternatives are professionally managed, reducing the hands-on demand of the real estate investor. Every fund is different, though, so investors need to do their due diligence on the performance of the sponsor before investing.

• Diversification: Investment minimums in real estate alternatives are generally lower compared to purchasing real estate directly, providing investors an opportunity for greater diversification across their portfolios. As a result, they can mitigate risks associated with market volatility.

• Portfolio Hedging: Most alternative real estate investments are not correlated to the stock and bond market, potentially reducing portfolio volatility during economic fluctuations.

• Tangible Asset: Investments included in an alternative fund are tangible—in other words, real estate is generally leveraged as security for the investment.

• Inflation Hedging: Like investing in direct real estate, investors can hedge against inflation through dividend increases and real estate appreciation.

However, it is always important to consider the potential risks as you consider potential rewards.

Potential Disadvantages

It's important to note that alternative real estate investments also come with their own set of risks and challenges. Investors should carefully evaluate each opportunity, conduct thorough due diligence and consider their risk tolerance and investment goals before allocating capital to these types of investments.

• Market Liquidity: Unlike stocks and bonds, it can be difficult to sell your alternative real estate investment shares quickly, as there is no secondary market for them and many require the investor to remain in the deal for a specified amount of time.

• Passive Ownership: Because these products are professionally managed, investors have a passive ownership role. While this may be preferable for some, others may prefer to have more control over management and may be better suited to traditional real estate investments.

Tax Advantages With Alternative Real Estate Investments

Real estate investing has always been tax advantageous for investors, and these same benefits may apply to alternative real estate investments. In some cases, investors can see up to 100% of their income tax-sheltered, while other investments qualify for a tax-deferred exchange. Here’s a closer look at some of the tax benefits of investing in real estate alternatives.

• Depreciation Deductions: Depreciation is the non-cash expense that reflects the wear and tear of a property. The Internal Revenue Service (IRS) permits real estate investors to capture this loss and reduce their taxable income, sheltering a portion of their investment returns from taxes.

• Passive Loss Deductions: When structured as an LLC or limited partnership, real estate alternatives can allow investors to deduct passive losses against other sources of passive income. The losses generated can offset an investor’s taxable income, ultimately reducing overall tax liability.

• 1031 Exchange Eligibility: Two alternative investment structures—tenants-in-common (TICs) and Delaware Statutory Trusts (DSTs)—are both 1031 exchange-eligible investments (disclaimer: our firm works with these investment structures). As a result, investors can defer their capital gains by investing in and exchanging into another 1031 exchange-eligible investment.

• Opportunity Zones: Under the 2017 Tax Cuts and Jobs Act, investors can, as of 2023, access two tax benefits by investing in an opportunity zone fund (disclaimer: our firm works with these investment programs).

• They can defer their capital gains on the sale of qualified investments until December 31, 2026. Secondly, their Qualified Opportunity Fund (QOF) investment can grow tax-free so long as the funds are held in the investment for at least 10 years.

Investments offer different tax benefits. Since tax regulations are subject to change, investors should consult with a qualified tax advisor or professional to assess the sheltering opportunity of every investment under consideration.

This material does not constitute an offer to sell, solicitation of an offer to buy, the recommendation to buy, or representation of the suitability or appropriateness of any security, financial product or instrument. This information should not be construed as legal, regulatory, tax, personalized investment or accounting advice.

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