JF2326: Highlights From 401(k)aos by Andy Tanner | Actively Passive Investing Show With Theo Hicks & Travis Watts

Investing in 401(k)aos: Highlights from Andy Tanner’s Book

The 401(k) retirement plan has taken its place alongside Mom and apple pie as a pillar of American wholesomeness. Most private-sector employees invest in a 401(k) where offered, and the public sector has its equivalent accounts. As workers, we learn that contributing to an employer-sponsored retirement account is the best way to fund retirement. Andy Tanner, in his book “401(k)aos”, questions this one-size-fits-all assumption. On this Actively Passive Investing Show podcast, we discuss Andy’s five main points and add our observations on the 401(k)’s potentially chaotic role in lives and markets.

1. 401(k) to the Rescue

To understand why the 401(k) is an agent of chaos, we need to look at its history. Invented in 1978 to help workers fund retirement, the 401(k) plan was meant to supplement other options such as IRAs, pensions, brokerage accounts, and personal savings. Ideally, the average American worker would draw from a diverse financial portfolio in later years. A financial strategy could include commercial investing and active investing in providing retirement income streams.

Fast forward to today, and many people rely on their 401(k) as their primary retirement strategy. They expect this account, along with social security and homeownership, to support them throughout retirement. In reality, most people won’t have nearly enough saved to cover their expenses. According to Andy, relying on the 401(k) has created a tragic and chaotic situation. He echoes the original architect Ted Benna in asserting that it was never intended as a primary retirement account.

Another aspect to consider is whether your financial goals are congruent with the 401(k)’s purpose. These plans build net worth, not provide cash flow. If you are involved in passive investing or commercial properties, you care about cash flow. Placing significant assets in a 401(k) may not be your best option, as withdrawing cash before retirement age could incur steep taxes.

2. The Peril of Mutual Funds

If you are an active investor, consider the lack of agency you have with a 401(k). These plans rely on mutual funds as investment vehicles. Further, they offer limited choices and stratify them according to risk. The conventional advice is that younger workers can tolerate more risk and should invest in riskier but potentially higher-yield funds. Older workers should invest more conservatively. Plans usually guide employees through a friendly online algorithm designed to help them allocate their contributions according to risk tolerance.

The issue here is with applying the same general investing strategy to all people. This approach also assumes that age primarily determines risk tolerance, irrespective of individual goals and circumstances. If you are an active investor, you know this view is shortsighted.

Andy flags historical mutual fund performance as a risk. Mutual funds generally track the stock market. If the S&P and Dow Jones indexes are down, your account probably is too. Reallocating a 401(k) is cumbersome and tied to specific time windows. You cannot react agilely to a volatile market, and you can’t plan to hedge losses.

The fundamental issue is that mutual funds are part of the Wall Street system and tied to its fortunes. Real estate and other assets can hedge against Wall Street, especially if they focus on people’s basic needs for goods, services, and housing. Retail shopping centers often survive market downturns. Other commercial properties, such as well-managed apartment complexes, usually thrive.

When you manage your own brokerage account, you can set a stop loss against sudden stock price drops. You can create other alerts that help you succeed with active investing. If your 401(k) nosedives, you wait for better days.

Retirement Fund Waiting Game

You may wonder if you need that flexibility in a long-term savings plan. After all, isn’t the 401(k) meant to be the ultimate vehicle for long-term passive investing? Don’t you want to let compounding and historical market trends work their magic? After all, many Americans lack the resources or knowledge to pursue commercial investing.

Let’s think back to the Great Recession. In many cases, the value of conventional retirement plans dropped by 50% or more. People lost half their retirement savings overnight. While the losses were unrealized, they quickly became real to the many people who needed to draw on the money within ten years. Employees approaching retirement did not have time to make up for the losses. Younger workers waited five years or more for their accounts to regain pre-recession value. If you were planning on borrowing against your 401(k) for an imminent home purchase, medical bills, or your children’s college expenses, you were out of luck.

If we look at the math behind the drops, the portfolio performance needed to recover is greater than the loss. If your account plummets by 50%, for example, you have to gain 100% to return to the initial value. In other words, you have to double your money to break even. This is an odd calculus for an investor, particularly when applied to mutual funds.

3. Feeding Wall Street

According to Andy, you should realize that the 401(k) was invented to enrich Wall Street. Though it may offer some advantages to individuals, its purpose is to promote mass participation in the stock market. Wall Street reaps fees and other profits from this vast investor base.

This doesn’t mean a 401(k) has no place in your financial strategy. Just keep in mind that the vehicle was not designed to benefit the individual. The tax situation illustrates this fact. If you want to withdraw from your account before retirement age, you face a stiff tax rate and penalties. To avoid this, you need to take a hands-off approach to that money or leverage the few exceptions, which still tax you at ordinary income rates.

Let’s take a mutual fund purchase as an example. If you buy a fund on your own through a broker, you can hold it for over a year and then sell at a long-term capital gains tax rate. This rate is 15% for most people. If you buy the same fund through your 401(k), hold for more than one year, and then cash out at retirement age, you may pay up to 37% in taxes on ordinary earned income.

Andy asks the question we should all ask ourselves: Do you plan on making more or less money in retirement than you do now? People’s answers vary depending on their goals. If you plan on making more, however, you are likely an investor. Does it make sense to take a 401(k) tax advantage now and pay much more tax later on that money in a higher income bracket? You may want to calculate scenarios in light of your investment strategy.

4. Abdicating Investing Responsibility

Andy points out an insidious side effect of mass reliance on the 401(k). If you trust your sponsored retirement vehicles to secure your future, you may forfeit owning your financial destiny. It becomes too easy to remain ignorant of basic investment and economic principles. Many people don’t learn financial literacy at home or in school. Without an incentive to learn fundamentals, they may pay excessive taxes because they don’t understand the system. Over decades of hard work, they may overlook opportunities and even risk life savings because they abdicated responsibility.

Structurally, the 401(k) reinforces dependence by offering limited investment choices. You typically have a small portfolio of mutual funds at various risk ratings, sometimes only one fund at each risk level. Your company may also offer a stock fund, but consider that you already invest in the firm by working there.

If you invest privately, you can choose from thousands of individual stocks, mutual funds, and other vehicles. You can complement real estate investments such as retail shopping centers or other commercial properties. Crucially, you can enter and exit investments as you need to.

5. Artificial Market Demand

Not only does the 401(k) affect individual financial habits, Andy describes its impact on the market. The millions of Americans regularly contributing to these plans create artificial demand for mutual funds, stocks, and the behemoth infrastructure that supports them. It is hard to cast the situation as a traditional bubble because retirement vehicles are funded so predictably and on a mass scale. We don’t yet know the consequences of this systemized influx.

The Takeaway

When viewed as an asset among several in your portfolio, the 401(k) offers some advantages. Often you can take out a loan against your vested balance. If your employer matches your contribution up to a certain percentage, you’re receiving free money. Before contributing above the match amount, consider weighing your particular situation’s pros and cons.

Andy’s key takeaway is that investing is a life skill we all need to own. You don’t need a degree in finance or a Wall Street job, but you want to understand tax code and market fundamentals. Know some history for context and be able to soundly evaluate your investment vehicle options. The better you can do this, the better you can invest in your financial future, not just Wall Street.

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Raising Real Estate Capital with Crowdfunding

When raising capital, real estate investors often graduate from personal contacts to complex partnerships or institutions. Another option to consider is crowdfunding. On this Best Ever Show podcast, real estate investor and CEO Chris Rawley explains the power of crowdfunding as a capital source and how to tell if it’s the right option for you.

About Chris Rawley

Chris Rawley has been a professional real estate investor for over 20 years. His portfolio includes single-family, multifamily, and commercial properties. He currently focuses on income-producing agriculture as an opportunity for passive investing. His platform, Harvest Returns, matches quality agriculture deals with investors to raise much-needed capital for U.S. farmers.

Why Crowdfunding?

If you’re doing real estate investing, the conventional funding path usually goes like this. You first use your own money and then approach friends, family, and business contacts for passive investing. When those sources run dry, you may turn to institutional funding or spend considerable time developing partnerships from scratch. Institutions have a high lending threshold and are suited for larger commercial properties such as retail shopping centers. They also come with significant oversight and conditions.

Many individuals engaged in commercial investing have quality deals that don’t meet institutional criteria. Crowdfunding provides a robust, flexible funding alternative. As the deal sponsor, you have access to suitable investors. You also gain legal and regulatory resources that would cost you considerable time and money to build on your own.

Advantages of Crowdfunding

Assembling a syndication deal involves adhering to complex financial regulations and drafting the requisite documents. If you do it yourself, you spend significant time and money on accounting, tax, and legal services. You need to understand the role of the various oversight agencies such as the SEC and hire the right experts. The beauty of crowdfunding is that the platforms handle much of this groundwork for you.

Each platform differs in the type and amount of guidance it provides. For example, Harvest Returns offers its sponsors the benefit of the legwork Chris initially did for his real estate ventures. His business spent considerable money to have securities attorneys put all legal and regulatory requirements in place. As a result, his platform’s listing sponsors benefit directly from this expertise and documentation. They still need to learn the legal environment, but they do not start from scratch and slow the deal.

Another major advantage of crowdfunding is the built-in pool of investors. You don’t have to find and vet your backers. You also have access to a more extensive and diverse group that you would likely discover independently. When the platform accepts your listing, you are guaranteed eyes on your project. You are not guaranteed quick results, but your deal will have the attention of the right audience. This alone is gold for commercial investing.

Crowdfunding may be right for you if:

  • You have exhausted non-institutional resources.
  • You have a successful track record.
  • You have a niche asset class, such as income-producing agriculture.
  • You have a partially funded deal that could benefit from additional investors.

Choose the Right Platform

Crowdfunding investment platforms took off around 2015 and today offer diverse opportunities for various real estate asset classes. You can find platforms tailored to single-family flips, wholesaling, and commercial projects such as retail shopping centers. You can also find options for specialized assets such as specific financial instruments or agriculture.

Chris advises beginning by defining the type of investor you are. Do you fix and flip houses? Do you wholesale apartment buildings? Are you targeting niche real estate markets such as sustainable development? You want to identify the crowdfunding platforms catering to your project niche and research each one to find the best fit.

Most platforms expect sponsors to list exclusively with them rather than attempt to raise funding on several sites. This requirement eases regulatory compliance, and you will likely sign an agreement with the platform you finally choose. A way to feel more comfortable about exclusivity is to speak with other sponsors who have succeeded on that platform. Most sites are happy to provide references. Chris suggests you be wary of any platform that won’t do so.

Your next step is to determine if you qualify for the platforms you’re interested in. They have listing criteria that syndication sponsors must meet. They also differ in the resources they offer, such as regulatory forms. Your best bet is to reach out to them and learn their guidelines and support for sponsors. Most have sales and marketing teams to provide information and perhaps speak with you about your particular situation. Established platforms have more stringent listing criteria, while smaller or newer players often have more flexible requirements.

For their part, investors are looking to mitigate risk. They examine each deal in light of questions such as:

  • Is this project viable?
  • What return can I expect?
  • Can this sponsor deliver results?
  • Can I safeguard capital gains or income?
  • What are the tax implications?

Chris stresses that many investors want to make personal connections and to believe that their capital helps the greater good. If you can demonstrate how your project will benefit the local community or causes such as sustainable farming, your support will grow.

As with any deal, investors look for strong fundamentals. Platforms differ in their due diligence procedures, but you always want to prepare a solid business case and be ready to speak to it.

Build Your Team and Track Record

Investors want to see that a sponsor has a successful track record. As Chris puts it, they don’t want to invest in a newbie’s mistakes. You are best off trying crowdfunding after you have done at least a few successful deals.

For investors, a sponsor’s experience is often the differentiator between two similar offerings. Even a short track record builds credibility. Before attempting crowdfunding, do one or two syndications on your own, either with personal contacts or an established partner.

A credible sponsor has a strong team as well as a track record as an active investor. Investors want to see that you have accounting and legal experts as well as any other business advisers appropriate for your asset class. This shows that you have some experience, are serious, and run your active investing as a business.

Present a Winning Deal

Many platforms conduct a thorough background check on potential sponsors before moving forward with them. They examine the deal’s structure and numbers to determine if it is a viable investment.

Each platform has requirements for putting your listing in front of investors. Your listing needs to differentiate itself from other concurrent offerings. At a minimum, it should include essential details about your project, such as location and asset type. Also, your platform may ask you to provide supplementary information for investors such as a business plan or pitch deck.

Once the raise is underway for your project, potential investors want a thorough understanding of the deal and expected return. Some platforms handle all of the interfacing for you and cater more to passive investing. Others treat the process more as active investing. You might host a webinar or answer questions in a formal round table for the active investor who wants a voice in your project.

Chris has found that people respond well to webinars, as they can interact with the sponsor and ask live questions. They can also meet the members of the sponsor’s team, such as the attorney or CPA. In Chris’s words, the process lends tangibility to the deal and builds trust.

Crowdfunding for Agriculture Investing

The food supply and related issues are hot topics today, and many investors are curious about agriculture opportunities. Crowdfunding is a good option because the platforms present you with curated projects appropriate for your goals. Chris’s platform structures agriculture deals similarly to the real estate deals he’s done for years. They have debt offerings from 7% to 12% and equity deals in the teens. They also offer opportunities in AgTech, which is the application of computer technology to farming. These offerings are higher risk but offer potentially greater returns as much as 40%.

Unlike most real estate, agricultural properties are unique. Each farm is distinctive and should be evaluated on its own merits. Indoor projects have gained momentum and include vertical and hydroponic farms. These options allow more locally grown produce and some refuge from climate and transportation infrastructure impacts. Successful investments enjoy a high rate of return.

Chris keeps the minimum investment in his projects as low as $5,000. This threshold allows more investors to participate and to diversify their portfolios. As for farmers interested in funding sources other than banks, Chris urges them to reach out to his team.

Crowdfunding for syndication is a relatively new and evolving space with numerous platforms catering to all asset classes. If you’re ready to move beyond personal capital, take a look at what it has to offer. Not only might you fund your next deal, but you might also find lucrative investment opportunities you never knew existed.

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5 Ways to Win the Apartment Bidding War

Whether you are new to apartment syndication investing or an active investor expanding your portfolio, you will compete for deals. Other bidders may have more experience or higher offers. How do you win the seller and the contract? Let’s look at five ways to make your offer stand out.

Keep in mind that even in competitive markets, sellers don’t always take the highest bid. Sellers differ in their motivations, and the five tips below will help you craft the best possible offer for the deal you are pursuing.

1. Offer Hard Earnest Money

Hard earnest money is a non-refundable deposit. It is a good-faith move that shows the seller you are serious enough to leave money on the table should something go wrong. It also signals that you can afford to buy the property.

In a typical deal, the earnest money is refundable. You provide a deposit as soon as possible after signing the contract, preferably within three days. The amount is often about 1% of the total price. If you purchase commercial properties for $500,000, you pay the seller $5,000. If you or the seller cancel the contract, you receive your money back.

A bolder move is to make the earnest money non-refundable. Even if the contract is canceled or falls through, the seller keeps the deposit. Sellers are rightfully concerned about buyers tying up the property in contract and then backing out or losing funding. The buyer may find a better opportunity or walk for financial reasons. Meanwhile, the seller has effectively taken the property off the market. Backup buyers may lose interest, and the market could shift by the time the seller relists.

You can view a non-refundable deposit as compensation for the risk the seller assumes by entering a contract with you. First, you want to decide when the money goes hard. The most straightforward option is to make the deposit non-refundable from day one. Sellers find this attractive as they can keep the money no matter what.

However, it may be in your best interest to tie non-refundable earnest money to a contingency clause or other stipulation. You could require that the funds harden at the end of the due diligence period. Alternatively, you could make a portion of the deposit immediately non-refundable and include the remainder after meeting a condition.

Include Contingencies

Even if you harden your earnest money from day one, you still want to include contingencies for events beyond your control. This approach protects you against deal-breaker concerns such as severely failed property inspections or title issues. It still covers the seller in case you back out due to funding or other reasons within your control. If a seller demands a no-contingency hard deposit, consider this a red flag.

2. Shorten the Due Diligence Window

Another way to woo the seller is to shorten the time to closing. If an active investor, you can often shrink the time needed to close from a boilerplate period to a realistic estimate. Advantages to the seller include faster closing and the assurance that you are serious about owning the property. Sellers often have stakeholders in passive investing and are motivated to provide a smooth transaction. Buyers keeping their options open do not press for fast closing. In turn, assuming you have your financing in place, you obtain your investment faster.

The most effective way to shorten closing is to compress the due diligence window, which is when buyers discover most issues. Be aware that the due diligence period protects your right to cancel the contract and reclaim your deposit should you find problems. The average window is 30 days. If you invest in retail shopping centers or other commercial properties, you may need that time or more.

After the due diligence window closes, you can’t cancel the contract or get your earnest money back. This applies even if you find a related problem. To protect yourself, be realistic about the scope of work. Determine the time you will need to conduct all activities, such as inspections and title verification. Build in some cushion for repeat inspections, inclement weather, or other factors that could slow progress. Then see if you can save a week or more without jeopardizing your interests.

3. Sign an Access Agreement

Typically, your property access for due diligence begins after you and the seller sign the purchase sale agreement. An access agreement gives you limited rights to begin property inspections early. Sellers like this option because it shows you are serious and potentially willing to shorten the closing time.

In an early access scenario, you sign an access agreement once the seller accepts your letter of intent and agrees to move forward with your offer. A contract negotiating period follows, which can be brief or extended depending on the deal. An access agreement lets you begin due diligence early by allowing limited property access for inspections.

If all goes well, you can complete at least some of your due diligence before signing the purchase sales agreement. You can even tie the formal due diligence period to the access agreement by starting the clock then. For example, your due diligence window could expire ten days after contract signing. However, you want to be confident of the property and the deal before you shorten your protection under contract.

4. Use the Seller’s Purchase Agreement

Once the seller has accepted your letter of intent, you begin contract negotiations. When active investing, you often provide your version of the purchase sales agreement prepared by your attorney. The seller compares yours with their contract version, and your teams hash out the details until reaching an agreement. The agreement becomes the final contract that all parties sign.

This negotiation process may be fast and smooth on a smaller residential property or with a seller you have previously worked with. If your focus is larger commercial investing, such as in retail shopping centers, finalizing a contract will likely be more complex and lengthy. Backers who are passive investing may not realize that contracts sometimes collapse due to non-financial discrepancies. During negotiations, you risk the deal falling through due to disagreements over legal language or similar matters.

You can mitigate risk by using the seller’s purchase sales agreement instead of drafting your own. Take their documents and have your attorney mark them up with proposed changes. Submit the revised contract to the seller for review. This way, the seller quickly sees which changes you present instead of comparing your version with theirs. The process makes it easier to negotiate specific terms under contention and validate those that are not. You and the seller can reach a final contract more quickly and with less chance of a legal stalemate.

5. Guarantee a Closing Date

A strategy often used in residential purchases is to guarantee closing by a specific date. Sellers frequently have personal contingencies that make a hard close date very alluring. Commercial investing is more impersonal, but timing the close still offers advantages in certain situations.

One scenario is to help the seller secure a tax advantage. If the deal is near year-end, the seller may prefer to close either in the current year or in January. Active investing requires considering the capital needs of any other investors as well as complex financial requirements for short and long horizons. Further, some sellers may have a fiscal cycle that differs from the calendar year. As a motivated buyer seeking a win-win, try to learn the seller’s timing preferences.

Sometimes non-financial events trigger a desire to close before or after a specific date. Major elections, local laws taking effect, and other situations may spur a seller to choose the buyer who can guarantee a closing window. Most often, the seller seeks an early close, but sometimes not. Be clear on which timing scenarios you are willing to accommodate before engaging with the seller on this point. If they ask for a 90-day close when you were expecting 60 days, will it work for you?

Target the Deal

In addition to a favorable price, which strategy should you include in your offer? The answer depends on the deal. Though the market for apartment investing is competitive, your job is to focus on this particular deal. It’s the one you want.

To help you plan your offer, try to learn:

  • About other offers on the table. If they all include non-refundable earnest money, you want to offer more.
  • The seller’s motivations. This will help you understand whether a committed buyer, quick close, highest price, or other terms matter most.
  • Other factors important to the seller. Are there tax considerations driving a desired close date? Did a previous buyer walk, leaving a skittish seller who would appreciate a non-refundable deposit and access agreement?

Keep in mind that you can combine strategies to craft a top offer. An access agreement facilitates a shortened due diligence period, for example. If other buyers are going with hard earnest money, perhaps you can meet an earlier date or raise the amount. With perseverance and flexibility, you can be the dream buyer sellers want.

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Joe Fairless