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The world of real estate investment is changing as investors look for new ways to diversify their portfolios and generate steady returns. One of the emerging trends in this space is the shift away from investing directly in real estate towards investing in real estate debt. This alternative investment strategy offers several advantages, including liquidity, the ability to capitalize on rising interest rates, the higher amount of opportunity, the 20% qualified business income tax deduction, and maintaining the security of real estate as an underlying asset. In this article, we will explore the top five reasons why investors are making this shift and how they can benefit from investing in real estate debt as a fixed income investment.
One of the most significant drawbacks of investing directly in real estate is the illiquidity of the asset. Selling a property can take months or even years, depending on market conditions and the specific property. In contrast, real estate debt investments, such as private mortgage REITs, offer a higher degree of liquidity. Because a mortgage REIT is comprised of dozens or even hundreds of loans, the REIT is often cycling between active loans that are paying off and new loans they are funding. Each of these transactions results in a liquidity event allowing investors the flexibility to add or withdrawal funds more easily.
Investing in real estate debt can provide investors with a stream of passive income through regular interest payments. This fixed-income asset class typically offers higher yields than traditional bonds and other fixed-income investments, making it an attractive option for investors seeking a steady income stream. By investing in, mortgage REITs or other real estate debt instruments, investors can earn a return on their passive investment in real estate within San Diego and beyond without the need for active management of a property, such as dealing with tenants, maintenance, and other responsibilities associated with direct real estate ownership.
The real estate debt market offers a wide range of investment opportunities, catering to different risk appetites and investment objectives. From residential mortgages to commercial loans and development financing, there is a diverse array of debt instruments available to investors. This variety allows investors to tailor their portfolios according to their specific goals and risk tolerance. Furthermore, investing in real estate debt provides exposure to the broader real estate market without the need for substantial capital outlays typically associated with direct property investments.
The other opportunity that has benefited private mortgage REITs has been rising interest rates. Rising interest rates can be beneficial for private mortgage REITs as they typically lead to higher yields on newly originated loans. As a result, the income generated by the REIT increases, translating into higher returns for investors in the form of dividends. Furthermore, since private mortgage REITs primarily focus on short-term loans, they can adjust their lending rates more quickly in response to rising interest rates. Their ability to quickly adjust enables private mortgage REITs to capitalize on the changing interest rate environment and maintain a competitive edge, making them an attractive investment option in times of rising interest rates.
The Tax Cuts and Jobs Act of 2017 introduced a 20% qualified business income (QBI) tax deduction for pass-through entities, including certain real estate debt investments. This tax incentive allows eligible investors to deduct up to 20% of their QBI from their taxable income, potentially reducing their overall tax liability. By investing in real estate debt through pass-through entities such as a private mortgage REITs, investors can take advantage of this tax benefit and increase their after-tax returns.
Another advantage of investing in real estate debt through a private mortgage REIT can be the elimination of Unrelated Business Income Tax (UBIT). When retirement funds are invested directly in debt-financed real estate, the income generated may be subject to UBIT, which can erode the tax-deferred or tax-free growth of the investment. However, when investing in a private mortgage REIT, or investing in private mortgage in San Diego the interest income generated from the underlying loans is typically exempt from UBIT, as REITs distribute this income to investors in the form of dividends. This structure allows investors to enjoy the benefits of real estate debt investments while preserving the tax advantages associated with their retirement accounts, making REITs an attractive option for those seeking to diversify their portfolios and maximize their long-term returns.
While real estate debt investments do not offer the same level of direct ownership as traditional real estate investments, they still maintain the security of having real estate as the underlying collateral. In the event of a borrower default, the investor has a claim on the property, providing a level of security that other fixed-income investments may not offer. This security, combined with the other benefits mentioned above, makes real estate debt an attractive investment option for those seeking diversification and steady returns in their portfolios.
As the real estate investment landscape evolves, investors are increasingly shifting their focus towards real estate debt as a means of generating passive income, diversifying their portfolios, and benefiting from tax incentives. With its greater liquidity, wider range of opportunities, and the security of real estate as collateral, this asset class offers an attractive alternative real estate investments in San Diego to traditional direct property investments. By carefully considering these factors and conducting thorough due diligence, investors can capitalize on the growing real estate debt market to achieve their financial goals.
TaliMar Financial is a pioneering hard money lender for residential and commercial real estate in San Diego and throughout Orange County, offering a platform for hard money loans for purchase, refinance, and cash out refinance loans. Call (888) 868 8467 to connect with us.
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