Why Invest Deal By Deal

As a family office, we think about wealth preservation in after-tax terms. This is an important distinction. I get asked a lot why we do not just raise a fund. One of the main reasons is because we want to be able to 1031 in and out of investments which we can do by raising capital on a deal-by-deal basis in individual LLCs. For venture capital it makes sense to invest in funds since you expect 9 in 10 deals to fail but in real estate we go in with the assumption that every deal is going to make money.

Let’s take a $10,000 investment today as an example. Say person 1 invests in a fund (real estate or venture capital, it doesn’t matter for our example) for 30 years (approximately a generation’s worth of time) and person 2 invests in direct real estate investments where they can defer capital gains taxes through 1031 exchanges. Person 1 is paying capital gains tax every 5 years and reinvesting the after-tax proceeds whereas person 2 is deferring capital gains tax and investing the full proceeds every 5 years. Further let’s assume that both are getting a 1.7x multiple on invested capital to keep things even. After 30 years, person 2 has 57% more money than person 1.

Yowzah. That’s material. And that is why we do not raise nor do we invest in real estate funds. It’s also why every investor should consider their after-tax returns to make sure they are comparing investments across asset classes on an apples-to-apples basis.

Please note: I am not saying I would advocate for doing a 1031 just to do one. We look to make the best business decision for the specific asset and market conditions. We always make a best effort but sometimes we are not able to find a good property to exchange into or find that it may not be the right business decision for a specific property or group of investors and we decide to pay the taxes. Please also note, everyone’s tax situation is different and executing a 1031 exchange requires each individual investor to manage the process themselves. I am not a tax expert so I strongly suggest you consult with your CPA or a 1031 legal specialist to see how or if any of the above provisions apply to your personal circumstances.