by Marc Halpern, Part Time Investors LLC
February 13, 2024
Investors often ask me, ‘what are the best private placement opportunities to invest in right now?’
I always refuse to answer and I respond with a question which is, ‘what is your current strategy for managing your portfolio of private placement investments?’
As you construct your private placement investment portfolio, you must take into account MANY factors that are personal to your financial needs at that moment and for your goals for the future. Your financial needs change with time because your life stage changes and the composition of your portfolio changes every time you make an investment. So, there is no universal answer to the question, ‘what are the best private placement opportunities to invest in right now?’
In this article, I will address the income and growth considerations when building a portfolio of private placement investments.
In this article, I will not address risk management considerations when building a private placement investment portfolio. I cover risk management in the full-day course “High-Return Private Placement Investing: Best Practices & Risk Management” that is presented live online or in-person from time to time or on streaming video at any time. More than half of the full-day course focuses on managing risk by performing DEEP due diligence on carefully selected best-in-class private placement investments offered by best-in-class sponsors while diversifying the portfolio by investing in multiple projects in multiple sectors from multiple syndicators, fund managers and project sponsors.
What is Growth and What is Income?
When investing in private placements, income is cash flow that you receive on a periodic basis, usually in the form of quarterly distributions of “preferred returns,” though they are sometimes distributed monthly. Growth is usually a big chunk of money that you get as a distribution after your initial capital contribution is returned and this is often in the form of proceeds from an exit, an IPO or other liquidity event(s).
Due to the timing and size of the distributions, private investors often seek income to fund their routine expenses and daily lifestyle and they often seek growth to increase net worth or to fund additional investments. Sometimes distributions from growth are used to fund special non-routine life events such as kids’ college, weddings or large purchases.
Category 1 - Primarily Income
Many newer private investors start building their private placement portfolio with investments that focus primarily on income. Examples of such investors are people who want to generate enough passive income to replace their active income from their jobs or leave their jobs to retire.
I made a private placement investment that is an income play to supplement my retirement and it generates a preferred return of 12%, paid quarterly, plus occasional extra distributions that amount to 2%-6% per year depending on performance. This is a land development lending fund with sound fundamentals as long as the US housing inventory shortage continues.
This investment has a provision that one can redeem the initial capital contribution after two years, but I didn’t redeem since I expect that the housing inventory shortage will last at least another 5-7 years. I will likely redeem my initial capital contribution well before new home construction slows down that will reduce the demand for land development. In the meantime, I have been benefitting from rather predictable truly passive income for several years and I expect this to continue several more years with zero effort on my part other than monitoring the market.
By the way, this investment was made by my self-directed Roth 401(k), so the income is tax-free and enjoys a measure of asset protection. Since I am older than 59 ½ and my Roth has been open for more than 5 years, I could use the tax-free income any time I want.
When investing in private placement funds with multiple projects that have been open for a while (often a year or more) but have not yet hit their funding limit, they usually have enough track record to perform DEEP due diligence on the assets in the fund and they often are already making distributions. These are attractive characteristics before making the initial capital contribution and the timing of the start of the distributions can be immediate.
Sometimes, the income play can be designed to start with a several year delay but then last for many years thereafter. An example is a new farm in which I invested that has orange orchards that take four years to start producing saleable fruit after initial planting and vegetable greenhouses that take time to construct and ramp up operations. While distributions are insignificant in the first years, returns in the range of 15%-20% per year are expected for 20 years or so thereafter. Since I was in my sixties when I invested in this farm, distributions will continue into my eighties that I can use as supplemental income.
Category 2 - Primarily Growth
An investor’s appetite for primarily growth investments depends on risk tolerance and long-term goals since these type of investments generate little or no income until a major milestone is met or a liquidity event occurs.
Such investments may be high-risk high-return projects that can take quite a while though the payoff can be 10X or more. I limit such investments to sectors in which I have specialized expertise (chemical process technology in my case) or are easy enough to understand in-depth to be comfortable with the risk level. My comfort zone is that I limit these investments to 3% or less of my net worth since they are typically high risk.
Other investments that are primarily growth plays may have a relatively short term of 6 months to 2 years before exit but have no income in the interim. One should very carefully choose such shorter-term growth play investments and preferably be able to perform deep due diligence on the underlying fundamentals and of course on the sponsors to get comfortable with the risk level. I have invested in two such private placements with 20%-40% annual yield. I limit these investments to 5% or less of my net worth.
I am not providing investment advice. I am simply sharing my thought processes and practices with which I feel comfortable.
Category 3 – Growth & Income Combination
The most common private placement offerings often combine income and growth. These include apartment syndications, self-storage funds, NNN lease industrial funds, open air retail projects, mobile home park investments and other real estate-related projects that generate cash flow through rentals and growth primarily through forced appreciation and optionally/secondarily through market appreciation.
When the growth & income investments are single projects, they often take a year or more to “stabilize” rent and cash flow in order to start generating income. The preferred returns typically accumulate during the initial period before stabilization and distribution, but once the distributions start, the income is usually reliable as long as the project performs according to plan.
Sometimes, the single projects do not perform according to plan. A recent example is apartment complexes purchased with high leverage and periodically adjusting interest rates before the Fed started raising interest rates at an unprecedented pace from March 2022 to July 2023. In such cases, the sponsor may make a capital call, reach our for mezzanine financing or the single project may be in jeopardy.
I am currently invested in three single-project apartment complexes and a single-project student housing complex. Two of the apartment complexes and the student housing complex have fixed interest rate financing or rate caps with terms that exceed the planned term of the project. They are doing well and the preferred returns flowed consistently throughout the period of the Fed lightning-fast interest rate hikes. One of the apartment syndications is tied to SOFR (Secured Overnight Financing Rate) which jumped dramatically after the purchase and will likely require either mezzanine financing or a capital call to get back on track. Preferred returns in this case are delayed but at least they accumulate. The growth will also likely be delayed. This example reinforces my confidence and discipline to avoid investing more than 5% of my net worth in any single project or fund.
I am also currently invested in several multi-project funds that combine income and growth. I invested in these funds after they already purchased 10 or so assets, so I was able to evaluate performance and financing in-depth before wiring the initial capital contribution. These funds are in NNN lease light industrial sector and self-storage facilities. They started generating passive income immediately due to the stage at which I invested.
Preferred Returns & Equity Split: Prior to the Fed raising rates in early 2022, many of the private placement investments that combined income and growth offered a preferred return of 7%-8% and a 60/40 or 70/30 equity split (limited partner/general partner). As it became harder for sponsors to raise capital, in late 2023 many of the private placement investments that combined income and growth offered a preferred return of 8%-9% and a 70/30 to 80/20 equity split. In 2024, the projected IRR’s for income and growth private placement investments are often in the mid to high teens, even though the track records of the best-in-class sponsors prior to 2022 had IRR’s in the 20’s (sometimes higher).
Term/Duration: Prior to 2022, the projected terms for private placement investments that combined income and growth were often 3-5 years. After mid-2023 until today (February 2024), the projected terms for these income and growth investments are often 5-7 years.
Markets conditions change and both capital raisers and investors adjust accordingly.
Summary
One of the key questions you should ask yourself as you construct your ever-changing portfolio of private placement investments and redeploy money from proceeds from exits or accumulation of preferred returns is ‘what is your desired mix that will meet your current needs and long-term goals for income and growth?’ You should be strategic in answering this question before you are distracted by shiny objects and even before you implement your best practices for risk management.
If you want to better understand how I manage my portfolio of private placement investments, including risk management and allocation for income and growth, register for my course “High-Return Private Placement Investing: Best Practices & Risk Management” that is conducted live online or in-person or purchase my course on streaming video at any time.
I explained here my strategy for managing my private placement investment portfolio only to stimulate your thought, not for any one else to copy it. After all, each of our situations is different due to different life stage, different household income, different net worth, different future needs (college, weddings, emergency fund, etc.), different available time, different expertise, different risk tolerance, different current private placement portfolio composition and many more different personal characteristics.
Each investor must construct their own personally customized strategy to meet their personal current situation and projected future.
I am hoping that my approach to consider private placement opportunities in three broad categories of income & growth, primarily income or primarily growth, based on YOUR individual current and future needs, might help you formulate your own customized approach.
Happy Investing!
