I’m often asked what my preference is when comparing angel investing to real estate investing, since I participate in both investment avenues. I invest in multifamily properties across the U.S., and I like to diversify and invest in local and foreign technology startups. Both real estate and angel investing have their pros and cons, so let’s take a closer look at each before revealing which one is my preference.
When it comes to real estate, I buy large multifamily properties (minimum 100 units and up), renovate them and hold them for three to seven years before selling them. I partner with passive investors, and together, we buy properties that my company manages.
Angel investors are generally high net worth individuals who use their own money to invest in startups or other types of businesses. They are private investors, and in return for putting up capital to help get a business off the ground, they receive ownership equity in the company they’re investing in. Often, angel investors are friends or family members of the entrepreneur running the startup, especially during the seed round.
Even though both investments can be passive, they are very different.
Profitability Versus Risk
One of the major pros of angel investing is the potential for profitability. If the startup is successful, you can make a significant profit — five, seven, even 10 times the original investment is not uncommon. That’s the upside to angel investing: it’s a true “high risk, high reward” proposition. The downside, however, is that most startups fail, and you’re likely to lose money before you hit the jackpot. It’s the occasional home run that keeps angel investors coming up with capital for new startups.
While you won’t see those types of returns with real estate investments, it is possible to double your money in several years. That’s due to the appreciation of the property over time, assuming that you bought it at the right price and in the right market. As long as that happens, it’s extremely unlikely that you’d lose all of your money.
Here’s why: With most real estate investments, you’re not the only investor. Generally, you’re part of a syndication that has other people included, along with their money. Unlike a startup, if the real estate deal goes south, there’s still some equity remaining in the property. It can be sold, and real estate investors can recoup some or all of their original investment. If you’re an angel investor who put up all the capital and the startup fails, your money is gone.
Liquidity
Neither angel investing nor real estate investing is considered liquid. If you have stocks, for example, you could sell your shares on a moment’s notice. As an angel investor, your money is tied into the company you invested in until it is sold, makes a substantial profit or fails.
Real estate, on the other hand, is semi-liquid. You can’t sell a real estate investment on a moment’s notice like you can with shares of stock. The property has to be appraised, listed and sold, which can take months of work. However, since most real estate investments are part of a syndication, a limited liability corporation usually owns the property, and each passive investor holds shares in that LLC. Investors can sell their share after a period of 12 months (as long as the sponsor allows it). This gives the advantage regarding liquidity to real estate investments.
Tax Benefits
Real estate investments provide excellent tax benefits to investors. It starts with deductions that include costs related to operating expenses, property taxes, mortgage interest, depreciation and repairs. In addition, real estate investors enjoy the benefits of depreciation, which can be deducted from any income earned on the property.
Thanks to what is called a 1031 exchange, investors can defer capital gains from the sale of a property as long as they purchase another property that is equal to or greater than the property they sold. Investors can continue to defer paying taxes for years until a property is finally sold without a 1031 exchange.
Angel investors can deduct losses from their investments on capital gains. There are limits imposed by the IRS, so you should familiarize yourself with how the deductions work.
The bottom line, however, is that because of the multiple tax benefits available to real estate investors, the nod goes to real estate investing.
Summary
While angel investing provides the potential for substantial profitability, there is also a huge risk due to the fact that most startups fail. On the other hand, real estate investing offers some liquidity, along with exceptional tax benefits that are not available to angel investors. For these reasons, I choose real estate investments as the better, and safer, way to go.