What is LIF?

Having the funds you need to support yourself in retirement is key to sustaining your quality of life after work. There are various ways you can fund your retirement in Canada, one of them being via a LIF. 

But what is a LIF? How does a LIF work, what can be placed in it, and how are funds taken out?

In this article, we will answer all of those questions and more.

What is a LIF? (LIF Meaning) 

A Life Income Fund (LIF) is a type of registered retirement income fund (RRIF) available in Canada. This type of fund can be used to hold locked-in pension funds and other assets for retirement. 

Some important characteristics of a LIF include the fact that:

  • LIF funds CANNOT be withdrawn in one lump sum
  • LIF funds ARE creditor-protected
  • In many cases, you MUST be of early retirement age to begin receiving LIF funds (55 years old)
  • You CAN choose your LIF investments
  • LIF contributions grow TAX-DEFERRED
  • There ARE legal limits to how much you can contribute/withdraw
  • You MUST start receiving LIF payments AFTER you turn 71
  • You NEED your spouse’s consent to set up a LIF as per pension legislation

LIFs are offered by institutions across Canada. Once funds are withdrawn from a LIF, they are subject to income tax. 

What is LIF?

The Meaning of LIF in the Investment Context 

The meaning of a LIF in an investment context is broad. 

Many jobs in Canada include a registered pension plan. Once you reach retirement, the lump sum value of your vested contributions to your pension plan, plus interest, must be unlocked in order to access the funds. 

How can you do this? Each province has an age at which you can begin to withdraw money from your pension. You can unlock your pension by converting the funds into a LIF, a locked-in retirement income fund (LRIF), a Locked-in Retirement Account (LIRA) also known as a locked-in Registered Retirement Savings Plan (locked-in RRSP), a Locked-in Retirement Savings Plan (RSP) or a Restricted Life Income Fund (RLIF). 

You may also unlock your pension by purchasing a life annuity

Your LIF can hold many types of investments including:

  • Cash
  • Securities listed on a designated stock exchange
  • Mutual funds
  • Corporate bonds
  • Government bonds
  • ETFs

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With your pension funds in a LIF, you can continue to grow your money while accessing it for life needs, over time. Depending on your province, you may have to purchase a secure guaranteed income in a life annuity at a certain age to use the money remaining in a LIF. This depends on where you live, however.  

In addition, if you live in Quebec, Nova Scotia, or Newfoundland and Labrador, you may qualify for something called temporary income as described by Sun Life.

With a LIF, you can control your investments, maximize your tax deferral and name a beneficiary as a recipient of your funds following your death. 

As a positive progression for your pension, a LIF presents a responsible way of dealing with pension income with the potential for growth over time. 

What is LIF: Understanding Withdrawal Amounts 

Why choose to place your pension in a LIF? 

With a LIF, as with other registered products, your contributions are allowed to grow tax-deferred when kept within the fund. In this way, a LIF can keep your investment retirement earnings tax-sheltered. 

You keep more money! In addition, LIF funds are creditor-protected. And as one of many registered products accounts available in Canada, having your money in a LIF can help reduce your taxes

In some circumstances, you can withdraw funds from a LIF at any age as long as they are to be used for retirement needs. These might include situations of non-residence, financial hardship, a shortened life expectancy or having a small account balance if you are 55 or older. 

At the time of this article’s publishing, pensions in federal jurisdictions like Alberta, Manitoba, New Brunswick and Ontario can be withdrawn once in a lump sum. In most cases, however, you cannot withdraw from a LIF before the age of 55 and it must be done gradually.

Meaning of LIF

Understanding the Meaning of LIF: Maximum and Minimum Withdrawal Amounts

It’s important to know that there are normally certain maximum withdrawal limits and minimum withdrawal rules for LIFs. 

The amount you can legally withdraw each year from your LIF is a percentage of your total fund. This fluctuates annually. This percentage is disclosed in the yearly Income Tax Act as information applicable to all RRIFs. 

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So, how does it work? 

When you are ready to begin LIF withdrawals, you must specify how much you would like to take out at the outset of each fiscal year. The idea is that you withdraw funds within a certain limited range in order to receive lifetime LIF income. 

Many online platforms have useful LIF withdrawal calculators to help guide you through the process. 

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LIF Minimum and Maximum

With so many investment options for your registered account, you may be asking, Why should I care about private real estate investments?

The private mortgage market provides a fixed-income alternative for investors looking to diversify away from government bonds and corporate debt. It also provides the opportunity to generate a generally predictable yield compared to some traditional fixed-income vehicles in a low interest-rate environment.

If you’re new to the world of real estate investment, you probably have some questions about your options. Let’s walk through a popular type of registered retirement life income funds (RRIF) offered in Canada: the life income fund (LIF) as well as LIF minimums and maximums.

What are LIF Minimum and Maximum Withdrawals?

A LIF or life income fund is a type of registered retirement income fund (RRIF) offered in Canada that can be used to hold locked-in pension funds as well as other assets for an eventual payout as retirement income.

Owners must use the fund in a manner that supports retirement income for their lifetime. Each year’s Income Tax Act specifies the RRIF withdrawal amounts, including the LIF minimum and maximum withdrawal amounts.

You must be at least of early retirement age (specified in the pension legislation) to purchase a LIF and begin receiving payments.

Why is it Important to Know My LIF Maximum Withdrawal?

The Canadian government regulates various aspects of life income funds, in particular the amounts that can be withdrawn, which are specified annually through the Income Tax Act’s stipulations for RRIFs.

Most provinces in Canada require that life income fund assets be invested in a life annuity. In many provinces, LIF withdrawals can begin at any age as long as the income is used for retirement income.

Once an investor begins taking LIF payouts they must monitor the maximum LIF withdrawal amount. The federal LIF maximum amounts are disclosed in the annual Income Tax Act, which provides stipulations pertaining to all RRIFs. The maximum RRIF/LIF withdrawal is the larger of two formulas, both defined as a percentage of the total investments.

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The financial institution from which the LIF is issued must provide an annual statement to the LIF owner. Based on the annual statement and the LIF maximum withdrawal amount, the LIF owner must specify at the beginning of each fiscal year the amount of income they would like to withdraw. This must be within a defined range to ensure the account holds enough funds to provide lifetime income for the LIF owner.

LIF Maximum Payment Amount Table

Below is the LIF maximum payment amount table showing the minimum and maximum withdrawal percentages for LIF and RLIF accounts in 2021 by province. Depending on your age or your spouse’s age (whichever you select), you must withdraw an amount between the minimum and maximum amounts as outlined by the percentages below.

An example calculation is included below; however, if you still need assistance with determining your withdrawal options, we recommend that you contact an investment professional.

LIF Maximum Payment Amount Table

Notes

  • Quebec, Alberta, Manitoba, New Brunswick, and British Columbia pension legislation permits LIF clients who begin a LIF in the middle of a calendar year with funds transferred from a LIRA or pension plan to take the FULL maximum payment for the year. First year payments under the other jurisdictions must be prorated based on the number of months the LIF was in force.
  • ON, BC, AB, NL maximum calculations are based on the greater of a) the result using the factor and b) the previous year’s investment returns. MB LIF maximum calculation is based on the greater of a) the result using the factor and b) the previous year’s investment returns + 6% of the value of all transfers in from a LIRA or Pension Plan during the current year.
  • Saskatchewan Prescribed RRIF – there is no maximum annual withdrawal and you can withdraw all the funds in one lump sum.

How Can I Use My LIF to Invest in Real Estate

How Can I Use My LIF to Invest in Real Estate?

LIF owners can choose their own investments (as long as the investments qualify). Qualified investments in a LIF include cash, mutual funds, ETFs, securities listed on a designated exchange, corporate bonds, and government bonds.

Unlike some other alternative investments, private real estate investments such as mortgage investment corporations and real estate investment trusts can be incorporated into your RRIFs including LIF, allowing you to grow your portfolio while enjoying tax-deferred status.

Like other registered products, contributions grow tax-deferred within a LIF. Funds within a LIF are creditor-protected and can’t be seized to pay off debt obligations. Contributions can grow tax-deferred until the year after you turn 71.

Want to Learn More About Investing with Mortgages? Check out these Blogs.

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Of course, there are also disadvantages to setting up a LIF. For example, a minimum age requirement applies to both starting a LIF and receiving LIF payments. Furthermore, the maximum withdrawal limits prevent you from accessing more income when you need it. If you’re new to real estate investing, adding such a large asset to your portfolio may seem intimidating.

But it’s easier and more attainable than you might think. I invite you to check out our marketplace and education centre, which has articles, webinars, tools, and more informative videos for investors of every experience level.

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Life Income Fund FAQs

At What Age Can You Withdraw Money From a LIF?

You can withdraw money at 55 years old. No withdrawals from a LIF are permitted before age 55.

Is LIF Income Taxable?

Yes. LIF income is taxable and must be added to your annual income. If the withdrawal is higher than the annual minimum withdrawal, taxes are withheld on the excess amount.

What Happens to a LIF When You Die?

Upon death, the balance of your LIF is paid to your spouse. If your spouse denies payment or if a spouse is absent, it is paid to your heirs.

3 Key Takeaways of this Article

  1. A LIF or life income fund is a type of registered retirement income fund (RRIF) offered in Canada that can be used to hold locked-in pension funds as well as other assets for an eventual payout as retirement income.
  2. Owners must use the fund in a manner that supports retirement income for their lifetime. Each year’s Income Tax Act specifies the RRIF withdrawal amounts, including the LIF minimum and maximum withdrawal amounts.
  3. The Canadian government regulates various aspects of life income funds, in particular the amounts that can be withdrawn, which are specified annually through the Income Tax Act’s stipulations for RRIFs.

Fundscraper Capital Inc. and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

What is an RSP?

It’s never too early to start saving for retirement. Investing in private real estate is an excellent way to diversify your portfolio and start thinking about your financial future. To help you understand all of the options in front of you, we put together a guide to the types of retirement savings plans (RSPs) you should know about.

Key Points

  • RSPs are registered through Canada Revenue Agency (CRA) and are designed to encourage us to save for retirement. 
  • Contributions are tax-deductible based on your marginal tax rate when you put the money in.
  • If you’re interested in investing your RSPs in private mortgages or opening an RRSP, the first thing you should do is seek expert advice. The process isn’t difficult, but if you’ve never done it before, you’ll need an expert to walk you through it.
  • Investing in private real estate is an excellent way to diversify your portfolio. Savvy investors know not to put all of their eggs in one basket, and private real estate helps minimize risk of loss. It also helps generate return and preserve capital.

Regardless of the time of year, it’s important that you have a solid understanding of the basics of registered Retirement Savings Plans (RSP). RSPs are registered through Canada Revenue Agency (CRA) and are designed to encourage us to save for retirement. But don’t wait until retirement is on the horizon to start saving for it! Read on to learn more about your options with RSPs.

What is an RSP?

What does RSP stand for? What is a RSP? An RSP, meaning Retirement Savings Plan, encourages saving for retirement. They can contain investments such as stocks, bonds, mutual funds, ETFs, GICs, and savings accounts.

Contributions are tax-deductible based on your marginal tax rate when you put the money in. If you make $100,000 a year, your marginal tax rate is 43.41%. If you put $1,000 in an RSP, you’ll get about $430 “back.” Your RSP deduction limit for 2021 is 18% of earned income reported on your tax return in the previous year, up to a maximum of $27,830.

You defer paying tax on the money and interest gained until you withdraw it. At that time, it’s considered taxable income, and you pay taxes on it according to your marginal tax rate at that time.  Generally, your income during retirement is lower than the income you earn during your active working years, so withdrawing your funds from your RSP account later will allow you to pay taxes at a lower marginal tax rate.

what is an rsp

How do I Get an RSP?

There are many different types of RSPs that come with tax benefits! Here are the three most common:

Registered Retirement Savings Plan (RRSP)
Often, when a financial institution refers to an RSP, they mean RRSP. The RSP definition can get confused with the RRSP definition. An RRSP can only be sold by financial institutions approved by the Canada Revenue Agency (CRA). You can hold many types of assets within an RRSP, including savings accounts, GICs, stocks, bonds, mutual funds, ETFs, and real estate. RRSP contributions are accepted until December 31 of the year one turns 71. You’re penalized with heavy withholding taxes if you withdraw the funds before you retire.

Tax-Free Savings Account (TFSA)
TFSAs can hold any type of RSP-eligible investment, including stocks, bonds, mutual funds, real estate, ETFs, or cash deposits. Any Canadian who is over the age of 18 and has filed a tax return can open a TFSA. Unlike RSPs, contributions are not tax-deductible. When you withdraw money from your TFSA, you don’t have to pay income tax on it.

Registered Pension Plans
Many employers set up pension plans for their employees. There are two types: Defined Benefit (DB) and Defined Contribution (DC). DB plans promise to pay a set pension amount based on a formula including age, years of service, and earnings history; DC plans provide pension benefits based solely on the contributions and investment earnings.

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What’s the Difference Between an RSP and an RRSP?

In conversation, people often use “RSP” when referring to an RRSP because it’s shorter and easier to say. And it’s not inaccurate: an RRSP is a type of RSP, which is an umbrella term that refers to any Retirement Savings Plan. An RRSP is a specific type of account with two stand out characteristics. The first — it has tax advantages in that any contributions can be deducted from your income. The second — there are yearly RRSP contribution limits. While an RSP can refer to a number of retirement accounts, an RRSP refers to one type of account specifically. Sometimes people will refer to an RRSP as an RSP (because it is) but so too are many other retirement accounts.

rsp definition

What are the Benefits of Using an RSP to Invest in Real Estate?

Investing in private real estate is an excellent way to diversify your portfolio. Savvy investors know not to put all of their eggs in one basket, and private real estate helps minimize risk of loss. It also helps generate return and preserve capital.

Most people think mortgages or mortgage backed investments are a financial instrument reserved only for banks and hedge funds. A mortgage does not have to be hundreds of thousands of dollars. Individuals such as yourself can execute mortgages against properties or participate in mortgage backed offerings as investments, and you’re able to earn returns through RSPs described above.

Investment advisors commonly recommend that a person’s portfolio have between 10% and 20% in real estate. It is generally thought that investors who are risk-averse tend to limit their investments to stocks and bonds, while investors who are less risk-averse hold a mix with more alternative investments like real estate. What is evolving today is that investors who want more diversification should actually be weighing more of their portfolio towards alternative assets like real estate than otherwise. This is because real estate is a strong non-correlated asset class, which many risk-averse investors are attracted.

How do I Invest in Real Estate Using an RSP?

If you’re interested in investing your RSPs in private mortgages or opening an RRSP, the first thing you should do is seek expert advice. The process isn’t difficult, but if you’ve never done it before, you’ll need an expert to walk you through it. That’s what we’re here for!

Your advisor should be a registered mortgage broker, dealing representative, financial advisor, accountant or an exempt market dealer focused on real estate and mortgages. At Fundscraper, we’re both a mortgage broker and exempt market dealer. We begin by asking about your investing experience, investment portfolio to date, risk appetite, expectations, current needs, and future needs. This is called a suitability assessment, and it helps us determine whether private real estate is an appropriate investment for you at this juncture of your life. If yes, the next step is identifying a mortgage backed investment product that would be suitable for you.

Once we have found something that is suitable for you, the next steps are setting up how you can acquire the private mortgage backed investment security with your current RRSP funds that are held by your bank or financial advisor. Those RRSP funds are likely tied up in mutual funds, exchange traded funds, and other RRSP eligible securities. We’ll help you with this process as much or as little as you need.

Fundscraper Capital Inc. and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

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An Inside Look: How Financing a Real Estate Project Works

Real estate investors often wonder why a developer might choose to pay what seems to be an unusually high rate of mortgage interest when compared to prevailing rates. Well, the truth is, sometimes it’s in their long term interest to do so, instead of raising equity capital. This article explains the whys and why not’s from an insider’s perspective.

Key Points

  • There are three ways to fund a real estate project: debt, equity, or a combination.
  • The costs associated with the money or capital required for a project from the various sources of capital is called the “cost of capital” and is vital to determining a developer’s “optimal capital structure.” It all hinges on the concept of ROE (Return on Equity), which very much takes into account leverage.
  • The choice of debt, equity, or combination financing is exceedingly complex and will depend on the circumstances and metrics of each project. At the very least, you may now have a better understanding of why sometimes a real estate developer will take on a high-interest first or second mortgage, bearing say 10% or 12% where going rates for standard mortgages or lines of credit are a lot less.

How does a developer fund a real estate project?

A developer needs capital to fund land acquisition, construction, and all soft and hard costs associated with a real estate project. In the absence of an unlimited bank account, they have three options: debt financing, equity financing, or a combination.

Debt financing is accomplished through borrowing. Usually, this: (i) means a higher ratio of investment via debt capital as opposed to equity capital; (ii) allows for tax-deductible interest (i.e., the interest paid on debt is a business expense and is deductible); and (iii) utilizes leverage to increase the return to equity owners.

Leverage is using borrowed money (debt) to amplify or increase potential returns from a project. It allows a developer to multiply buying power in the marketplace. So, for example, if the project costs $100, the developer could get 10 investors to chip in $10 each.  They each own one tenth of the project.  When finished, let’s presume the project will be worth 133.00.  Now, each investor’s share is worth 13.30! Well the developer knows banks are in the business of lending money so the developer (and his investors!) know the bank will come in for $60 of the cost of the project! Whoo – woo! The investors only have to put in $40! So, for $40 the equity investors have $100 of brick and mortar.  But once the building is finished those $40 investors will have building worth $133.00! That’s not bad.  If we were to increase the amount of indebtedness by another $20, the investors would only have to put up $20! Now for $20 you get a building worth $133.  That’s how leverage works! The more debt you “lever” into a project, the less equity you need; the smaller the equity requirement, the greater the return on that equity!

Equity financing refers to selling part of the project to investors who then become equity owners in the project. Equity holders generally get paid last, after any debt holders, so it is natural to expect a higher rate of return given this higher risk.  Given more risk to an equity investor, the cost of equity, or in other words the return expected from an equity investment, is generally highest — except in the case where the developer is able to keep equity for itself and benefit from owning more rather than less. The only time a developer has to share ownership of a project is when the developer needs more equity.    

There are three ways to fund a real estate project: debt, equity, or a combination.

Choosing between debt financing and equity financing

The “cost of capital” is generally the return expected by the suppliers of capital for their contribution of such capital. It is vital to determining a developer’s “optimal capital structure” – where you have an optimal balance from various capital sources (such as debt and equity) to reduce the overall weighted average cost of capital (more on this later). It all hinges on the concept of ROE (Return on Equity) which very much takes into account leverage. The actual calculation of ROE is “net income” of the business (i.e., income after expenses (including debt repayment!) and taxes) divided by the shareholder equity. As debt is subtracted from the calculation, the ROE increases. In fact, if the ROE appears too high, it may be a warning sign that there is too much debt in the enterprise.  Generally, an ROE equal or less than 10% would be considered poor. 

Typically, equity financing returns deliver a higher IRR (Internal Rate of Return) over the life of the project than debt financing which is reasonable when you think about. Debt financing is generally secured.  If something goes wrong, the secured lender can step in, seize the assets and repay themselves.  Equity is full “at risk”; it’s not secured. If something goes wrong, the equity investor is out of luck! They potentially lose everything.  Therefore an equity investor will demand more in return than a debt investor. In real estate it is not unusual at all that an equity investor will look for a return of 20% or  more on its investment.  And because they are an owner, they expect that forever!  If the need for additional equity could be satisfied with high interest rate debt, then that becomes a credible alternative for the developer.  If high rate debt is 14%, but the developer anticipates being able to pay it all back in 3 years, debt makes a lot of sense.  A developer with an eye on maximizing ultimate profit will be understandably jealous of keeping as much equity as feasible and therefore may prefer to pay a risk premium for mortgage financing.

There’s also “bridge financing” (which really has nothing to do with bridges), which is a type of mortgage financing that is a premium when compared to the risk free rate of return, but a discount if you compare it to the cost of equity. It’s often used by developers to temporarily finance the cash flow for a short period of time (ergo, the “bridge”). Instead of injecting additional equity, they will need to fund the financing gap and bridge the project until it reaches the next stage of development or a subsequent financing stage. Generally, bridge loans are short term (12-36 months), pay interest only so it is non-amortizing, and have a well-defined exit strategy.

Here’s what a typical project lifestyle looks like and what kind of financing is utilized during different project development stages.

A developer may also choose a combination of debt financing and equity financing, coming up with an “optimal capital structure” that balances both and keeps in mind the cash requirements of the project at its various stages.

What are cost of debt and cost of equity?

If you need financial capital to construct an asset and then sell the asset, the interest expense for borrowing the capital is the cost of debt. Equity also has a cost, in the form of profit-sharing, and this is the cost of equity or the expected rate of return a fellow owner would expect for a similar risk profile investment. The weighted average of a project’s cost of debt and cost of equity is generally the cost of capital. The lower your overall average cost of capital, the more profit you can keep for yourself as the owner.

Consider a small project where the developer is planning to do a build and flip, with the below Pro-forma budget. This model below assumes a duration of 12-18 months:In the above No Leverage scenario, the developer maximizes the cash profit. However, they have to inject 2.146M of their own equity. For every dollar the developer invests, i.e. their equity injection, they will earn a 19% return or 19 cents for every dollar of equity. When a party invests for an ownership interest, then they have an equitable interest, or equity, and have a beneficial interest in the profits from the project. Put another way, an equity investor will likely expect or require a 19% return on their invested equity capital (the “expected return” or equity’s “cost of capital”).

Whereas if someone were to invest and own the debt or mortgage of a property, then they become a debtholder entitled to a return defined by a predetermined interest rate. As a debtholder, you will get paid first, but that’s why your return is fixed. As an equity holder, you may get paid last, but you keep the rest of the upside.

What is leverage?

As stated above, leverage is using borrowed money (debt) to amplify or increase potential returns from a project. In some scenarios, for every dollar a developer invests, they can earn more per dollar by investing less equity. Consider this example:

By taking on additional debt and actually reducing the nominal dollar profitability, the developer achieves a few strategic objectives. It frees up over $550K of the developer’s capital, which they can deploy to another site, thereby diversifying their portfolio and helping them line up additional sites (a pipeline) for future work. It adds additional liquidity into the project. And financially, it increases the rate of return or ROE for every dollar the developer invests. Instead of earning $0.19 for every dollar invested, the equity owner earns a projected $0.238!

Borrowing from a private lender vs bringing on additional equity partners

We’re going on a math tangent now — stay with us! Even if you don’t speak equations, seeing real-life examples is a helpful way to better understand investing concepts.

The weighted average cost of capital (WACC) is calculated by the formula:

(Proportion of Equity Capital %) * (Cost of Equity) + (Proportion of Debt Capital %) * (Cost of Debt) = [100% * 19% + 0% * 12% ] = 19%

Your debt holders only demand 12%, but equity partners will want their 19% return. From a project point of view, the cost of that capital is going to be 19%! It’s the expected return your equity holders expect to receive by investing in the project. If you took on debt even at 12%, the math would work out to be 13.8%. So, overall, you can pay $0.138, or pay $0.19 for every dollar invested.

Ask yourself: Which project has a lower cost of capital? As the principal owner of the project, you want to drive down your cost of capital as much as possible. That way, you can take on projects of varying profitability and be competitive with how much you can pay for the residual value of the land at the time of acquisition.

The choice of debt financing, equity financing, or combination financing depends on the circumstances and metrics of each project.

How to get started

Funding a real estate project is a complex subject. We hope you now have a better understanding of why sometimes a real estate developer will take on a high-interest first or second mortgage when going rates for standard mortgages or lines of credit are a lot less.

Still have questions? Fundscraper is here to help its community wade through these kinds of considerations which are key to analyzing the underpinnings of its project offerings. We aim to provide our clients with the ability to make informed decisions and deliver a transparent investing process. Contact us today to learn more about your real estate investment options.

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