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Every investment has risks and a downside. Energy Royalties are no
exception. Here are a few things to think about when exploring this investment
option:
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All Cash
Transactions
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Energy Interests are an all-cash
transaction and there is usually no leverage unless you secure a
loan with your other assets. Therefore, in a 1031 Exchange, if the
property you are selling has a high loan-to-value (LTV) the energy
option probably will not work without borrowing funds from elsewhere
or inserting a cash portion into the investment.
However, if you have a property with a low LTV, perhaps less than
40%, you may do a combination of a real estate property with, say
60% LTV, to satisfy the debt element of the exchange and combine
that with Energy Royalties to diversify your investment and satisfy
the Exchange.
We find that
Tenant in Common (TIC) deals work the best because of
the flexibility in investment amount that is inherent in the
structure. These two structures compliment each other very well and
give investors, who seek passive investments, diversity.
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The Operators
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As a Royalty owner you do not have any
expenses because you are not responsible for operating the well.
This means that you rely on the operators to be good stewards of the
property.
Poor operators can affect your investment just like poor property
managers can affect your commercial property investment. The good
news is that the operators are required by law to pay Royalties off
the top of their gross revenue; but they do have to be good stewards
of the property who are capitalized to maximize the opportunity for
no production interruptions.
We always recommend only buying those groups that are well
capitalized and have the greatest incentives for keeping production
consistently flowing.
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3. |
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Commodity Prices
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Because the underlying asset in Energy
Royalties is the commodity (oil, natural gas or coal) your
investment is susceptible to price fluctuation in these markets.
While consistent cash flow is usually a part of these investments
the returns will vary as the prices of the commodities fluctuate.
The real question to ask yourself before investing in any Energy
Asset is, "Where do I think the price of energy will be in the
future?"
We always tell prospective buyers that if you think the price of
energy is currently at its peak, then investing in domestic energy
reserves is probably not a good idea for you. However, if you think
the price will be higher in the future, then it is an option to
explore.
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