Sunday, September 28, 2008

A combined Oil & Gas and Real Estate Investment – The best of both worlds

I get emails and phone calls resulting from reading this Accredited Investor Talk blog. One discussion I had this week was with an oil and gas (O&G) investor who combines these investments with real estate. I thought his strategy would be of interest to both the oil and gas investors and real estate investors who follow this blog.

Most of my previous articles on oil and gas investments assume someone else owns the associated land where these wells are drilled, but the partnership funding the drilling projects secures the rights to a lease for drilling on the land. In the case of the investor I talked with, he first buys land near Texas cities with strong suburb growth that are also strong prospects for oil or gas. Once the land is purchased, he drills and puts the associated wells online to generate cash flow from the land. Later, when the value of the land grows from nearby homes being developed in the suburb, this investor starts also developing the land with homes to sell.

My thoughts on a plan for this type of investment:
- Create a detailed business plan and investment strategy before even starting this project: One of the first steps before starting this project must be a detailed business plan and associated investment strategy. The business plan needs to detail what the entry and exit strategies are for the various phases of this project (the O&G phases and real estate phases). It needs to detail all the key stakeholders in the project, their roles and responsibilities, and how they will be compensated. The plan should document the various probabilities of success (and failure) for each phase of the project which links to the level of risk involved. The plan should also discuss what the investment strategy is for this project which should relate to the probabilities and risk levels involved. There are infinite strategies that could be used throughout the project. Will other investors be brought in for various phases of the project or will all funds come from the initial investors only? Having a clear strategy identified and documented in the business plan for each phase of the project helps keep the focus and helps articulate the project to others. I’ve written a past article on an O&G investor’s investment strategy that provides an example of one O&G investment strategy.

- Buying the right land: This investment should include land with a strong probability of containing productive oil and gas deposits. One way to raise the odds of buying potentially productive land is to buy near other productive wells. The logs from these wells should be reviewed to see potential O&G deposits underground in this land. However, purchasing land near current producing O&G wells usually means the price of this land will be high. This must be considered in any revenue model used to support a business plan for this combined real estate and O&G drilling venture. If you over pay for the land, then the revenue from the wells won’t provide enough returns to make the project profitable enough to counter the high risks involved.

- Finding a good developer for the O&G drilling projects: My personal thoughts are a project of this size and cost should use the services of a very capable oil developer to ensure the highest probability of success with hopefully drilling many profitable O&G wells. Unless the investor has a very strong background with the associated experience to develop these wells, due diligence should be conducted to select the best developer for this project. The business plan should state whether outside investors will be used to fund these wells or if funds will come from the initial project’s investors. A good developer will be able to raise outside investor funding for these projects, if that is what the business plan calls for. As a side note, I have written a complete series of articles that covers all the steps needed to drill O&G wells.

- Managing the cash flow: The project needs to clearly document how cash generated from the O&G wells will be used. Will they be used to: 1) pay down debts including purchase of the land, 2) pay back investors, 3) fund additional O&G wells, 4) initiate development of the real estate, 5) paying ongoing expenses, etc. These wells will not provide income forever as the associated limited supply of oil and gas is pumped out. Therefore, a clear strategy must be defined on where the resulting revenues will be directed - leveraged/or not, reinvested, or otherwise spent. Once the revenues start coming in from he real estate development side of the project, this too must be defined and planned. In all situations, the resulting tax issues must be known and dealt with in the cash flow strategy.

- Finding a good developer of the real estate projects: Again, unless the creators of this project have the necessary experience developing successful real estate projects, a successful real estate developer should be used. This may cost more, but their ability to develop successful projects should reduce the risks involved.

- Define what real estate revenue strategy will be used: Will the land be sub-divided and sold off as homes/commercial sites are developed? This would provide large funds to the investors while also giving them an exit strategy as the real estate is sold off. Alternatively, will apartments and/or commercial buildings be built and leased or rented for ongoing revenues to the investors? This would generate ongoing income to the investors while also hopefully providing capital gains as these property values increase. Perhaps a hybrid strategy will be used that considers selling off some of the land while keeping other portions for ongoing rental revenues. That solution provides both large upfront revenues from sales and ongoing revenues from the remaining rental properties.

- Exit strategy: An exit strategy must be defined on how the investors will be able to sell out their interest in the project. Will the project be taken public (if it is large enough) where investors could sell out their shares on the market? Will other investors have the right to buy out an investor’s interest in some other way? An exit strategy needs to be defined and agreed to by all associated investors before the project is started. There should also be agreement between involved investors on what happens in special situations such as the death of an investor, divorce, law suit, etc. All of these things could severely impact the project without an agreed upon plan for each situation that ensures the remaining investors are able to continue moving forward with the project. To cover all of these issues, I highly recommend using a lawyer to draw up documents before investors put in a cent.

This is an interesting way of getting the best from real estate and O&G investments, including all of the unique tax benefits provided to O&G investors and other tax benefits provided to real estate investors. However, there are many issues that must be understood and addressed before starting such a project. I don’t pretend to have all of those issues covered in this short article. Any project of this size should employ the best talented people available to ensure success in all phases. If that happens, any included investor would be very richly rewarded.

Your feedback is wanted:
Please provide feedback to our generic email at on questions you have, ideas for future articles, and any other thoughts that could lend themselves to future articles for the benefit of all readers. Happy investing to you.

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Copyright 2008 Ole Cram. Ole Cram is President of Marcobe Investments, Inc., a corporation that invests in various oil and gas ventures and refers accredited investors, investment managers, financial advisors, investment funds, and others to the associated oil producer of these projects for their consideration to also participate. We are not licensed to sell any interest in a project, nor are we registered advisors. Feel free to email us at with any questions, thoughts, or requests for other topics to cover in future articles.

This article was posted at Accredited Investor Blog: Key past articles related to investments in oil and gas can be found at This article is provided for educational purposes only and is not meant to be a substitute for tax, legal, financial, or other registered professional advice for your specific situation. Always seek the advice of a professional before making any related decision.

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