I speak to investors every day – so often, they express fear and hesitation about putting their money into passive real estate syndication. They are worried about making that type of investment and understandably so. Investing in general can be very intimidating – especially for an inexperienced investor. As with any investment or business venture, there are certain risks involved with passive investing, and there simply is no foolproof way to completely avoid the risk that naturally comes with real estate investment projects. However, knowing and understanding these risks and finding ways to mitigate them can make passive investing a safe opportunity to make your money grow.
In my recent conversation with Lucas Miller of Bannock Capital, we talked about the biggest doubts and uncertainties new investors have about passive investing in commercial real estate. As we tried to identify the risks from the investors’ perspective, we discussed how these risks are managed and mitigated so investors can feel more confident as they get into this market.
Let me share essential points of our discussion here to help calm your fears and leave you with just a healthy dose of prudence as you navigate the world of passive investing. I hope you can gain clarity and a good sense of what you should and shouldn’t focus on. If you’d like to hear our full conversation, please click here.
Fear #1: I don’t know if I could trust the syndicator/sponsor
“I’ve interviewed a lot of passive investors, and the resounding theme of worry among them is the trustworthiness of the sponsor of the syndication deal”, reveals Lucas. I don’t want to wire money to someone I don’t know well is a common expression of unease. Investors want to make sure that the person they’re talking to can be trusted with their hard-earned money.
It is understandable to be skeptical about a sponsor. After all, the sponsor underwrites the whole project, selects a property, renovates, manages, and eventually sells it. The sponsor will be the one making decisions on the investor’s behalf so you want to be sure you work with an experienced and reliable syndication sponsor. But, how can you do that?
Vet the sponsor. Take your time to get to know the sponsor. Ask questions. Check the sponsor’s background and track record of projects. Speak with references or previous clients who can vouch for character and sponsor-investor relations. Get to know the sponsor’s team (accounting firm, legal team, construction team, property management team), and make sure these entities are legitimate and have a good reputation. It’s also a good indicator if the sponsor invests their own capital into the project. You can also perform a Google search to learn more from reviews and comments on forums. Social media platforms, websites, and online communities are also important sources of information about a sponsor.
To further erase doubts, an investor and a sponsor should be able to establish open communication and should start building trust. A competent and trustworthy sponsor would be transparent about any aspect of the project including the risks. Refusal to give information is a red flag. If data is not available, there should be a valid reason.
Fear #2: What if this turns out to be a scheme and I lose all my money
Most investors are afraid of losing their money from fraudulent get-rich-quick schemes, having been fueled by stories of uncles or cousins duped by shady investment deals, says Lucas. The dread of having entire savings wiped out in one mistake paralyzes potential investors into taking that first step to invest. While losing money is possible, it would take events of cataclysmic proportions for passive investors to lose their entire investment from syndication. The worst-case scenario is that an investor would not earn the returns projected in the placement memorandum. Then again, to protect your money, invest only in deals that will pass your rigorous assessment.
This is where performing due diligence becomes crucial. If needed, ask the help of a professional to help you analyze the deal. Check the market and the underwriting assumptions. A conservative underwriting on rent premium, occupancy rate, exit CAP, and rent growth is crucial to ensure preservation of capital and protection against a downturn. It is also important for investors to know the deal structure to ensure that the hold period, fees, and share of earnings are aligned with their interests and expectations.
Another way to protect your money is to diversify your investments among different markets or spread your investments among different syndicators. In the event of a recession, each market would be affected in different ways hence minimizing your overall risks.
As you can see, the upfront due diligence work needed to evaluate a deal and vet a sponsor requires time and effort as you need to deliberately collect information to ensure trustworthiness, viability, and alignment with your goals.
Fear #3: I won’t have the time to focus on my real estate investments
Lucas and I hear this often from people who have expressed interest (and reluctance) in real estate investing. It made us realize that many people have no idea that there is syndication in real estate investing. I, for one, didn’t know this for a long time. When I learned that there is a real estate investment that allows partnerships among several investors that combine their resources and capital to purchase and manage a property, it was a game-changer. Acquiring properties that otherwise individual investors couldn’t afford has given smaller investors the opportunity to participate in the real estate investing industry and grow their money.
Not only that – this is the answer to those of you who are interested in real estate investing but do not have the time or the skill to manage it all yourself. Real estate syndications allow investors to reap the benefits of owning an investment property (cash flow, capital appreciation, tax benefits) without dedicating an excessive amount of time and work, or taking on the unnecessary stress of being a landlord themselves. A passive investor need not fear a lack of focus on day-to-day operation because the sponsor or syndicator handles everything from finding the property, structuring the deal, arranging the transaction, and operating the asset. The sponsor executes the business plan and delivers the returns to the passive investor who can continue to use time as he pleases. Passive investors will be able to continue working on their profession and maximize their income potential in syndication while essentially outsourcing their investment in real estate to somebody else, adds Lucas.
Fear #4: Multifamily is too big and scary, I think I’ll start small
Big doesn’t always mean harder to do, just as small does not always mean easier. In fact, in multifamily syndication, it is the opposite for a passive investor. When you become a passive investor in a big multifamily property (think apartment buildings), you don’t have to worry about the day-to-day operations of the business, maintenance, dealing with tenants, etc. Investors simply buy shares of the investment, receive distributions, and enjoy the long-term outcomes of smart investing.
However, if you choose to invest in smaller assets such as single-family rentals, you’ll indeed have control of the daily operation as a landlord. However, this comes with more responsibilities such as tax preparation, dealing with tenants, reserves for vacancies, and maintenance. It’s basically a full-time job with almost similar, if not lesser, returns than syndication investing. For busy professionals such as doctors, lawyers, dentists, managing smaller assets is not an option.
Many investors turn to passive investing in multifamily properties for various reasons. But essentially they all come down to the fact that most passive investors do not have the skill and experience, the time, and the needed funds to purchase multifamily properties on their own, and pooling resources with other investors gives that opportunity.
Fear #5: What will happen to my investment if the market crashes
No investment is risk-free. We have to accept the fact that it is impossible to eliminate all the risks and give a guarantee of resounding success every single time that we invest in a deal. However, real estate – particularly multifamily real estate – has proven to be among the safest investments available in the market. Compared to the stock market during the recent recession, the real estate market has recovered much quicker attracting younger investors to put their savings in real estate rather than in stocks and mutual funds.
In addition, a syndication deals’ investment is protected by the real estate asset. Compared to stock market investments, real estate portfolios offer lower risk, yield better returns, and provide greater diversification. One more thing to keep in mind: rent costs have been on an upward trend that is projected to continue for decades to come. Multifamily properties generating monthly rental income that increases with inflation even in a rent-controlled area and in times of economic downturn offer additional protection for your investment. It provides a robust plan for future ROI (return on investment).
We know that great rewards are reaped by those who take risks. Investors need to study available options and manage those risks before making a decision so they can make the best choice for themselves. Armed with knowledge and the right preparation, you shouldn’t let fear hold you back from taking action. Start building your wealth with peace of mind and achieve your financial and life goals.
Interested in passive investing? Reach out to us if you need any resources to help you make a decision or if you’d like to learn more about passive investing in multifamily real estate. Our team will be glad to assist you. You may also email us at email@example.com or call to see if LifeBridge Capital’s investments are a fit for you.