Real Estate

Think about passive real estate What is safe? Here are 9 hidden dangers that could apply to you.

You cannot eliminate all risk from investing. After all, the zombie apocalypse could strike tomorrow and probably wipe out your entire portfolio. But you can minimize risk, even with high-return investments. in fact, These are exactly the kinds of investments you want to de-risk—your Treasury bonds don’t need to.

I Love real estate syndication. As a high return investment. They are completely passive: you don’t have to worry about financing or contractors, permits or inspectors, tenants or property managers.. You don’t have to be. a LandlordYet You still get all the benefits of owning real estate, including Cash flow, DefinitionAnd Tax benefits.

If you find terms like “real estate syndication” or “private equity real estate” intimidating, don’t. These are simply group investments, where a professional investor enlists the help of silent partners to help fund the deal. You effectively become a part owner in a large property such as an apartment complex, mobile home park, or industrial or retail property.

So what risk should you take? look for When screening potential investments? Here are nine to keep in mind.

1. Sponsor Risk

Before look at specific investment, Start with an assessment Syndicators (also known as Sponsors, General Partners or GPs, and Operators).

An experienced, skilled sponsor who puts their investors first can find ways to save. Deals that go sideways.. Inexperienced or lax sponsors can find ways to screw up even good deals.

There are a number of questions you should ask sponsors though, some of which to get started include:

  • How many deals have you done in your career? How many of these were sponsored syndication deals?
  • How many of them are gone? Full Cycle What kind of returns have you provided for your investors?
  • Have you ever lost an investor’s money? Have you ever lost your money on a deal?
  • Have you ever made a capital call?
  • Tell me about some of the deals that went sideways. on you And how did you respond?
  • What is your specific strategy, and why did you choose it?

Do not invest with an investor. What you don’t feel 100% confidence I. If you say “hell yes!” Does not feel! Attitude towards the sponsor, consider them a difficult number.

2. Credit risk

plenty of Syndication deals have fallen through in the past two years. Due to risky financing. Many syndicators took out short-term or variable-interest loans, only to find themselves in trouble when interest rates went up. They ended up with weak or negative cash flow., May be unable to refinance at today’s high rates.

When we review deals in our Co-Investing Club, the first thing we look at is the loan structure. We ask questions like:

  • What is the term of the loan?
  • What is the interest rate? Is it fixed or floating?
  • If it is floating, is the sponsor buying a rate cap or rate swap or some other protection against further rate hikes?

We turned down the investment. That last year was financial aid With a two-year bridge loan. I am not ready for To Gambling on interest rates And cap rates are falling over the next two years.

Instead of this deal, we invested in a deal where the sponsor took out a fixed 5.1% interest loan from the seller. Contract settlement: Nine years were left in its term.

I don’t know what the market will do in the next two years. But I’m pretty sure that sometime in the next nine years, there will be a good market for sales.

3. Market risk

Markets are constantly changing and evolving, moving up or down. below. They rarely sit down.

If Cap rate Increase, income decreases property prices. she is Great for investing in new deals And bad for you Current real estate investment

Risk of recession Comes under the umbrella of market risk. In a recession, rental defaults tend to rise, as do vacancy rates. Both were hurt Net operating income of the property and therefore, both of them Its cash flows and of that Value.

You can’t control cap rates or recessions. Markets move, sometimes in your favor and sometimes not. But you can invest conservatively in properties that cash flow very well with long-term, low-fixed-interest loans.

As a final thought about market risk, all real estate investing is local. When people talk about “market risk,” they may be concerned about the macroeconomic market and the broader economy. but what Really Matters for real estate investors are the local market: local cap rates, vacancy rates, and rents and expenses. This is what inspires you. real return on that particular investment.

Fortunately, you can. Invest passively from anywhere in the world.In any city of the country. I certainly do from my current home base in Lima, Peru.

4. Concentration risk

I dont know What would happen in any city or state or, for that matter, in any given asset class (multifamily, mobile homes, retail, industrial, etc.). This is why we do these deals together: to spread a small amount of money across many different properties, regions and property types.

At my last count there is interest in about 2,500 units in two dozen properties in 15 states. In most cases, I only have $5,000 to $10,000 invested in each property.

That means I don’t need a crystal ball. I don’t need to predict (gamble?) on the next hot market or asset class. I Bus Keep investing in different properties in different areas Every single month As a form of Dollar cost averaging.

Because come on Face it: Any local market can rise or fall unexpectedly. You avoid this risk. Diversity: Spread small eggs in many baskets.

5. Regulatory Risk

Local cities and states impose them. own Landlord Tenant Regulations. Some are investor-friendly, and others lean heavily toward protecting tenants at the expense of property owners.

Properties subject to tenant-friendly regulations come with additional risk. It takes a lot of time to enforce lease agreements and evict defaulting or other violating tenants. I’ve seen evictions take 11 months in tenant friendly jurisdictions!

Owners in some markets are forced To renew nuisance tenants even when their leases expire. They cannot renew lease agreements.

That doesn’t mean we never consider investing in anti-landlord markets. But we prefer non-residential investments in these markets. For example, we have invested in a short-term cabin rental business in Southern California.I An undivided hill town supported by tourism. The risk is zero. Short term rentals A ban is being imposed Or eviction nightmares when these cabins only support guest stays of up to a week.

6. Cash flow risk

I touched on the risk of local rents stagnating or falling earlier. This can pinch cash flow.

Your cash flow may decrease in the other direction as well. In the form of rising costs. Look no further than Skyrocketing insurance premiums Labor costs over the past two years or sharply higher.

So, how does our investment club protect against cash flow risk? We look for deals with conservative estimates including low rent. Development and increasing high costs. If the numbers still work, even duty tough Market conditions, you have some wiggle room if things go wrong.

7. Construction Hazard

When syndicators plan to add value through renovations, they need a great team. in fact Swing those hammers and get the job done on a budget. On Schedule

Who is doing the work? Is the construction team in-house or outsourced? Any way, any way many times Has the sponsor worked with this team on prior deals?

If This is the sponsor’s first rodeo with this out.

8. Property Management Risk

The same principle applies to property management. who is going Manage properties day-to-day? Whether the property management team is in-house or outsourced, how? many times The sponsor has worked with them. First?

Poor property management is a recurring theme in syndication deals that go south. Our investment club Searches Deals with proven PM teams to mitigate this risk.

9. Partner Risk

I Great In syndication deals, you sometimes see one primary sponsor and several supporting sponsors. Make sure you understand who is who. Will manage assets, and focus your testing on them.

I have seen a deal where a supporting partner sponsor had a strong track record., But They weren’t Lead sponsor or in charge of asset management. The lead sponsor bungled the deal, leaving others to clean up the mess.

This brings us back to sponsor risk and full circle. Making sure you understand That’s exactly what you’re handing your money over to.

Final thoughts

If you keep these nine risks in mind while investing in passive real estate projects, you can reduce your risk while still earning more than 15% return. You can also manage risk. Investing in real estate debt instead of equity.

A few months ago, our co-investment club invested in a six-month note paying 10% interest, which has a right of first refusal under a 50% loan-to-value. Property prices can go up or down, as can interest rates, and we will still feel safe. Well, it’s not the 15% plus annual return we usually aim for as a club. But the short, flexible term and incredible guarantee leave us. feeling Confidence about risk.

You will never completely eliminate risk. But you can reduce and manage it by finding those disproportionate returns that pay well with minimal risk.

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Note via BiggerPockets: These are the opinions expressed by the author and do not necessarily represent the opinions of BiggerPockets.

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