Welcome to Strategy Saturday; I’m Charles Carillo and today we’re going to be discussing How to Minimize Risk When Investing Passively in Real Estate Syndications.
No real estate investment is risk free but, there are steps that passive real estate investors can take to minimize their risk exposure. In this episode, Charles discusses several steps to help real estate investors reduce their risk when investing in passive real estate syndications.
Charles:
Welcome to Strategy Saturday; I’m Charles Carillo and today we’re going to be discussing How to Minimize Risk When Investing Passively in Real Estate Syndications.
Charles:
Have you always wanted to invest in real estate, but didn’t have the time, didn’t know where to find the deals, couldn’t get the funding and didn’t want tenants calling you. Since 2006, I’ve been buying income producing properties and great locations that provide us with consistent passive income. While we wait for appreciation in the future and take advantage of tax laws while we’re waiting and unlike your financial advisor, we invest alongside our investors in every property we purchase. Check out to investwithharborside.com. If you like the idea of investing real estate, if you like the idea of passive income partner with us at investwithharborside.com, that’s investwithharborside.com.
Charles:
So real estate outperforms many other asset classes, but many real estate investors are weary of real estate investing because they do not wanna become a landlord and I cannot blame them. Buying, owning, managing and selling real estate can be a very daunting process. And one way to avoid all the active responsibilities with real estate is to passively invest into a real estate syndication. Real estate syndications are a great way to diversify your investment portfolio and all the active duties are now the responsibility of the operator, also known as the sponsor. The question is how does a potential passive investor vet not only the sponsor but also the deal itself? I’ve passively invested in dozens of syndications in addition to being an active sponsor in our deals here at Harborside Partners. And I’m gonna break down how I initially vet sponsors and deals when I’m planning on passively investing. So first, let’s talk about the sponsor. What is the sponsor’s track record? How many deals have they done? How many deals have they exited sold? How long have they been actively investing in real estate?
Charles:
Have they been through a recession? How much are the general partners investing into this deal? And how are they compensated for their involvement in the deal? What are their roles in the deal? Are they part-time or full-time in the syndication business? And do they have a successful business background? It is important to note that when we talk about their track record, it does not just include their real estate syndication experience, it includes their other real estate investment experience. I have previously invested with two sponsors who had many years of small apartment complex investing experience, but only limited syndication experience. These turned out great, but not all these real estate investing experiences the same. Someone with single family rentals or flipping or short term rental experience is good, but it is different from commercial multi-family investing complex with five plus units. I personally started with small apartment complexes, so it wasn’t a huge stretch when I syndicated our first syndication, which was a 59 unit complex.
Charles:
Now let’s talk about this specific deal. I only invest into landlord and business friendly states and markets. So that cuts out about 50% of the United States leaving me able to invest in parts of the Midwest, mid-south, southwest and southeast of those markets. I wanna see an increase in jobs population and a decreasing crime all over the past 20 years. I invest in a c plus and above neighborhoods. Better yet, I focus on B minus and above neighborhoods. Never go below a c plus neighborhood. Never. Next is financing in the business plan. What is the expected hold period? What is the business plan? Is this a light value add or a heavy value add? When the economy is hot, I am more likely to invest into a heavy lift, major renovation project. When compared to a slow or declining economy, I’m focusing on light value ads where there is minor work being done and there is less disruption to the property’s income during the renovation period, I don’t wanna see a project being financed over 78% more likely.
Charles:
I want to see the project with a a loan of value in the 65 to 75% range. The lower to ltv, the lower the risk. What is the cap rate in financing spread? The bigger the spread between the two, the safer the deal, an interest rate of 5% and the cap rate of 7% is safer than an interest rate of 5% and a cap rate of 6%. What is the estimated whole time? Does the debt have a floating rate? Is there a rate cap? Two years or three years are common. Two years is more common cuz three years can be very expensive. Is a debt fixed rate? What is the term and what is the prepay penalty, which is also very important to ask What type of reserves are they raising? Six months plus of expenses is best? And do the sponsors have any other deals in the area?
Charles:
Do they have a team in the area and will it be the same management company? You know, this is really important cuz most passive investors feel that they are passively investing only because they don’t want to be active and they want to access bigger and better properties. This is true however, as a passive investor, I want to invest with a team that has a proven system in place. Years back I passed them invest into a 250 unit complex. In the Midwest, the sponsor had six other properties, complexes in the area, over 1200 units already. A proven team on the ground, a great property management company, and relationships with great contractors. This usually means that their rent comps and renovation estimates are gonna be very accurate cuz they’re in the market and they’re doing this all the time. This is just printing money for the passive investor.
Charles:
When you invest into their seventh deal, all the hard work in guesswork has been done and the past investor on the sim deal just slips into the proven system that’s already been set up by the sponsor. Next is rent comps. You know, where are rents currently and what does the sponsor want to raise them to? This is very important. I mean, what are the comps they’re using for underwriting and where the comps located in a sense of, in a perfect world, you want to have the comps to be from an apartment complex across the street, build the same year that has been renovated and rented out already. And this is not always a case. You need to see how close the comps are, how similar the properties are, size of units, amenities, and you wanna see a path of raising rents 20% to 25%.
Charles:
How do you mitigate risks as a passive investor? So invest with an experienced sponsor in a market where the sponsor has other properties, have a business plan that is not all about raising rents. Yes, driving income is the number one goal, but you want to see some portions of the plan were expenses will be decreased. This can be from hiring new vendors and new management, utility saving upgrades or independent metering. But when the economy falls, major re unit renovations will usually be put on hold and keeping tenants and units and keeping the tenants paying is now the main goal. The asset management portion becomes very important here. This is where the net operating income can still be increased, but by cutting expenses. Next is half financing. With a term of five plus years, floating rate debt must have an interest rate cap and there must be funds in reserve that purchase another cap in two to three years.
Charles:
And you have to check because sometimes they’ll say two or three years. And then when sponsors actually go out to market and see what a three year rate cap is, it’s very expensive. So it’s usually just a two year cap, which isn’t a problem if you have money in reserves for them to purchase one down the road or if they’re gonna be able to refinance that down the road. Always buy for cash flow. You want the complex, the cash flow from day one. Ask what the break even occupancy is and it should be under 78%. And this allows for there to be a 22% delinquency. Vacancy and expenses will still be covered. So that’s really important too. So if you have dips in people paying rent or dips with lots of vacancies and everything like this, you wanna make sure that all your bills are gonna be covered. So I hope you enjoyed. Please remember to rate, review, subscribe, submit comments and potential show topics at globalinvestorspodcast.com. Look forward to two more episodes next week. See you then.
Announcer:
Nothing in this episode should be considered specific, personal or professional advice. Any investment opportunities mentioned on this podcast are limited to accredited investors. Any investments will only be made with proper disclosure, subscription documentation, and are subject to all applicable laws. Please consult an appropriate tax legal, real estate, financial or business professional for individualized advice. Opinions of guests are their own information is not guaranteed. All investment strategies have the potential for profit or loss. The host is operating on behalf of Syndication Superstar, LLC, exclusively.
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