SS45: How Do I Passively Invest in Real Estate?

Charles shares his thoughts on how and why he invests passively in real estate.

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Talking Points:

I am an active investor in the majority of my real estate holdings. However, I still passively invest in syndications.
- What convinced me to make this episode was that a passive real estate investment I was involved with was just sold.
- Why would I passively invest when I’m a syndicator? I am looking to diversify my portfolio into different assets that I am not an expert in. For example; I passively invest with a group that invests in different tech startups and I get an email about each new startup and founder they are working with; but for this episode, I want to explain why and how I passively invest in real estate.
- It is a perfect way to diversify your real estate portfolio; giving you access to more markets and asset classes. More units equal less volatility. You own 20 units (say worth $1M) with no debt vs. another investor that has that same $1M of capital spread over 4,000 units in different markets and different asset classes.
- My company focuses on C+ to B-class multifamily throughout the Mid-South and Southeast United States. If I want to venture into another commercial real estate asset class; passive investing allows me to do that.
- In regards to my passive investment that just sold; this was a large apartment complex in a market that I was not familiar with but it was growing rapidly. Passive investing allowed me to get involved in a deal to which I normally would have not had access.
- Passively investing allows me to quickly place capital without a deal of my own. As a real estate professional, I am able to utilize depreciation to decrease my income; if we sell an asset at the end of a year and I need to place capital in order to minimize taxes before Jan. 1; passive investing is a great solution.
What do I look for in GPs and deals?
- Investor communication is important; I don’t need reports; I prefer regular, short communication. Longer emails always look to me at first glance that there is an issue. If there is an issue like COVID; I want more frequent updates, for example; a short email on the 5^th and 10^th of the month telling me about rent collections. I don’t want to wait till the first week of June in the monthly report to learn about rent collections in the first week of May when there is something like COVID that is happening. If 80%+ of rent is collected; most other issues will work themselves out.
- Who is the property manager; what is their experience in the area and asset class?
- Is it a good market? How has the market been growing over the past 5-10 years? What are the future market growth predictions? Are rent predictions actually possible in the neighborhood the property is located in?
- Experience of the GP team; have they done a deal like this before? In this market? I do not want to be investing with a new real estate investor or a first-time syndicator. I want to see 15+ years of real estate investing experience in the deal sponsor.
- How much money is the GP putting in? Who are the other investors; family offices? Is there an alignment of interest? How fee-intensive is the deal? If fees are higher than normal, are they justified?
- What type of debt? Short-term or long-term? Loan to cost?
- What type of reserve is being raised?
- Is there going to be a cost segregation study?
- How aggressive is the business plan? What is the current vacancy?
- Finally, does the risk justify the potential returns?

Transcript:

Charles:
Welcome to Strategy Saturday; I’m Charles Carillo and today we’re going to be discussing how do I passively invest in real estate? And I’m an active investor in the majority of my real estate holdings. However I do passively invest in syndications will convince me to make this episode. Was that a passive real estate investment I was involved with just sold. So why would I pass me invest when I’m also a syndicator, I’m looking to diversify my portfolio into different assets that I’m not an expert. In. For example, I passively invest with a group that invest in a different tech startups, and I get an email about every new startup and founder they are working with. But for this episode, I want to explain why and how I passively invest in real estate is a perfect way to diversify your real estate portfolio, giving you access to more markets and asset classes, more units equal less volatility.

Charles:
So for example, you own 20 units say worth a million dollars with no debt versus another investor that has the same million dollars of capital spread over 4,000 units in different markets and in different asset classes, the amount of the first vacation you have, there will minimize any type of volatility that you have. My company focuses on C plus the B class multi-family throughout the mid south in the Southeast, in the United States. If I want to venture into another commercial asset class, passive investing allows me to do that in regards to my passive investment that just sold. This was a large apartment complex in a market that I was not familiar with, but was growing rapidly. Now passive investing allowed me to get involved in a deal where I normally would not have had access to passively investing allows me to quickly place capital without a deal of my own as a real estate professional.

Charles:
I am able to utilize depreciation to decrease my income if we sell an asset at the end of the year, and I need to place capital in order to minimize taxes before January 1st, passive investing is a great solution. So what do I look for in GPS and in deals? Well, number one, investor, communication’s very important. I don’t need reports. I prefer regular short communication on a consistent basis. When they send out reports on the monthly, it can have just a bank statement. It can have also a profit loss. Some will just have just some graphs that are put inside the email. I always feel a longer emails, always look to me at first glance that there’s an issue. If there’s an issue like COVID I want more frequent updates, for example, a short email on the fifth and 10th a month telling me about rent collections, where they stand, what percentage we’re at.

Charles:
I don’t want to wait until the first week of June in the order, in the monthly report to learn about rent collections in the first week of may, when there was something like COVID, that’s happening. And a lot of our groups that we were involved with and when we were sending out updates, that’s how we did it. We gave mid month updates and letting people know how rents coming in, because if 80% plus of rent is collected, most other issues will work themselves out. So you just want to make sure you’re getting those updates and know exactly what’s going on. And again, these little updates can just be a percentage and say how many people paid and what’s outstanding, et cetera. It can be just a few bullet points, very simple next, who is a property manager? You know, what is their experience in the area and in the asset class next, is it a good market?

Charles:
I mean, how has the market been growing over the past five to 10 years? And what does the future market growth predictions, our rent predictions actually possible in the neighborhood and the property it’s located in. So you’ll have to check some of the comms experience of the GP team. Have they done a deal like this before in this market? I do not want to be investing with a new real estate investor or first-time syndicator. I want a 15 plus year real estate investor, veterans as deal sponsors. And how much money is the GP actually putting in? Who are the other investors, maybe a family office, maybe some really high net worth individuals. I mean, is there alignment of interest in a lot of the deals that I’ll pass the investment, the GPS have maybe 5, 10, 20 times the amount of investment that I’m putting in personally invested themselves, how fee intensive is the deal.

Charles:
Now, if the fees are higher than normal, are they justifying? If this is a great asset in a really hot market and it took them hundreds and hundreds of deals look through, it might be justified. In some instances for the most part, I haven’t really seen too many syndicators that up deals, but I’ve seen some that have very expensive acquisition fees. And unless it’s a really, really awesome deal, I’m going to pass on that. There’s, you know, you want people to be compensated for the work, but also you don’t want something to be completely fee intensive. So what type of debt are they taking out as a short-term or long-term debt and what’s the loan, the cost? I see a lot of stuff where we are now in the market cycle that is 80% loan to cost, which if it’s not inexperienced borrower and experienced syndicator operator you might feel a little worried about I see some other deals that are 70% or 75% loan to value loan the cost.

Charles:
If that is what you’re, what you’re going to be investing in, that’s going to be usually a little safer of a play. And then also how long or short term, you know, the more aggressive the business plan is. The more experience you want your group to be. You don’t want to be investing with a first time syndicator of that SCADA, you know, two or three year debt 80% loan to value and never done one of these before. I mean, it’s very, very risky. What type of reserve is being raised? You know, the lot, I like to see hundreds of thousands of dollars several months of operational reserves that are being held. And I want to make sure that they’ve raised an over raised for the cap budget, because that’s something that you don’t want there to be any slowdowns when they’re doing work.

Charles:
You know, you don’t want people to be doing any of the cap ex out of any of the operational cashflow and also you don’t want the deal to be slowed at all. You know what I mean? You want them to hit the ground running and you want them to start turning units and putting the whole value, add strategy into high gear after you’ve purchased next, is there going to be a cost segregation study? So the cost segregation study is great for having you can look it up separately, what cost segregation is, but it is really speeding up the amount of depreciation right in the first year. And that allows real estate professionals in particularly to take a lot of their income deduct it from their taxes. So that’s a good thing. It’s also, if someone just had an exit and they’re not a real estate professional, but it’s to have a passive gain, this is something that will allow them to offset some of those games they had.

Charles:
Next, how aggressive is the business plan and what is the current vacancy? If you know, if you’re going in with a newer group you want to see an, a business plan. That’s not as aggressive. You know, you want to see something where the property is already stabilized. It’s already cash flowing. They might be going in and doing a couple of things here and there. And it’s not going to be, you know, the best return ever for you. However, it’s going to be a much safer property. If the current vacancy is over 10%, they’re going to have to get some sort of debt. That’s not agency debt. Not that it’s very high risk, but it might not be as long-term, you know, the key with agency debt is it’s long-term. And that’s why I like it in nature, because you’re going to get terms that are 10, 15, maybe even longer.

Charles:
And it’s, if you’re holding a property for five or seven years, you want to see that the debt you want to see whatever they save for the business plan, wherever the whole time is. You want to see that debt to be almost a twice as long. So someone’s doing the, they want to do a three to five-year hold. You want to set them getting 10 year fixed term debt. And that makes it if there’s any type of pullback or any type of issue they more than can cover wading through it before they have to refinance or before they sell, you know, you want to sell when you want to sell. And you want to refinance when you want to refinance, you want to be forced into anything that’s where you’re not going to get the best deal and rate. And finally does the risk justify the potential returns.

Charles:
I mean, if you have a deal that has a lot of hair on it, I mean, are you being compensated for that? I mean, if it’s, if it’s, if you’re looking at it and another deal, that’s a lot less risk and it’s got similar returns. Well, you probably would do that versus one that they’re putting in 12 or $12,000 a unit, and they’re going to be raising rents $500 and all this type of stuff that has to work like clockwork in the short amount, in a short amount of period, compared to someone that might have a deal that might not be in as hot of an area, but it might be something that’s a little bit more consistent where they’re going in putting two, $3,000 a unit in raising rents 120, $150 and something like this it might be a little safer of an investment. Whereas the other one, there has to be a lot of things of that connect in for those returns to be reached. So I hope you enjoyed, please remember to rate, review, subscribe, submit comments, and potential show topics at global investors, podcast.com. Look forward to two more episodes next week. See you then

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