You work hard for your money, right? The single worst thing you can do is throw your hard-earned money at real estate and “hope” it works out. Everyone’s heard Warren Buffet’s famous quote, “Rule No. 1: Never lose money.” “Rule No. 2: Don’t forget Rule No.1.” Keep this in mind as you choose which investments to make and how the align with your risk profile.
Below are six areas to research before investing passively in an apartment syndication. Through research and asking the right questions, you will give yourself the best opportunity to succeed as a passive real estate investor.
#1 ASSET CLASS
Multifamily offers many different asset class types. You have A,B,C, and D. Each one offers a different style return when it comes to investing. In short, here is a high level breakdown of each from a passive investors mindset.
Class A
- Typically less than 10 years old and are upscale (luxury)
- Bought primarily for appreciation
- Potential vacancy spike during a recession due to white-collar workers living here
Class B
- Generally 10-25 years old
- Mix of white-collar and blue-collar residents
- Cap rates are higher than Class A but lower than Class C
- Bought primarily for appreciation but cashflows better than Class A
- 30-40 years old
- Mix of blue-collar to lower income earning residents
- Can be the first to appreciate in a rising market
- Rents below market rate
- Generally most attractive for cashflow investors as it has a healthy mix of cashflow and appreciation
- Class B and Class C are where the best deals typically are since your able to force appreciation and not solely rely on the market.
- Built over 40+ years ago
- Generally Section 8, government-subsidized residents
- In rough areas of towns/cities
- Can be a management nightmare with bad debt, high crime area, spikes in vacancy, and heavy security needed
- If operated properly, moderate to high cashflow can be achieved when the market is strong
#2 TEAM
Who are the operators and what is their track record? Do they have an in house property management company or are they hiring a third party management company? Ask what mistakes have been made on past or current deals and how did they overcome it. If they haven’t made any mistakes… run. Spend a few dollars and do a background check. You’re investing 50,000+ with them so make sure their story checks out.
#3 MARKET
As I have written in previous articles, markets do make a major difference. There are many data sources online to find which markets perform better than others. You want to find out which markets hold up during recessions. Find out things such as: job growth, population growth, job diversity, and current living cost compared to the median household income. By doing your own research, you will be able to identify which markets have strong drivers and ones you feel confident to invest in.
#4 UNDERWRITING
Underwriting is arguably one of the most glossed over sections when an investor looks at an opportunity. Why? They don’t know how to properly analyze a deal. Before you make your next investment, learn how to underwrite a deal properly. If you can underwrite, you can be sure to find errors in summaries sent out and also gauge very quickly if their underwriting is too aggressive. For example, if the subject market over the last 30 years has a growth rate of 3%, but the syndicator is writing 3.75% because that’s what the last 5 years has performed at, that’s not conservative underwriting. All operators will tell you they underwrite conservatively. Don’t take their word for it and do your own digging in the numbers.
#5 DEBT STRUCTURE
Identify which debt is best for the opportunity. Not all debt should be 10-12 years, fixed rate, with 5 years interest only. Each asset has its own story and hold period. Knowing if the wrong debt is placed on a deal can save you from making a poor investment.
#6 FEES
Fees are a good thing. It’s a way for the sponsor to keep the passive investor’s interest aligned with their own. It’s up to you to decide if you feel the sponsor is fair on fees and if they align with your investment goal. There are fees that sponsors will have on a deal. Some of the most common ones are: acquisition, asset management, property management, construction, financing, refinancing, disposition, and termination. These fee’s can range from 1%-5% depending on the asset and business plan. If all of these fees are being applied to the deal, there is a good chance you don’t want to invest. Typically, a reputable sponsor will only incorporate a few of these fees into a deal.
Doing your homework on these six areas will help you make the most of your investments. Be patient and wait for the right deal to come along before investing. If you have studied these six points and have done your research, you will be able to invest with confidence.
If you have any questions or want to learn more about making an investment please reach out.
