As we enter uncertain times, we will see more and more investors searching for quality and stability. Investors, especially those getting closer to retirement, do not like or cannot manage the volatility of traditional investments. Rising interest rates mean bond prices are falling. The 10-year also dropped by over 50% to be more precise. Not to mention these are supposed to be your “safe” investments. The preservation of capital is more important than ever!
As investors look for quality, they are turning to real estate. Some benefits to investing in real estate in volatile times include finite, insured, an inflation hedge, you can add value to it and it can produce income. But there are some downsides to investing in real estate too. Tenants locking themselves out or trashing your house to name a few. Savvy investors see the benefit of diversifying into real estate, but they don’t want the headache that comes with it. That is why they are investing passively in other people’s deals. A passive real estate investment is when you invest in someone else’s deal and let them do all the work. These are known as real estate syndications. If you are looking at investing in syndications, here are 4 steps to underwriting the deal.
Underwrite The Manager
This is hands down the most important piece of a passive real estate investment. A great deal can lose money because it is mismanaged. Or worse, the manager may not always be honest with their investors. Obviously, you want to invest in a team with experience. When I underwrite a manager or management team, it starts with getting to know them. I read the bios and then I want to speak with them and, if possible, meet them in person. From there, you can do all the normal steps which would include Google searches, references and double-checking past projects. I would do this same process for each individual manager of the deal. You would be surprised how often I find negative information about one of the managers in the group. I had one who served time for a white-collar crime. Don’t skip this step!
I like to see past and projected performance of the target asset. I am specifically looking at the manager’s plan for the asset and how they will be adding value. Past performance can be financial statements, but it is better to get tax returns. I will always run a comparable rental analysis so I can get an idea of the true market rent. Depending on the asset, you can get that info from websites such as rent-o-meter, appartments.com, CREXI and Loopnet. These numbers will be in the financials that you receive so I am only verifying what is being presented. I also examine current and projected expenses and try to poke holes. Can the new manager really do a better job than the seller or the old manager? Often, I see low projections with maintenance and loss reserves so focus on those.
Due Diligence Documents
There is a lot to this step depending on the plan. We are funding a hotel conversion right now and part of the documents we want to see is that the city will approve the projected use of the building. It does no one any good if the manager cannot execute their plan. I always want to see environmental and appraisal reports. There is a ton of information in those two reports. Depending on the plan, there are other documents I would ask for that include soils reports, compliance reports, inspections, traffic studies, and engineering and/or architectural plans.
These are the documents for the actual investment which typically include the Operating Agreement and Subscription Agreement. It will detail what you should expect for the operation. How much of the pie do you get and how much is promised or preferred to management fees, if any? These are good indicators of a fair deal. Will I be getting a preferred return and is the split on profits fair? If I see the management team getting 60% or more, I pass on the deal. To me, that shows a sign of greed and is not a partner I want.
Secure A 100% Passive Real Estate Investment With A Real Estate Lending Fund
Outside of syndications, you can still get real estate exposure by investing in passive assets backed by real estate. Real estate lending is becoming more popular as banks tighten up. Loaning money is a great way to invest in something with monthly cash flow with the safety net of real estate. As good as lending is, you still need to locate and underwrite each individual deal. You can get a 100% passive investment with even more diversification by investing in a real estate lending fund. If you are looking at a fund, I would underwrite it much in the same way as a syndication. Focus on the manager first and then look at what the fund invests in and the financials. You can look for transparency by double-checking the list of loans to the county records to ensure the fund is making the loans they are disclosing.
There are many ways to diversify into real estate without the effort. Syndications can be a great way if you do your due diligence and invest in quality projects with a quality management team. Real estate lending or mortgage funds can provide some liquidity with much more diversification, but again you need to invest in a quality team.
This article was originally written for the Forbes Business Council.