Accredited Investors

3 Reasons Why I Invest in Other People’s Apartment Syndication Deals

I am my company’s 2nd largest passive investor in terms of total dollars invested as a limited partner (LP).

Obviously, I’m not just passive. Since I’m the co-founder of Ashcroft Capital, I take a very active role in the business as a general partner (GP). But I have passive dollars as a limited partner in our deals. By a long margin, the majority of my personal money is allocated to investing in my own deals with Ashcroft Capital.

That said, I invest in other people’s deals as well. In fact, as of this writing, I have $818,500 invested in 14 non-Ashcroft deals.

And I do it for three reasons.

 

1. Makes Me a Better GP on My Deals

First, by investing as an LP in other people’s deals, it makes me a better GP on my deals. As an LP I see first-hand how other GPs organize and execute their deals. Some of the things I am exposed to are:

Initial email announcing the deal – How do they write the email? How is it designed? What does it say? What doesn’t it say? What is their call to action?

The signup process for investing – Do they use an investor portal? If not, what do they use? AdobeSign? DocuSign? Something else?

Deal structure – What is their profit split? What fees do they charge? What type of financing do they secure? What information is included in their investment package? What are their underwriting assumptions?

Deal presentation to investors – I do not attend the new deal presentation. But if I did, I would learn how the deal is presented and what presentation service they use (conference call or webinar, live or recorded). The reason why I don’t attend the presentation is because I prefer to read the information and base my investment decision on that. Plus, I don’t receive investment opportunities from anyone that I wouldn’t invest with because I’ve already screened the operator. Once a new deal hits my email inbox, since I have already vetted the operator, I only vet the deal.

Ongoing communications – Do they send monthly updates, quarterly updates, or sporadic updates? I have invested with one operator whose communication was sporadic and the deal didn’t perform as well as my other passive investments. I won’t be investing with them again – lesson learned though! If they are sending monthly or quarterly updates, what are they including in those updates? What financial reports do they proactively send?

Distributions – Do they send monthly distributions, quarterly distributions, or some other distribution schedule? Do they send the distributions via check in the mail or do they offer direct deposit? I hate getting checks. I prefer direct deposits because it’s easier to track and doesn’t require an extra time commitment. Do I get paid when they say I will? For example, some GPs do quarterly distributions but the investors don’t actually see the money for a month or two due to processing.

What happens when things don’t go according to plan – Do they go dark? Do they clearly communicate the problem and the steps they are taking toward the solution? Investors want to be told succinctly and in a straight-forward manner what is going on at the property. They want consistent updates. If communication slows down when challenges or issues arise, that is a red flag and is something I’ve experienced with one of my passive investments.

 

2. Test Drive Other Markets

The second reason I invest in other company’s deals is because it lets me test drive other markets. At Ashcroft Capital, we are laser focused on five markets – Dallas, Fort Worth, Tampa, Orlando and Jacksonville (here is the process we use to select target investment markets). Because of our laser-focused approach on those five markets, we don’t have opportunities anywhere else at this time. However, should I want to see how other markets are performing for other operators, this is a great opportunity to get in a deal or two in a market I’m curious about to see any challenges other operators have. This helps me gain first-hand knowledge about some additional considerations about new markets should be start exploring outside our current five markets.

 

3. Strengthen Relationships with Influencers

Third, by investing with other GPs I am strengthening my relationship with influential people in my industry who are also putting together deals. I live in a world of abundance. And by investing with other GPs, it allows me to help them grow their business while staying in touch with them in a relevant way since I am now one of their LPs.

 

Other Takeaways From Investing in Other GP’s Deals

Here are some specific observations I have made as a result of investing in other GPs deals:

  • One operator sent out a deal. I said I’d invest. Then after a month or so they sent a follow-up email saying they are pulling out of the deal. It was a thorough explanation of why they pulled out of the deal and it made a lot of sense. The result of the experience gave me even more confidence in them as a GP.
  • Some of our Ashcroft Capital investors have said they prefer higher preferred returns and don’t care as much about the upside in the deal. I saw an offering from one GP that offered a 10% preferred return for Class A investors, and a 7% preferred return for Class B investors. Class A had virtually no upside but Class B got the upside at a 70/30 split (LP/GP). After seeing that, and talking to other GPs about it, we tested it out on a deal and it was very well received.
  • One group I invest with does interviews with experts like SD-IRA custodians, property managers, etc. and shares the webinar recordings exclusively with their LPs. I obviously know a thing or two about doing interviews but I don’t have an exclusive interview series just for my accredited investors. It’s something I’m going to implement.
  • Another operator mailed me the legal documents which I’d actually preferred not happen. I personally want everything digital and if I want to print something out I’ll do it myself.
  • An operator mailed me a gift with their logo on it. I think this is a miss. I think that accredited investors don’t need or want another mug, thermos, pen, etc. We have the money to buy one ourselves. I think gifts for accredited investors should be much more thoughtful and personalized. I’m working with my team to create a program for our investors that provides thoughtful gifts on special occasions. Perhaps I’ll write about that once we have it implemented.

To summarize, I invest the majority of my own money into my own deals with Ashcroft Capital. However, I find it valuable to invest my own money into other people’s deals because it educates me on ways to improve Ashcroft Capital, lets me test drive other markets and strengthens relationships with influential people in the industry. The net result is our investors at Ashcroft Capital have a better experience with us because I am constantly learning from others and using those lessons to optimize the experience for our investors.

 

Are you an accredited investor who is interested in learning more about passively investing in apartment communities? Click here for the only comprehensive resource for passive apartment investors.

2019 Cap Rates of the Nation’s Top 50 Multifamily Markets

Every 6 months, CBRE releases their bi-annual North American Cap Rate Survey, which calculates cap rates and expected return on cost based on recent transactions and interactions with active investors in markets across the country.

Download CBRE’s most recent report here.

The cap rate is the rate of return based on the income that an asset is expected to generate More specifically, it is the ratio of the net operating income and the current market value of the asset (cap rate = net operating income / current market value). Generally, at the same net operating income, the higher the cap rate, the lower the property value.

In multifamily investing, the cap rate is used by appraisers in order to determine the value of an apartment building being purchased or sold. Therefore, as investors, the cap rate can be used on the front end to help us determine a fair purchase price – although it is not as important as cash-on-cash (CoC) return and, if you’re an apartment syndicator, the internal rate of return (IRR). However, the cap rate is very important on the back end, because it is used to determine how much the investor or syndicator can sell their asset for, which determines how much profit they can make at sale.

 

Here are the cap rate trends for the nation’s top 50 tier I, II, and II multifamily markets for Class A, B, and C asset classes.

 

Tier I Markets

CBRE Research

 

Tier II Markets

CBRE Research

 

Tier III Markets

CBRE Research

 

Are you an accredited investor who is interested in learning more about passively investing in apartment communities? Click here for the only comprehensive resource for passive apartment investors.

Here’s Why Buying Apartments is the Most Timeless Investment Strategy

We’ve all read articles that tell us how much money we would have made if we had invested in a major stock when it first became public. If we would have invested $100,000 in Apple in 2009, it would be worth over $1 million today. However, if you waited and invested that same $100,000 in Apple in 2014, you would have lost over $70,000. So, in order to make huge gains in the stock market, you must “time the market” or, in other words, speculate.

That is one of the major advantages that real estate investing, and multifamily investing in particular, has over investing in the stock market. As long as you follow my Three Immutable Laws of Real Estate Investing, you will make consistent cash flow without having to time the market.

And as evidence to support this claim, here is how much money you would have made if you invested $100,000 into a multifamily building every five years starting in 1985, according to the NCREIF Property Index:

 

If you invested $100,000 in 1985, you would have made $43,370 in five years.

Year NPI Cash Flow
1985 11.14% $11,140
1986 6.93% $6,930
1987 6.78% $6,780
1988 9.97% $9,970
1989 8.55% $8,550
Total 43.37% $43,370

 

If you invested $100,000 in 1990, you would have made $26,130 in five years.

Year NPI Cash Flow
1990 5.69% $5,690
1991 -1.31% -$1,310
1992 1.71% $1,710
1993 8.47% $8,470
1994 11.57% $11,570
Total 26.13% $26,130

 

If you invested $100,000 in 1995, you would have made $59,260 in five years.

Year NPI (%) Cash Flow
1995 11.19% $11,190
1996 11.07% $11,070
1997 12.33% $12,330
1998 13.43% $13,430
1999 11.24% $11,240
Total 59.26% $59,260

 

If you invested $100,000 in 2000, you would have made $51,020 in five years.

Year NPI Cash Flow
2000 12.41% $12,410
2001 9.06% $9,060
2002 8.48% $8,480
2003 8.62% $8,620
2004 12.45% $12,450
Total 51.02% $51,020

 

If you invested $100,000 in 2005, you would have made $18,640 in five years.

Year NPI Cash Flow
2005 19.68% $19,680
2006 13.89% $13,890
2007 10.91% $10,910
2008 -7.20% -$7,200
2009 -18.64% -$18,640
Total 18.64% $18,640

 

If you invested in 2010, you would have made $62,570 in five years.

Year NPI Cash Flow
2010 17.19% $17,190
2011 14.63% $14,630
2012 10.80% $10,800
2013 10.03% $10,030
2014 9.92% $9,920
Total 62.57% $62,570

 

Since NCREIF began calculating their property index, apartments have seen a positive cash flow during every five year interval, even during the period that includes the 2008, 2009 economic recession. The best five year period is 2010 to 2014 (62.57% NPI) and the worst five year period was 2005 to 2009 (18.64% NPI).

If you are interested in seeing the quarterly NPI breakdown for apartments, other commercial real estate classes, click here.

 

Are you an accredited investor who is interested in learning more about passively investing in apartment communities? Click here for the only comprehensive resource for passive apartment investors.

11 Questions to Ask Someone With a Trillion Dollars to Invest

“Hey Joe. My cousin’s friend’s grandfather’s former college roommate is a Russian Oil Tycoon with a trillion dollars to invest. Do you want me to make an introduction?”

Okay, maybe not that extreme…

While I do receive the majority of my potential inquiries through my Invest With Joe landing page, I also receive inquiries from people I meet who say they or someone they know has a whole bunch of money and either want to buy a piece of real estate or passively invest in one of my future deals.

If you have had some level of success in apartment investing, you do or will run into similar scenarios – even if you aren’t currently raising capital.

Many high net-worth people know the wealth conservation and wealth building benefits of multifamily real estate. However, just because someone has enough capital to invest in your deals doesn’t mean they can, will, or even should invest. In order to determine if a high net worth individual is serious about investing in one of my deals, here are the 11 questions I ask:

 

1. Do you want to invest in multifamily, value-add projects?

Our business plan is to purchase stabilized multifamily deals that have the opportunity to add value. That is, either increase the income or decrease the expenses by improving the physical property or improving the operations.

Value-add multifamily projects are just one of many syndication business plans. Maybe they invest in value-add deals that aren’t multifamily. Or maybe they invest in multifamily deals that aren’t value-add. If the high net worth individual doesn’t invest in value-add deals and multifamily deals, then my business may not be the ideal fit.

Obviously, if you’re business model isn’t value-add multifamily, then replace “multifamily, value-add projects” with your investment strategy.

Keep in mind that just because they haven’t invested in your investment type in the past doesn’t automatically disqualify them. Instead, you should provide them with a resource that educates them on your business plan (like my Passive Investor Resources Page).

 

2. What are your return expectations?

Most passive real estate investors’ base their return goals on the cash-on-cash return and the internal rate of return. Therefore, those are the two main return factors we analyze when underwriting and presenting new deals to our passive investors.

When speaking with a prospective investor, I want to know what their return expectations are. Most high net-worth individuals will be familiar with these two return factors. If their cash-on-cash return and internal rate of return expectations differ greatly from the returns we offer to our limited partners (LPs), our deals may not be an ideal fit.

Of course, you may run into high net-worth individuals who care more about another return factor or care more about capital preservation than the ongoing returns. The purpose of this question is to determine if the returns you offer to LPs are aligned with their return expectations. If they aren’t, this individual likely won’t invest in one of your deals.

 

3. What is your investment minimum and maximum hold time?

Another important question I ask prospective investors is when they need to receive their initial equity investment back. Generally, our exit strategy is to sell our deals within 5 to 7 years. On some deals, we are able to return a portion of the LP’s initial equity upon a refinance or supplemental loan. However, this question is focused on the investors’ entire equity investment.

If I ask a potential investor this question and they say “I would like all of my capital back within 2 years” or “I don’t want my capital back for 10 years”, then our deals may not an ideal fit.

 

4. Can you show proof of funds?

I may speak with an individual who claims to be an accredited investor, but doesn’t actually met the liquidity and net worth requirements.  Asking for proof of funds is a simple way to confirm their accredited investor status.

If you are doing a 506(b) and are accepting non-accredited investor money, you may still want to ask for a proof of funds. If you have a minimum investment of $50,000 and they send you a screenshot of their bank statement that shows a balance of $15,000, they likely won’t be able to invest in your deals (or at least not in your next deal).

 

5. Have you invested as a limited partner on a syndication deal?

I ask this question to gauge the experience of the high net-worth individual. From my experience, if I receive an inquiry from someone who hasn’t invested in a syndication deal before, the chances of them investing in one of my deals is very low. Apartment syndication is a complex investment strategy. Heck, the PPM is usually over 100 pages long. It takes time for someone to not only become educated on the syndication investment strategy but to become comfortable with it as well.

I don’t recommend that you reject someone who has never invested as an LP before. However, while it is definitely possible, don’t expect them to invest right away.

 

6. Are you comfortable investing with other LP’s or would you require to be the only LP in this investment?

The majority of my investors are comfortable investing alongside other LPs or they don’t have enough capital to cover the entire LP equity investment themselves. However, I do have a handful of investors who want to be the only non-general partner (i.e., my business partner and I) LP on the deal.

When speaking with a prospective investor, I like to know if they are comfortable investing alongside 10, 20, 50, or more other investors or if they would like to be the only LP. If it is the former, great. If it is the latter or if they are investing a substantial portion of the equity, I will ask them if they are willing to commit non-refundable equity (we will do the same) to create an alignment of interest to close. Our reasoning is simple – if they are investing all or most of the capital and back out last minute, we have to scramble to find other investors on very short notice.

 

7. What is the amount you are looking to invest should we both find this to be a good fit to move forward?

I also like to get an estimate on the amount of capital they are able and willing to invest. First, we have a minimum investment amount for all of our deals, so I need to confirm that they will exceed that threshold.

Second, if someone invests more than 20% of the equity required to close, the lender will perform additional due diligence on that person, which includes looking at bank statements and tax returns.

Third, see question 6.

And lastly, and this is more important for investors who are just starting out, the size of deals you look at is dictated by the amount of money you can raise. For example, if you are capable of raising $1 million, your maximum purchase price is around $3 million (generally, you are required to raise 30% to 35% of the total project costs). Additionally, a good rule of thumb is to have verbal commitments equal to 150% of the project costs, because not every single one of your investors is going to invest in every single deal. If you need to raise $1 million, you want verbal commitments of at least $1.5 million. By understanding the maximum amount of money someone is able and willing to invest will allow you to calculate your maximum purchase price.

 

8. What is your timeframe for investing that equity?

Assuming this high net-worth individual is a good fit, I want to know when they are able to invest their equity. Some people are ready to invest right away. Others may need to liquidate other investments before investing. The individual’s answer to this question isn’t a disqualifier, but if they account for 50% of your verbal commitments and cannot invest in a deal for 12 months, then that will affect your maximum purchase price for those 12 months.

 

9. (If out of the country) Have you invested in the US real estate market before?

If you are speaking with an international investor, the first thing you need to determine is if your offering type (i.e., 506(b), 506(c), etc.) allows you to accept international money.

If you are able to accept international money, you want to know if this international individual has invested in the US real estate market before. There are extra steps required on the part of the international investor to place capital in US real estate. If they haven’t completed those steps, their capital might be delayed to the point where they cannot invest in one of your deals. If they committed a substantial portion of the equity, that is a huge issue.

 

10. Should we both think this is a good fit, who is/are the decision maker/s when deciding to invest or not invest?

The answer to this question also isn’t a disqualifier. It just lets me know how to approach this individual. If they are the sole decision-maker, great. But if I know that they have a partner, significant other, or someone else that needs to sign-off on the investment, I want to also speak with that person as well.

They may have different passive investing expectations or concerns than the person I’m speaking with that I would like to know and address upfront, rather than in the middle of the capital raise.

 

11. Is there anything else we should know about you?

This final question is to obtain information about the potential investor that wasn’t provided in the answer to one of the previous ten questions on this list.

 

The entire purpose of asking these questions is to gauge the seriousness of the investor. Whenever you send out a new offering to your list of investors or present the deal on a conference call, expect to receive a lot of questions from investors. When you understand each investors’ specific situation, you will have a clear picture on who will and who won’t ultimately invest, which can save you a lot of time and headaches while raising capital for a specific deal.

 

Are you an accredited investor who is interested in learning more about passively investing in apartment communities? Click here for the only comprehensive resource for passive apartment investors.

 

Multi-colored, multi-unit apartment buildings side-by-side

Types of Real Estate Investments You Can Take to Accredited Investors

When it comes to making money in real estate, you generally need to have a healthy amount of capital upfront to make a lot. But who says you have to use your own capital?

 

The reality is that accredited investors are out there, and, if you know how to work with them, you can easily operate in the major league of real estate investing.

 

An accredited investor is any high-net-worth party—either an individual or an institution—that can access higher-risk and complex investments. For instance, an individual must have a net worth of over a million dollars to be considered an accredited investor, in addition to earning at least $200,000 during the past couple of years (or $300,000 with a spouse).

 

The question is, though, what types of real estate investment opportunities attract these types of investors?

What Real Estate Investors Look For

For many accredited investors, the prospect of investing in properties is an exciting one. However, they may feel insecure about owning their own properties. Fortunately for them, it is relatively easy today for accredited investors to own partial stakes in jointly funded commercial deals or even invest in funds that focus on these types of deals.

 

A wide variety of deals are available to accredited investors. For example, they can own parts of the mortgages of shopping malls if they’re interested in lower-risk opportunities. Of course, the lower the risk, the lower the return.

 

Meanwhile, they can also invest in local fix-and-flip professionals who are selling equity in upcoming projects. This strategy comes with high risk but also a higher return.

 

The reality is that a mix of property types, risk profiles, and expected returns exist in real estate investing for accredited investors. Here’s a look at a few types of real estate investment projects you can present to these investors so that everyone involved, including yourself, can build wealth and diversify their portfolios.

Intro:

If you want to attract new accredited investors to your deals, consider the following types of real estate investment deals.

Body:

  • Multi-family Property: offers the greatest amount of stability
  • Industrial Property: staple of your average investor in real estate
  • Retail Property: offers more stable returns than office property
  • Office Property: offers variable returns, but strong ones in a good economy

 

By the Numbers:

Requirements to be an Accredited Investor:

  • $1 million net worth
  • Individual earnings of $200,000 within the past two years
  • Combined earnings with a spouse of $300,000 within the past two years

 

Multi-family and Apartment Properties

These types of real estate investment projects have historically featured the most stability of all classes of nonresidential real estate. Why? Because the renter culture is as strong today as it’s ever been. After all, no matter how the economy is doing, people will always need places to live. This makes apartment and multi-family investing a smart engine for creating wealth over the next two to three decades.

 

In a normal market, residential occupancy usually remains reasonably high. And even if you lose a tenant, this won’t affect your bottom line much. The opposite is true if you invest in single-family residences (SFRs) with the intention of renting them out.

 

In addition, for most types of commercial property, a tenant lease is either partially net or net. In other words, you can pass most of your operating expenses along to your tenants. This is not true with a residential property, as the property owner must bear building operating cost increases during a current lease.

Industrial Properties

If you’re wondering what real estate investors look for, note that industrial properties also offer good passive real estate investment opportunities. These deals often require smaller investments on average and also aren’t as management intensive. In addition, their operating costs are lower when compared to retail and office properties (more on these properties later).

 

A variety of industrial properties are available for accredited investors, depending on how these buildings will be used. For instance, buildings can be utilized for distribution, research/development, manufacturing, and warehousing.

 

However, a number of factors are important to consider when dealing with an industrial property. For instance, is it functional (is the ceiling high enough) and is it close to key transportation routes? Also, what’s the building configuration like? Consider these items carefully before taking these types of real estate investments to an investor.

Retail Properties

Retail properties are also a viable option today, despite recent news reports about the death of retail. The truth is, physical retail is not dead—it’s simply changing.

 

A number of retail property options exist, including single buildings or large shopping malls that are enclosed. However, right now, the power center retail format is in demand. With this format, retailers occupy bigger premises than they would with the enclosed shopping mall format. As a result, they have a lot more visibility as well as access from nearby roadways.

 

Several factors drive retail space demand, including the following:

  • Income levels
  • Population growth
  • Population density
  • Visibility
  • Location

 

The great thing about retail is that returns from these deals are more stable when compared with those of office properties, for example. This is partly because a retail lease is usually longer. In addition, a retailer is typically less motivated to relocate when compared with office tenants.

 

Still, office properties do offer some advantages to accredited investors.

Office Properties

Offices are flagship investments for many owners of real estate. Why? Because they are often the highest-profile and largest types of properties. These properties are usually located in office parks located in sprawling suburban areas, or you can find them in downtown areas.

 

Returns from these types of real estate investment can admittedly be quite variable, as the market is sensitive to how the economy is performing. In addition, these properties’ operating costs can be on the high side. However, office properties may attract accredited investors because, when times are prosperous, these properties are usually high performing. The reason for this is that rental rates can quickly increase during these periods, and it takes a while to build new office towers to offer relief from these rate increases.

Start Working with Accredited Investors

Now couldn’t be a better time to start investing in real estate with the help of accredited investors. With these types of investors and the many types of real estate investment projects available today, you can be well on your way to boosting your bottom line based on your desired risk level and financial goals.

 

Get in touch with me, Joe Fairless, to find out more about what real estate investors look for and how to start building your real estate empire. In no time, you can be creating wealth at levels you previously only dreamed of.

Interior room with stripped walls and floors

The Pros and Cons of Investing in a Distressed Property

One of your fiscal goals is to get more money flowing into your bank account through your real estate investing business. Specifically, you want to thrive in the world of property flipping.

Not a bad goal.

The question is, should you flip properties that are in fairly good condition, or would a distressed property be a better investment?

 

The reality is that distressed properties offer both pros and cons that you should consider before getting started with distressed real estate investing. Here’s a rundown on a few of these advantages and disadvantages.

Pros and Cons of Investing in a Distressed Property Infographic

Pro: Low Pricing

One of the biggest benefits of purchasing a distressed property is the low pricing often associated with it. That’s because homeowners who are about to experience foreclosure are generally eager to unload their properties, and the same is true for the lenders and banks that already possess foreclosed homes.

 

When you are working with highly motivated sellers, you’ll likely end up with bargain prices—or prices under market value. You can capitalize on this to renovate your new property with the goal of increasing its value, then unload the property for a nice profit. With home prices moving in an upward direction in the current market, your distressed real estate’s value has a good chance of increasing—or appreciating—in the months and years ahead.

Pro: High Profit Potential

Although you can certainly sell a distressed property to make a profit, this is not the only way you can generate profits with these types of properties. You can also turn these properties into income-generating rental properties.

 

The return on your investment, or your ROI, can be high if you choose distressed properties that are in good neighborhoods with high rental demand. So, even though such a property may be a negative cash flow deal, you can make it a positive cash flow when leasing it out.

Pro: Better Financing Opportunities

As mentioned earlier, lenders and banks are very interested in selling their properties. For this reason, they’re often open to giving real estate investors better financing if they’re interested in buying their distressed properties.

 

What does this mean for you? It means you may end up having lower closing costs, interest rates, and home mortgage payments.

Of course, distressed real estate investing has its share of cons, too, like anything else. Let’s take a look at a few major ones.

Con: The Paperwork and the Competition

When you’re purchasing a distressed property, this may take longer compared with the purchase of a conventional home. Why? Because lenders own many of the properties that are distressed, and their plates are so full that they usually can’t give your properties of interest their undivided attention. Alternatively, they could be searching for better deals, or their properties have second mortgages attached with different lenders.

 

Also, because distressed investment properties happen to be cheaper, more investors/homebuyers will compete with you to claim ownership of these properties. So, even if a bank is willing to sell you a property that is distressed, it may reject your offer because of the fierce competition in the marketplace. (Of course, if you’ve got an excellent team of people who can help you to find these properties before others do, you can overcome this obstacle.)

In light of all of the above, patience is a necessity if you want to close on a high-potential distressed property.

Con: A Potentially Lackluster Location

Another important consideration when dealing with distressed properties is their locations. Unfortunately, the majority of distressed homes are not in high-income neighborhoods, which can have an adverse impact on your homes’ values.

 

The ideal situation is for you to find an investment property in a decent neighborhood with a high demand for rentals. You also want a neighborhood where the occupancy rates are good, and where the potential property appreciation is good. Rehabbing your property won’t matter much if it’s in a subpar part of town. Your property’s location will ultimately dictate how much you’ll be able to charge a future renter or buyer.

Con: The Maintenance Requirements

In some cases, distressed homes are in okay condition. However, in other cases, foreclosed properties are abandoned by their previous owners or are not maintained. For instance, some might require extensive plumbing or electrical repair. Meanwhile, others may have foundation issues or damaged walls.

 

These properties can be costly to fix up to make them livable, and they can also be time consuming to renovate. So, factor this in before purchasing them.

Consider Purchasing a Distressed Property and Making Money from It Today!

If you’re excited by the idea of making distressed properties look brand new, then investing in such properties may be a smart move for you this year. The potential for profits is high; you just need to know what you are getting into before you move forward with any deal. You also need a little patience when you discover an excellent piece of property. After all, like any other aspect of the real estate business, investing in distressed properties is not a get-rich-quick scheme.

 

If you know how to play the distressed real estate investing game—and if you have the necessary resources, energy, time, planning, and hard work ethic—you’ll end up with good properties that will make good investments for you long term. To learn more about fix-and-flip real estate strategies, check out other articles in my blog!

Bookshelves lined with books

Everything You Need to Know About Rule 506 of Regulation D for Apartment Syndications

Regulation D (also referred to as Reg D) includes two important exceptions to the general requirement securities registration with the SEC set forth in the Securities Act of 1933. Through Reg D, you can raise capital from investors without having to register the securities (i.e., the securities you are selling to your investors to fund your deal) with the SEC.

The volume of transactions completed through Reg D far outpace those of the other two common money-raising options: Reg A and IPOs. The Reg D transaction volume in 2017 across 40,000 offerings was $1.7 trillion, compared to $250 million for Reg A.

Reg D states that the issuer (i.e., the person selling securities) is exempt from registering with the SEC if the following requirements are met:

  • Must file a notice to the SEC on Form D within 15 days of the date of the first sale of a Reg D security on the SEC’s Edgar System (online database that allows for electronic filing) – Form D asks for basic information about the offering and the issuer
  • Must file a notice with the state in which the security is sold within 15 days of the first sale – the majority of states have an online databased to allow for electronic filing through the North American Securities Administrators Association (NASAA).

Work with your securities attorney to make sure you are filing these notices on time and accurately.

The two distinct Reg D registration exceptions are 506(b) and 506(c).

 

What is 506(b)?

If you sell securities under the 506(b) exception, here are the general guidelines:

  • General solicitation or advertising of the securities is prohibited
  • Allowed to sell to an unlimited number of accredited investors (current accredited investor requirements are a $200,000 annual income individually ($300,000 jointly) or a $1 million net worth (individually or jointly) and up to 35 non-accredited (but “sophisticated”) investors
  • Must provide the non-accredited investors with disclosure documents, including an audit of the fund’s balance sheet
  • Issuer may rely on investor self-certification
  • Issuer must have a substantive, pre-existing relationship with investors

The SEC defines a pre-existing relationship as “one that the issuer has formed with an offeree prior to the commencement of the securities offering…”. In other words, it is a relationship that began prior to them investing in your deal.

The relationship must also be substantive, which the SEC defines as “a relationship in which the issuer (or person acting on its behalf) has sufficient information to evaluate, and does, in fact evaluate, a prospective offerees financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor…self-certification alone without any knowledge of a person’s financials circumstances or sophistication is not sufficient to form a substantive relationship.”

The SEC has made it clear that the establishment of a substantive, pre-existing relationship results from actual effort on the part of the issuer in getting to know the individual investor, and their current financial situation and wherewithal, rather than just checking a self-certification box, subscribing to your email list, or waiting a set amount of time.

When in doubt about whether your relationship with an individual investor will qualify as a substantive, pre-existing relationship in the eyes of the SEC, speak with your securities attorney.

 

What is 506(c)?

In 2013, the second exception of Reg D was introduced – 506(c).

If you sell securities under the 506(c) exception, here are the general guidelines:

  • Issuer may openly market their offering (i.e., advertising and general solicitation) but may only sell to accredited investors
  • Investors must be accredited – current accredited investor requirements are a $200,000 annual income individually ($300,000 jointly) or a $1 million net worth (individually or jointly)
  • Issuer must verify that the investors are accredited

For 506(c) offerings, you must take reasonable steps to verify the accredited investors status. To do so, you can have your CPA, attorney, or a registered broker-dealer review the investors financials, such as W-2s, tax returns, brokerage statements, credit reports, and the like. Self-certification is not permissible.

The major differences between the 506(b) and 506(c) are:

  • Solicitation is prohibited for 506(b) but permitted for 506(c)
  • Non-accredited investors may invest in 506(b) but not 506(c)
  • Self-certification of investor status is permitted for 506(b) but not 506(c)
  • You must have a substantive, pre-existing relationship for 506(b) but not 506(c)

So, if you are interested in raising capital from non-accredited investors with whom you have a pre-existing relationship, 506(b) may be your best option. If you are interested in mass marketing your deals online to accredited investors you do not know, 506(c) may be your best option.

 

Other Capital Raising Option

One of the other capital raising options you may identify is Regulation A (also referred to as Reg A). Reg A allows qualifying companies to raise capital from the public without taking on the exorbitant costs and legal requirements needed for filing a traditional IPO.

At its inception in the Securities Act of 1933, the Reg A requirements set forth were:

  • Securities sold in a year must be valued at $5 million or less
  • The issuer must file an offering statement with the SEC
  • An offering memorandum must be prepared for the potential security purchases
  • The issuer must register the offering in any state in which they plan to sell securities

For comparison purposes, there were over 100 Reg A filings in 2017 totaling more than $250 million. So a much smaller volume compared to Reg D.

In 2015, there was an update to the JOBS Act which broke the Reg A filings into two tiers. For tier I Reg A, the annual limit is $20 million. For tier II Reg A, the annual limit is $50 million. To find more information about Reg A offerings, click here.

 

More Resources on Money-Raising with Reg D

For more information on Regulation D, listen to my following podcast episode:

Contributor: Roland Wiederaenders, Wiederaenders Law Firm, roland@rpwlegal.com

Are you an accredited investor who is interested in learning more about passively investing in apartment communities? Click here for the only comprehensive resource for passive apartment investors.

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Key Improvements You Should Make to Increase the Value of Your Single-Family Property

You take pride in being the owner of an investment property, but are you getting the most bang for your buck—or, the greatest return on your investment?

 

The reality is that sprucing up your single-family property can quickly add value to it. That’s exactly why recent research shows that nearly 60% of people queried said they would probably or definitely undergo home renovations or improvement projects within the next 12 months.

 

Of course, as you explore how to increase property value, you may be asking yourself, “What improvement projects will yield the best results for me?” Here’s a rundown on key improvements you should make to increase property value.

Improve Your Curb Appeal

This is one of the smartest moves you can make relatively quickly. That’s because the outside is a potential buyer’s first impression of the home. Unfortunately, it’s one of the areas that many investors neglect as they focus on changes to the interior.

 

What Exterior Projects Can You Complete to Increase Value?

 

Perhaps your single-family home could use an extra coat of paint, or maybe you need to replace that dilapidated fence. In addition, your driveway might be due for power washing, and you may need to groom some shrubs and trees or plant some flowers.

 

It’s also a wise idea to make sure that your patio space or deck is functional if you’d like to increase property value. Adding extra lighting or even a small table and setting are easy ways of accomplishing this. Getting rid of overgrown weeds from your yard, painting and weather-stripping your front door, and ensuring that your storage outside is usable and clean are also great steps that may help you to improve the value.

Upgrade Your Countertops

When it comes to your single-family home’s interior, your kitchen should be one of your first priorities if you’re wondering how to increase property value. According to research, a minor kitchen remodel (of no more than $15,000) may recoup nearly 93% of its cost at resale!

 

Kitchen Projects to Focus On

 

First, upgrading your countertops can quickly make your kitchen more valuable, thus making it easier for you to sell your single-family home or demand a higher rent amount. Quartz and cement are especially popular in higher-end housing markets, but granite is also a great option. The most important thing is that your new countertop is stylish, functional, and durable.

 

You could also add some fresh paint or stain to your cabinets to make them stand out and look brand new. However, if your old cabinets are made of particle board, you might want to upgrade them to something more functional and modern if you want to really increase property value.

Improve Your Fixtures

You can’t go wrong investing in better light fixtures and faucets for the kitchen and bathroom, as well as adding ceiling fans. You may also want to add new locks, door handles, or even window blinds, with faux wood blinds being especially popular for adding a lavish touch to any space.

 

Upgrading your fixtures will make your single-family home appear more polished. It’ll also increase the durability of the items in your home that experience a lot of wear and tear over time. If your upgrade is professionally done, you can sell your property or fill it with renters more quickly, thus maximizing your real estate investment income.

Upgrade Your Appliances

If you are planning to rent out or sell your home after you increase the property value, be sure to upgrade your appliances as well. This is critical because appliances are some of the first items that renters and home buyers look at when entering potential new homes.

 

If your kitchen features mismatched appliances, or if your appliances aren’t functioning at their optimal level, you likely won’t get top dollar for your property when you sell it. This is why you should purchase an appliance package with matching appliances and make sure that it comes with a warranty.

Improve Your Flooring

Finally, don’t overlook your flooring when trying to figure out how to increase property value. A general rule of thumb is that you should install wood flooring versus carpet, as it can add a more sophisticated touch to your single-family property. Plus, if you’re renting, you may have to change out your carpet every other tenant, as a single juice or bleach stain can permanently ruin it. Constantly replacing your carpet can get expensive and, thus, negatively impact your rate of return each year.

 

More on Wood Flooring

 

Wood flooring is a broad category that includes not only hardwood but also laminate, plank/faux wood, bamboo, and laminate. A major benefit of this type of flooring, besides its appearance, is that it is better health wise for those who suffer from carpet allergies.

 

Still, some renters and home buyers prefer to have carpet in the children’s bedrooms, or during the winter months. Thus, it may behoove you to install carpet in all bedrooms and then use flooring throughout the rest of the single-family property’s living spaces. Also, if you have linoleum or vinyl in your kitchen or bathroom, you may want to replace this lower-quality flooring with classier travertine or ceramic tile, which renters and buyers generally prefer.

Start Making More on Your Investments

If you would like to increase the return on your investment in a single-family property, completing the above projects is a great start. Apply these tips to your fix-and-flip and wholesale deals!

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Top 9 Cities with the Largest Increase in Renter-Occupied Units

In a recent blog post, I outlined the three economic metrics that will encourage you about the impact a potential market correction will have on the multifamily industry (which you can read here).

 

Essentially, the economy has been extremely strong since the last market correction in 2007-2009 while, at the same time, the overall number of renters and the overall share of renter-occupied units has also increased.

 

In 9 cities, the percentage of renter-occupied units has increased by 30% or more. And in one of those 9 cities, the increase was more than 50%.

 

Those 9 cities are:

 

9 – Glendale, AZ

AZ Sedans

  • 2006 % renter-occupied: 34.6%
  • 2016 % renter occupied: 44.9%
  • 10-year % change: +30.0%

 

8 – Mesa, AZ

desert scenery

Hotpads

  • 2006 % renter-occupied: 31.6%
  • 2016 % renter occupied: 41.2%
  • 10-year % change: +30.1%

 

7 – Virginia Beach, VA

Virginia Beach real estate

Unpakt

  • 2006 % renter-occupied: 28.6%
  • 2016 % renter occupied: 37.4%
  • 10-year % change: +30.9%

 

6 – Fremont, CA

Elegant cityscape

City of Fremont

  • 2006 % renter-occupied: 32.1%
  • 2016 % renter occupied: 42.1%
  • 10-year % change: +31.0%

 

5 – Toledo, OH

International Cash Systems

  • 2006 % renter-occupied: 38.3%
  • 2016 % renter occupied: 50.3%
  • 10-year % change: +31.3%

 

4 – North Las Vegas, NV

North Las Vegas sign

Review Journal

  • 2006 % renter-occupied: 33.4%
  • 2016 % renter occupied: 46.2%
  • 10-year % change: +38.5%

 

3 – St. Petersburg, FL

beach apartments

St. Pete Rising

  • 2006 % renter-occupied: 28.6%
  • 2016 % renter occupied: 39.8%
  • 10-year % change: +39.4%

 

2 – Plano, TX

Plano Texas apartment real estate

Cross Country Moving Companies

  • 2006 % renter-occupied: 24.2%
  • 2016 % renter occupied: 33.8%
  • 10-year % change: +40.0%

 

1 – Gilbert, AZ

Street Scout

  • 2006 % renter-occupied: 19.9%
  • 2016 % renter occupied: 30.6%
  • 10-year % change: +53.4%

 

Source: US Census

 

 

 

wholesale real estate in the city

Why I Am Confident Multifamily Will Thrive During and After the Next Economic Correction

In March of 2008, the Dow Jones was at 12,216.40. One year later, the Dow Jones plummeted to 6,626.94. Nine years later, the Dow Jones has skyrocketed – nearly tripling to over 24,000. During that same period, unemployment decreased from nearly 10% to 4% and GDP increased from $15 trillion to $19.39 trillion.

All-in-all, the economy has seen a strong bounce back since the 2008/2009 recession.

With such a strong performance over the past decade, there are fears in the air about a looming correction. And everyone who was investing in 2008/2009 knows firsthand the effects a correction/downturn has on real estate.

The economy is a complex animal that is nearly impossible to predict. However, by studying the impacts of economic corrections on real estate in the past, you can have an idea of how real estate will be impacted by any correction in the future– big or small, in the next few months or the next few years.

One major fact that will encourage you about the impact a potential economic correction will have on the multifamily industry is that renting has increased as the economy has gotten better.

Say what? There are more renters even when the economy has gotten stronger?!

Yep.

One of the most telling statistics is the increase in the number of renters during the past decade. Between 2006 and 2016, the US population grew by 23.7 million. During that time, the number of renters increased by over 23 million and the number of home owners increased by less than 700,000. In relative terms, the overall renter population grew by more than 25% in a decade. In fact, according to Pew Research Center, more U.S. households are renting than at any point in the last 50 years!

Sure, a large portion of this growth occurred immediately following the economic recession (an increase of 1.4%, 3.1% and 4.4% in 2007, 2008, and 2009), which is expected. The economy tanks and people cannot afford nor qualify for a mortgage, so they are forced to rent.

But what is surprising is that the increase in renters didn’t stop. In fact, while the Dow Jones tripled, unemployment was cut in half, and the GDP rose by nearly $5 trillion, the renter population increased nearly every single year (3.4%, 3.3%, 3.1%, 2.0%, 2.0%, 0.9% in 2010 to 2015).

And a lot of this growth has been concentrated in big cities across the US (population greater than 200,000).

That said, the number of overall owners in the US still exceeds the number of renters (63.8% owners to 36.2% renters). However, the gap is closing. Because the number of big cities where more than 50% of the population choses to rent increased from 20% to nearly 50% during that same period. In other words, more and more people are choosing to rent over buying in big cities.

Additionally, renter growth outpaced homeownership in 97 of the 100 largest cities in nearly every year between 2006 and 2016. That means that the number of owners grew at a faster pace than the number of renters in only 3 major cities across the county.

Even more staggering, during a robust economy in 2015 and 2016, rent growth outpaced homeownership in 46 of these major cities!

Okay, more people are renting now, but they plan on buying a home eventually, right?

Well, in a 2017 survey conducted by Freddie Mac, renters were asked a series of questions, including when they expected to move and whether they expected to rent or buy when they move.

Because of the turnaround we saw in the economy, you might think people would move out of their rental and into their own home. But, only 14% of renters expected to move within a year while 37% said they didn’t know and another 9% said they expected to never move. But what was even more shocking was this – only 41% expected to buy, which is the lowest it has ever been.

Another interesting fact is that 55% said they either strongly agree/somewhat agree with the statement “I like where I live and don’t plan to move despite the changes in my rent.” And only 31% said they would move into a different rental property if their rent increased in the next year.

 

Now the question is why did more people decide to rent while the economy was booming?

Well, there are many reasons, including:

All of these reasons will be with us for the immediate future.

The fact that the number of renters increased by over 25% in the decade following the recession, even while the economy dramatically improved, gives me confidence in the prediction that when the next correction occurs, the same percentage of people or more will rent. And when the economy begins to improve again, the same percentage of people or more will rent. Which means that the multifamily investment strategy will continue to thrive now and in the foreseeable future, regardless of which correction takes place.

That said, you want to always make sure you are adhering to my Three Immutable Laws of Real Estate Investing to maximize your real estate portfolio during any part of the market cycle.

 

Take the first steps towards passive investing.

Are you an accredited investor who is interested in passively investing in an apartment community?

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5 Proven Ways to Attract Passive Apartment Investors

I was recently a speaker at Dan Handford’s virtual multifamily summit. The topic of my talk was how to attract passive apartment investors. More specifically, I provided 5 proven ways to attract passive investors based on my experience raising capital for over $470,000,000 worth of apartment communities, interviewing over 1,000 passive investors, and writing the best-selling book on apartment syndications – Best Ever Apartment Syndication Book.

The main thing I’ve discovered through my money raising experience is that passive investors don’t chose to invest with apartment syndicators who offer the best returns, who invest in the most favorable market, or who implement the greatest investment strategy. These are all reasons why someone choses to invest, but not the primary reason. Primarily, passive investors will invest only with someone they trust – both personally and as a business person.

And it must be both. I trust Jim Halpert from The Office as a person, but I would never invest in Jim’s apartment syndication because I don’t trust him as business/real estate person.

The best way to gain a passive investor’s trust is through time (to gain their trust personally) and expertise (to gain their trust as a business person). So, a more apt title to this blog post is “5 proven ways to build trust with passive apartment investors,” and here are those 5 ways:

 

1 – Thought Leadership Platform

A thought leadership platform is an interview-based blog, YouTube channel, or podcast on which you publish valuable content for free on a consistent basis.

You gain both types of trust with a thought leadership platform.

With a thought leadership platform, you are reaching hundreds of potential investors every day. This provides you with a head start in gaining people’s personal trust, because when you eventually hop on an introductory call with them, they’ve already heard you speak for hours. At the same time, since you’re interviewing other real estate experts and offering your own expertise on the apartment syndication process, you’ll become recognized as an apartment expert, which covers the “business person” type of trust.

My overall thought leadership platform and online presence (via podcast, YouTube newsletters, Facebook, and Forbes) has attracted a large portion of my passive investors.

 

2 – BiggerPockets

There are 1.2M members on BiggerPockets and only 6,702 (~ 0.5%) have received the “addict” award. To receive the addict award, you must visit the BiggerPockets website every single day for a month.

When I was first launching my apartment syndication business, I made it a habit to visit and engage on BiggerPockets every day, which is why I am one of the 0.5% who’ve received the “addict” award. And these efforts have paid off greatly, because another large portion of my passive investors have come from BiggerPockets.

To get the most out of BiggerPockets, you need to be engaged in the forums and member blogs and add value on a consistent basis. Set up apartment syndication and passive/accredited investor keyword alerts so you are immediately notified when those keywords were used in the forums.

Answer questions in the forums. Reply to direct messages quickly. Provide referrals to other investors in your market. Republish thought leadership platform content to the forums and member blogs.

In doing so, just like the thought leadership platform, you will build a personal connection with people you haven’t met in person, as well as become recognized as an apartment syndication expert, especially if you make it on the Top Contributors list on the multifamily or private lending forum.

 

3 – Create a Local Meetup

Creating a local meetup group in your market is very similar to a thought leadership platform. The major difference is that the meetup group is an in-person event. You will form personal connections with the followers of your thought leadership platform, but you can form deeper personal connections faster at an in-person meetup.

By being the host of the meetup, you will instantly gain the trust and respect of the attendees, and even more so after you host the meetup month-after-month and it continues to add value to their investing businesses.

Start small with a monthly meetup group in your target market. Then, slowly scale over time. Capture content provided at the meetup (via speakers or conversations you’ve had/overheard) and share it on social media, ideally on a Facebook community you’ve made for the group. On that same Facebook community, have attendees post their monthly goals. Also, use that community to create Facebook ads that target passive investors within a certain radius of the event.

Once you’ve successfully scaled your meetup group, the next step is to create a yearly, in-person conference, where you’ll gain even more respect and trust from potential passive investors – both those who attend and those who simply hear about how great your conference was.

 

4 – Transparent and Quick Communication

Who do you trust more? A colleague who is constantly shows up to work late, takes 2 to 3 days to reply to emails and texts, never answers their phone, and brings up problems without solutions? Or a colleague who shows up 15 minutes early, replies to emails within a few hours, always answers the phone, and is a problem identifier and problem solver?

It should be a no brainer. We trust people who are punctual, transparent, and quick communicators. And that also holds true for apartment syndications.

One of the voicemails I have saved on my phone is from a passive investor who was thanking me for my communication skills. He appreciated our monthly recap emails and the fact that we sent accurate distributions and accurate K-1s on-time. And I’ve received countless more phone calls, emails, and texts from investors saying the same thing, so what we are doing is clearly appreciated. Here is a list of what we do to ensure that we are effectively communicating with our investors:

  • Send detailed, transparent monthly recap emails with images for all deals
  • Send profit and loss statements and rent rolls on a quarterly basis
  • Provide information on new business and economic developments in the surrounding market
  • Send accurate monthly distributions on-time
  • Reply to emails, texts, and voicemails within 24 hours at most
  • Provide investors with cell phone number
  • Record new investment offering calls to send to investors who couldn’t attend
  • Send accurate K-1 tax statements on-time

 

5 – Volunteering

Volunteer at a nonprofit organization that aligns with your values, interests, and beliefs. The primary reason is to give back. But while you are giving back, a secondary objective is to get on the board.

A board member at a nonprofit organization is likely affluent with a high net-worth and has a circle of influence consisting of other high net-worth individuals. So, find a nonprofit organization, volunteer for a few months, and work your way onto the board. Once there, focus on building genuine personal relationships with your fellow board members outside of volunteering (which covers the personal trust). Then, organically bring up passive investment opportunities and see where the conversations lead.

Let me reiterate: the primary objective is to give back. Do not show up to your first day of volunteering and ask others to invest in your deals. Focus on giving back. Try to get on the board with the intentions of giving back even more. When you are volunteering, focus only on volunteering. But once you start to build relationships with other board members outside of volunteering, you can begin to organically bring up things that interest you, with apartment investing being one of them.

 

There are many ways to attract passive investors and this list is by no means exhaustive. However, I have used every strategy on this list to raise capital for my deals (hence the “proven” in the title). I recommend picking one of the strategies that interest you the most and focusing on scaling it for at least 6 months. Once it is rockin and rollin, pick a second strategy and repeat until you’ve built yourself a passive investor lead generating machine.

Top 4 Real Estate Market Trends & Red Flags to Look For, Before Investing

You no longer have to sip your cup of joe on your way to your 9-to-5. Instead, you’re sipping coffee as you browse the Internet from home, looking for the next piece of real estate to flip for a profit. All of a sudden, you shake your head and snap back to reality. You were daydreaming. But who says your dream of becoming your own boss as a real estate investor can’t become your reality?

 

Research shows that investment in commercial real estate in particular increased 17% between the fall of 2017 and the fall of 2018, and residential real estate also remains attractive to investors. So, if you’re asking yourself, “What is the best long-term investment?”, now appears to be as good a time as any to seriously explore investing in single-family homes, apartment communities, or even business spaces as your next career move.

 

Of course, just like the greater economy, the real estate market goes through various highs and lows, so it’s critical that you assess the current market before simply diving in. Here’s a rundown on the top four real estate market trends or red flags to look for before investing in a deal.

1. The Demand for Property

If you notice a slip in property demand and/or you see businesses folding in a real estate market, this is a sign that you should not invest your money in the area right away for two reasons.

 

First, if companies are shutting down rapidly, this means that property values overall may start to decline as people move away and seek new job opportunities. Second, if business owners are avoiding the area, this might mean that the demand for properties in that area is low for one reason or another. If you ignore these signs and move ahead with a property purchase there, you may not get much return on your investment when you decide to sell. Or it might take a while for you to unload it.

 

Reasons for Low Interest in an Area

If a certain area is not piquing the interest of buyers, the culprits could be increasing crime rates, new developments close by, subpar school systems, or a less-than-stellar economy. No matter what the situation may be, it’s a good idea to select locales that are established or are rising in popularity if you want to avoid profit loss in the future.

2. The Job Market

In a similar vein, before purchasing real estate in a certain market, you should take a detailed look at your target area’s current job trends. For instance, are hiring volumes climbing and what kinds of positions are available?

 

This is critical because job market trends have a correlation with real estate market trends. For instance, if jobs in an area are not high-paying and don’t offer much growth potential, there will be fewer reliable renters or buyers available to you.

3. The Commercial Sector

A commercial sector that is stagnant in an area is a major red flag for investors. If businesses in a locale haven’t been there very long or if there aren’t many new companies moving in, this area might not be the wisest place to pursue an investment property. Many companies invest in their communities, so areas with lots of industry or other businesses are likely more financially sound.

 

Also, see if any major employers are planning to close their doors or downsize in the near future. If it appears that large employers plan to stay put long-term, this is good news for you. You can find information about which companies are planning to stay or go by reviewing local newspapers or even city council meeting and zoning board meeting minutes.

4. Community Planning

If the community you’re targeting for your investment property has a solid master plan in place, it’s likely a good one to stick with. That’s because master plans essentially lay out communities’ visions for themselves, and visionless communities will likely end up fizzling out at some point.

 

Elements of a Solid Master Plan

 

A strong master plan at the community level should explain not only how the community sees itself but also how it plans to turn its vision for itself into a reality. This plan outlines truly realistic and relevant changes, and it also focuses on actual solutions. Furthermore, it fosters innovation and promotes problem-solving. If there is little evidence that a community’s master plan is being executed, you may want to bypass that community when it comes to looking for a real estate investment property.

Start Real Estate Investing Today!

If you’re asking, “What is the best long-term investment?” and you are interested in getting your feet wet in real estate investing, I can help. In no time, you can experience the unique monetary potential that real estate has to offer. Get in touch with me today to find out more about the current real estate market trends and to start earning money as a real estate entrepreneur.

investment plan written in notebook

What it Means to be an Accredited Passive Investor & the Requirements to Become One

Being an accredited passive investor gives you the ability to make and participate in a wide variety of real estate investments. These may include single-family homes, commercial spaces geared towards businesses, and even apartment syndications.

According to federal securities laws and the Securities and Exchange Commission (SEC), an accredited passive investor is defined as a person or entity that is able to invest in securities, such as apartment deals, and non-registered investments. Both securities and apartment syndications are an extremely lucrative way to build sustainable passive income. Whether you’re looking to build your investment portfolio or simply want an additional stream of income, becoming an accredited investor is the first step to making that a reality. So what are the accredited investor requirements and how can you ensure that you become one?

Your Income and Net Worth

In order to qualify as an accredited investor, you must meet at least one of the following requirements: have an annual income of $200,000 or more ($300,000 if you have a joint income with your spouse) for the last two years or have a net worth that exceeds $1 million, either individually or joint. Basically, this ensures you can manage the risk inherent in investing.

When determining your net worth, be sure to exclude the value of your primary residence. Add the value of all your other assets (investments, bank accounts, vehicles, vacation homes, etc.) and subtract any liabilities (various loans, home equity line balance, etc).

Verifying Your Claims

Once you have met the accredited investor requirements, then you are considered an accredited passive investor. There isn’t a certificate, form to fill out or formal process to recognize you. You’re either accredited or you’re not. However, the SEC may require that individuals or entities selling to accredited investors verify that these requirements are met, depending on the investment offering type.

For apartment syndications, if the deal is a 506(b) offering (which is what we do), you can self-certify your accredited investor status. If the deal is a 506(c) offering, you must submit your financials, including W-2 forms, tax returns, and any additional documentation that further confirms your financial standing, to a 3rd party to verify your accredited investor status prior to investing.

Benefits of Accreditation

There are many benefits to becoming an accredited investor, particularly when it comes to real estate investing and building sustainable wealth through real estate. If you are able to meet the accredited investor requirements, then you will be able to meet with apartment syndicators, venture capitalists, hedge fund managers and more to further discuss your investment opportunities.

As a passive investor, it is possible to eventually live on cash flow brought in by your investments. When buying into an apartment deal, for example, you will get a portion of the rent from the residents, as well as the eventual sale of the property. This means bringing in money for bills and leisure while making time for the activities and people you love.

For more detailed information on becoming an accredited investor and to learn more about investment opportunities for accredited investors, check out my comprehensive Passive Investor Resources guide.

Top of cream-colored house and clear, blue sky

SFRs Vs. Apartment Syndications: Which Is The Better Passive Investment?

We’ve weighed the pros and cons of passive apartment investing versus investing in REITs, but what about another type of real estate — single family residences? To passively invest in single family residences (SFRs) is to purchase an SFR with the purposes of holding it as a rental property from a turnkey provider who handles every aspect of the transaction. To passively invest in apartments is to invest in an apartment syndication — a partnership between a sponsor who handles every aspect of the transaction and the passive investor who funds a portion of the down payment — and share in the profits.

 

Related: What is Apartment Syndication?

 

Since both strategies are passive, they’re equal in regard to control (or lack thereof). However, being two distinctive types of real estate, the benefits and drawbacks of each are different. So, in order to determine which passive investment strategy is better, let’s compare and contrast them based on three categories: time commitment, returns and risk.

 

1. Time Commitment

There is no such thing as a 100% passive investment. There are similar time commitments for both strategies: You must initially qualify the sponsor/turnkey provider, qualify their deals before investing and stay up-to-date on the progress of the deal after close.

There are also differences.

Because it is a one-unit residential property, understanding and evaluating an SFR is not that complicated. You likely have the education to acquire a passive SFR investment. On the other hand, apartments are a more complex asset class. Before becoming a passive investor, you’ll likely need to educate yourself on the apartment syndication process.

It’s easier to scale by passively investing in apartment syndications. After you’ve qualified the sponsor, it’s as simple as they send you a deal, and you decide whether to invest. For each SFR investment, you’ll select from a menu of deals. It can take months until you find one that meets your investment goals, at which point the process repeats itself.

Additionally, since you’re limited to the number of residential loans you can obtain, you’ll eventually have to either purchase SFRs with all cash or with creative financing, both of which take more time than traditional financing. For apartment syndications, you can usually invest any amount — although a minimum investment of $25,000 to $50,000 is common — an unlimited number of times without having to worry about securing or qualify for financing. This reduces your ongoing time commitment and increases your ability to scale.

 

2. Returns

In regard to returns, the two factors to address are cash flow and equity. Cash flow is the profit distributed to the passive investor on an ongoing basis, and equity is the profit captured at sale and/or refinance.

As a passive SFR investor, you have 100% ownership of the property, which means you receive 100% of the profits. Since an SFR has one rentable unit, the returns are more fragile. If you have one vacancy, you’re 100% vacant. If you have one maintenance issue or expensive turn, your cash flow for a few months to a few years can be wiped out.

As a passive apartment investor, you only have partial ownership of the property, which means you receive a smaller percentage of the profits. But, since apartments have hundreds of units, a few vacancies, evictions or maintenance issues have a lower impact on the cash flow. At the same time, you are typically offered a preferred return, which is a threshold return distributed to investors before the sponsor receives payment. A greater number of units combined with a preferred return results in more certainty as it relates to cash flow.

The value of SFRs is dependent not on the rents but on the market, which is out of your control. Sure, in an appreciating market, you could double the property value. But you could also get unlucky with a stagnating or depreciating market.

The value of an apartment is dependent on the revenue, not the market, which is in your — or technically, the sponsors’ — control. The sponsor can increase the rents through renovations and increase the revenue by offering certain amenities (i.e., coin-operated laundry, carports, storage lockers, etc.). Luck is removed and replaced with skill. If the sponsor executes the business plan and increases the revenue, the property value, and thus your investment, is increased.

 

Related: 27 Ways to Add Value to Apartment Communities

 

3. Risk

You have 100% ownership as a passive SFR investor, which means you participate in 100% of the upside and 100% of the downside. You hold all of the risk. Since you sign on the loan, you are responsible for 100% of the debt. Default on a payment, and you are the one who is impacted.

Again, the SFR cash flow is more fragile due to having one rentable unit. However, this risk is reduced once you’ve scaled to a certain number of SFRs. But having a passive portfolio of 100 SFRs is different than passively investing in a 100-unit apartment community. The SFRs are scattered across the market, which means you don’t benefit as much from economies of scale. Management and contractor (i.e., landscapers, maintenance people, etc.) fees are costlier. The benefit, however, is that you have 100% ownership of the 100 SFRs as opposed to partial ownership in the 100-unit apartment community, which means you’ll have a greater long-term upside potential.

Passively investing in apartment syndications is less risky because you aren’t signing on a loan. The risk is also reduced from day one because you are investing in multiple units right away as opposed to having to scale to hundreds of units. And with hundreds of units in one centralized location comes economies of scale, which means lower management and contractor costs.

 

Related: Active vs. Passive: Which is the Superior Investment Strategy?

 

The Winner?

Apartment syndications have a lower time commitment, more certain returns and less risk. SFRs have less scalability, more risk and fragile returns in the medium-term with a greater long-term upside potential.

Ultimately, the best strategy comes down analyzing the pros and cons of each and determining which one aligns the best with your risk tolerance, time commitment and return goals.

 

Want to learn how to build an apartment syndication empire? Purchase the world’s first and only comprehensive book on the exact step-by-step process for completing your first apartment syndication: Best Ever Apartment Syndication Book.

internal rate of return vs. cash on cash return

Internal Rate of Return (IRR) vs. Cash on Cash (CoC) Return: What Is the Difference?

When an apartment syndicator analyzes the results of their underwriting, and when a passive investor is deciding whether to invest in a syndicator’s deal, the two main return factors they focus on are the cash-on-cash return and the internal rate of return.

In this blog post, you will learn the definitions of these two important return factors, how they are calculated, and why they are relevant in apartment syndications.

 

What is Cash-on-Cash Return?

Cash-on-cash return (commonly referred to a CoC return) is a factor that refers to the return on invested capital. CoC return is the relationship between a property’s cash flow and the initial equity investment, which is calculated by dividing the initial equity investment by the cash flow. For the purposes of the CoC return calculation for apartment syndications, cash flow is the profits remaining after paying the operating expenses and debt service.

There are actually two different versions of the CoC return for apartment syndications: including profits from sale and excluding profits from sale. The CoC return factor excluding profits from sale will show passive investors how much money they should to expect to receive for each distribution during the hold period, as well as an average annual return on their investment. The CoC return factor including the profits from sale will show passive investors how much money they should expect to make from the project as a whole.

In order to calculate both CoC return factors, you need the initial equity investment amount, the projected annual cash flows, and the projected profit from sale for both the overall project and to the passive investors.

Here is an example of how to calculate CoC return for an apartment project:

 

 

Passive investors aren’t as concerned about the overall project’s CoC return but more so the CoC return to the limited partners (LP).

Here is an example of how to calculate the CoC returns to the limited partners based on an 8% preferred return and 70/30 profit split:

 

 

In this example, the average annual CoC return to the LP is 8.33%, which is good because it is above the preferred return offered. The overall CoC return for the five years is 185.72%. So, someone who invested $100,000 would make $85,720 in profit.

However, as you can see in the example above, the CoC return to the limited partner is below the preferred return percentage in years one and three. So, for this deal, the syndicators options are to review their underwriting assumptions to see if they can increase the cash flow, have the preferred return accrue and pay the accrued amount at sale or when the cash flow supports it (i.e. end of year two to cover the year one shortfall), or pass on the deal.

A “good” CoC return metric is subjective and based on the goals of the syndicator and the passive investors. However, a good rule of thumb is a minimum average CoC return excluding the profits from sale equal to the preferred return offered to the limited partners.

 

What is Internal Rate of Return?

The main drawback of the cash-on-cash return metric is that it doesn’t account for the time value of money. For example, receiving a 185.72% CoC return over a 5-year period is very different than receiving the same CoC return over a 10-year period or a 1-year period. That is where internal rate of return comes in.

The technical definition of internal rate of return (commonly referred to as IRR) is the interest rate that makes the net present value of all cash flow equal to zero. In layman’s terms, this equates to a project’s actual or forecasted annual rate of growth by isolating the effect of compounding interest if the investment horizon is longer than one-year, which CoC return does not.

If you have the data to calculate the CoC return, you can calculate an IRR for the overall project and to the passive investors. What is needed is the initial equity investment and the annual cash flows, with the final year including the profit from sale.

The IRR formula is complex (click here if you want to see the full formula), so for simplicity, the IRR() function in excel should be used.

Following the same example, here is the 5-year IRR for the overall project and for the limited partners:

 

 

Another IRR metric is XIRR. For the regular IRR calculation, the assumption is that the cash flows are distributed on a fixed, periodic schedule (i.e. annually, monthly, quarterly, daily, etc.). The XIRR function calculates the internal rate of return when cash flows are distributed on an irregular period.

In order to calculate XIRR, the additional data required are the exact days that the cash flow was distributed. Examples of instances where the XIRR would come into play are when the syndicator refinances or secures a supplemental loan to return a portion of the passive investors’ equity and when the syndicator sells the asset since the closing date likely will not be exactly 1, 2, 3, etc. years after purchasing the deal.

A “good” IRR metric is also subjective and based on the goals of the syndicator and their passive investors. For my company’s deals, we want a 5-year IRR to the limited partners of at least 15%.

 

The main difference between the cash-on-cash return and internal rate of return metric is time. If the investment is held for one-year, then the two return metrics are interchangeable. But if the projected hold period is more than a year, internal rate of return is more accurate.

 

Want to learn how to build an apartment syndication empire? Purchase the world’s first and only comprehensive book on the exact step-by-step process for completing your first apartment syndication: Best Ever Apartment Syndication Book.

how passive investors make money

How Do Passive Investors Make Money in Apartment Syndications?

Passive investing is one of the best ways to receive the benefits of owning a large apartment building without the time commitment, funding the entire project or obtaining the expertise require to create and execute a business plan.

A passive investor might not see the same returns as an active investor who is finding, qualifying and closing on an apartment building use their own capital and overseeing the business plan through its successful completion. But compared to other passive investment vehicles, like stocks, bonds or REITs, apartment syndications cannot be beat (assuming the passive investor has found the right general partnership and qualified their team).

The returns offered to the limited partner (i.e. the passive investors) vary from general partner to general partner. Before making the commitment to invest, the limited partners (referred to as the LP hereafter) should understand the general partner’s (referred to as the GP hereafter) partnership structure, which includes the type of investment structure and how the returns are distributed.

Typically, a passive investor is either an equity investor or a debt investor in an apartment syndication. In this blog post, I will outline these two investment structures and the types of return structures for each.

 

Equity Investor

Of the two main types of investment structures, being an equity investor is the most profitable, because they participate in the upside of the deal. However, they typically will not receive their initial equity investment until the sale of the apartment.

The equity investor is offered an ongoing return, as well as a portion of the profits at sale. Generally, after the operating expenses and debt service are paid, the a portion of the remaining cash flow is distributed to the LP. For some partnership structures, the GP will take an asset management fee before distributing returns to the LPs. I do not like this approach since it decreases the alignment of interest because the GP receives payment before the LP. So, my company puts our asset management fee in second position to the LP returns (which means we don’t get an asset management fee until we’ve paid the LP).

The most common ongoing return is called a preferred return. The preferred return ranges from 2% to 12% annually based on the experience of the GP and their team, the risk factors of the project and the investment strategy. The less experience and the more risk, the higher the returns. In regards to the preferred returns associated with the three main apartment syndication investment strategies, the GP will offer the highest percentage for distressed apartments and the lowest percentage for turnkey apartments, with value-add apartments falling somewhere in-between.

For example, on a highly distressed apartment deal, the GP may offer a 12% preferred return. However, since the deal will likely have a lower or no return during the stabilization period, the preferred return would accrue and be paid out to the LP in one lumpsum. For turnkey apartments, the preferred return will fall towards the lower end of the range because, since the apartment is already stabilized and minimal value can be added, there is less risk. For value-add apartments, the typical preferred return that is offered to the LP is 8%.

Conversely, the GP may not offer a preferred return but a profit split instead. For example, 70% of the cash flow is distributed to the LP and the remaining 30% to the LP. However, I do not like this structure for the same reason why I don’t like putting the asset management fee ahead the LP returns – a reduction in alignment of interest. Therefore, the GP will usually offer a preferred return and the remaining cash flow is split between the LP and GP.

This remaining profit split can range from 90/10 (i.e. 90% to the LP, 10% to the GP) to 50/50. A common variation on the profit split will include hurdles, using return factors like the internal rate of return (referred to as IRR hereafter) or cash-on-cash return. For example, the LP is offered an 8% preferred return and the remaining profits are split 70/30. But, once the LP receives a 13% IRR, the profit split drops to 50/50.

Another example is the LP is offered a 6% to 8% preferred and the remaining profit is split 50/50. But, once the LP receives an annualized return of 12% to 16% (which would occur at sale), the GP receives the remaining profits. This is the most ideally structure from the GPs point of view.

The equity investor also participates in the upside of the deal, which means they are offered a portion of the sales proceeds.

The most common equity structure for value-add apartment deals is an 8% preferred return with a 50/50 LP/GP profit split. The next most common equity structure is an 8% preferred return with a 70/30 LP/GP profit split until the LP IRR passes a certain threshold (10% to 20% is the standard range), at which point the remaining profits are split 50/50.

 

Debt Investor

Of the two main types of investment structures, being a debt investor is the least profitable. However, the lower profitability comes with a lower risk. Once the GP pays operating expenses and debt service, the remaining cash flow must go to distributing the fixed interest rate to the debt investor. However, unlike the preferred return offered an equity investor, if the GP is unable to pay the fixed interest rate (assuming they are still able to cover the operating expenses and debt service), the debt investor can take control of the property. Hence, less risk.

Unlike the equity investor, the debt investor doesn’t participate in the upside of the deal. Instead, they are offered a fixed interest rate until the GP is able to return 100% of their investment.

Similar to the preferred return, the interest rate that is offered to a debt investor is based on the GP’s experience, the risk factors associated with the project and investment strategy. However, since there is an overall reduced risk involved with being a debt investor, the interest rate is typically lower than what the preferred return would be for a similar project.

Another difference between equity and debt investors is that debt investors will typically receive their capital back before the apartment is sold, which generally occurs after a refinance or securing a supplemental loan. A supplemental loan is a financing option that is secured on top of the existing financing on the property that is typically available 12-months after closing the initial loan.

 

What’s a Better Passive Investment?

Like any investment, the best partnership structure is based on the passive investor’s goals. For those looking for a low-risk investment vehicle to park their money for a few years while receiving a fixed return that beats inflation, then becoming a debt investor may be more appealing. For those looking for an investment vehicle that offers a higher ongoing return (although not guaranteed) and the potential for a large lumpsum profit at sale, then being an equity investor may be more appealing. And of course, diversifying between the two structures is also an option!

 

Want to learn more about passively investing in apartment syndications? Visit the Best Ever Passive Investor Resources page, the only comprehensive resource available to passive investor.

 

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glossary of apartment terms

Glossary of Apartment Syndication Terms

A glossary of terms and definitions, listed in alphabetical order, used in apartment syndications for aspiring apartment syndicators and passive investors to study in order learn the industry terminology.

 

A

 

Absorption Rate: The rate at which available rentable units are leased in a specific real estate market during a given time period.

Accredited Investor: A person that can invest in apartment syndications by satisfying one of the requirements regarding income or net worth. The current requirements to qualify are an annual income of $200,000, or $300,000 for joint income, for the last two years with the expectation of earning the same or higher, or a net worth exceeding $1 million either individually or jointly with a spouse.

Acquisition Fee: The upfront fee paid by the new buying partnership to the general partner for finding, evaluating, financing and closing the investment.

Active Investing: The finding, qualifying and closing on an apartment building using one’s own capital and overseeing the business plan through its successful execution.

Amortization: The paying off of a mortgage loan over time by making fixed payments of principal and interest.

Apartment Syndication: A temporary professional financial services alliance formed for the purpose of handling a large apartment transaction that would be hard or impossible for the entities involved to handle individually, which allows companies to pool their resources and share risks and returns. In regards to apartments, a syndication is typically a partnership between general partners (i.e. the syndicator) and limited partners (i.e. the passive investors) to acquire, manage and sell an apartment community while sharing in the profits.

Appraisal: A report created by a certified appraiser that specifies the market value of a property. The value is based on cost, sales comparable and income approach.

Appreciation: An increase in the value of an asset over time. The two main types of appreciation that are relevant to apartment syndications are natural appreciation and forced appreciation. Natural appreciation occurs when the market cap rate naturally decreases over time, which isn’t always a given. Forced appreciation occurs when the net operating income is increased by either increasing the revenue or decreasing the expenses. Force appreciation typically occurs by adding value to the apartment through renovations and/or operational improvements.

Asset Management Fee: An ongoing annual fee from the property operations paid to the general partner for property oversight.

 

B

 

Bad Debt: The amount of uncollected money owed by a tenant after move-out.

Breakeven Occupancy: The occupancy rate required to cover all of the expenses of a property.

Bridge Loan: A mortgage loan used until a borrower secures permanent financing. Bridge loans are short-term (six months to three years with the option to purchase an additional six months to two years), generally having higher interest rates and are almost exclusively interest only. Also referred to as interim financing, gap financing or swing loans. The loan is ideal for repositioning an apartment community that doesn’t qualify for permanent financing.

 

C

 

Capital Expenditures (CapEx): The funds used by a company to acquire, upgrade and maintain a property. Also referred to as CapEx. An expense is considered CapEx when it improves the useful life of a property and is capitalized – spreading the cost of the expenditure over the useful life of the asset. CapEx included both interior and exterior renovations.

Capitalization Rate (Cap Rate): The rate of return based on the income that the property is expected to generate. Also referred to as the cap rate. The cap rate is calculated by dividing the net operating income by the current market value of a property.

Cash Flow: The revenue remaining after paying all expenses. Cash flow is calculated by subtracting the operating expense and debt service from the collected revenue.

Cash-on-Cash Return: The rate of return based on the cash flow and the equity investment. Also referred to as CoC return. Coc return is calculated by dividing the cash flow by the initial equity investment.

Closing Costs: The expenses, over and above the purchase price of the property, that buyers and sellers normally incur to complete a real estate transaction. These costs include origination fees, application fees, recording fees, attorney fees, underwriting fees, due diligence fees and credit search fees.

Concessions: The credits given to offset rent, application fees, move-in fees and any other cost incurred by the tenant, which are generally given at move-in to entice tenants into signing a lease.

Cost Approach: A method of calculating a property’s value based on the cost to replace (or rebuild) the property from scratch. Also referred to as the replacement approach.

 

D

 

Debt Service: The annual mortgage amount paid to the lender, which includes principal and interest. Principal is the original sum lent to a borrower and the interest rate is the charge for the privilege of borrowing the principal amount.

Debt Service Coverage Ratio (DSCR): The ratio that is a measure of the cash flow available to pay the debt obligation. Also referred to as the DSCR. The DSCR is calculated by dividing the net operating income by the total debt service. A DSCR of 1.0 means that there is enough net operating income to cover 100% of the debt service. Ideally, the DSCR is 1.25 or higher. A property with a DSCR too close to 1.0 is vulnerable, and a minor decline in revenue or minor increase in expenses would result in the inability to service the debt.

Depreciation: A decrease or loss in value due to wear, age or other cause.

Distressed Property: A non-stabilized apartment community, which means the economic occupancy rate is below 85% and likely much lower due to poor operations, tenant problems, outdated interiors, exteriors or amenities, mismanagement and/or deferred maintenance.

Distributions: The limited partner’s portion of the profits, which are sent on a monthly, quarterly or annual basis, at refinance and/or at sale.

Due Diligence: The process of confirming that a property is as represented by the seller and is not subject to environmental or other problems. For apartment syndications, the general partner will perform due diligence to confirm their underwriting assumptions and business plan.

 

E

 

Earnest Money: A payment by the buyers that is a portion of the purchase price to indicate to the seller their intention and ability to carry out sales contract.

Economic Occupancy Rate: The rate of paying tenants based on the total possible revenue and the actual revenue collected. The economic occupancy is calculated by dividing the actual revenue collected by the gross potential income.

Effective Gross Income (EGI): The true positive cash flow. Also referred to as EGI. EGI is calculated by subtracting the revenue lost due to vacancy, loss-to-lease, concessions, employee units, model units and bad debt from the gross potential income.

Employee Unit: An apartment unit rented to an employee at a discount or for free.

Equity Investment: The upfront costs for purchasing a property. For apartment syndications, these costs include the down payment for the mortgage loan, closing costs, financing fees, operating account funding and the fees paid to the general partnership for putting the deal together. Also referred to as the initial cash outlay or the down payment.

Equity Multiple (EM): The rate of return based on the total net profit and the equity investment. Also referred to as EM The EM is calculated by dividing the sum of the total net profit (cash flow plus sales proceeds) and the equity investment by the equity investment.

Exit Strategy: The general partner’s plan of action for selling the apartment community at the conclusion of the business plan.

 

F

 

Financing Fees: The one-time, upfront fees charged by the lender for providing the debt service. Also referred to as finance charges.

 

G

 

General Partner (GP): An owner of a partnership who has unlimited liability. A general partner is usually a managing partner and is active in the day-to-day operations of the business. In apartment syndications, the general partner is also referred to as the sponsor or syndicator and is responsible for managing the entire apartment project.

Gross Potential Income: The hypothetical amount of revenue if the apartment community was 100% leased year-round at market rental rates plus all other income.

Gross Potential Rent (GPR): The hypothetical amount of revenue if the apartment community was 100% leased year-round at market rental rates. Also referred to as GPR.

Gross Rent Multiplier (GRM): The number of years it would take for a property to pay for itself based on the gross potential rent. Also referred to as the GRM. The GRM is calculated by dividing the purchase price by the annual gross potential rent.

Guaranty Fee: A fee paid to a loan guarantor at closing for signing for and guaranteeing the loan.

 

H

 

Holding Period: The amount of time the general partner plans on owning the apartment from purchase to sale.

 

I

 

Income Approach: A method of calculating an apartment’s value based on the capitalization rate and the net operating income (value = net operating income / capitalization rate).

Interest Rate: The amount charged by a lender to a borrower for the use of their funds.

Interest-Only Payment: The monthly payment for a mortgage loan where the lender only requires the borrower to only pay the interest on the principal.

Internal Rate of Return (IRR): The rate needed to convert the sum of all future uneven cash flow (cash flow, sales proceeds and principal paydown on the mortgage loan) to equal the equity investment. Also referred to as IRR.

 

J

 

K

 

L

 

Lease: A formal legal contract between a landlord and a tenant for occupying an apartment unit for a specified time and at a specified price with specified terms.

Letter of Intent (LOI): A non-binding agreement created by a buyer with their proposed purchase terms. Also referred to as the LOI.

Limited Partner (LP): A partner whose liability is limited to the extent of their share of ownership. Also referred to as the LP. In apartment syndications, the LP is the passive investor who funds a portion of the equity investment.

London Interbank Offered Rate (LIBOR): A benchmark rate that some of the world’s leading banks charge each other for short-term loans. Also referred to as LIBOR. The LIBOR serves as the first step to calculating interest rates on various loans, including commercial loans, throughout the world.

Loan-to-Cost Ratio (LTC): The ratio of the value of the total project costs (loan amount + capital expenditure costs) divided by the apartment’s appraised value.

Loan-to-Value Ratio (LTV): The ratio of the value of the loan amount divided by the apartment’s appraised value.

Loss-to-Lease (LtL): The revenue lost based on the market rent and the actual rent. Also referred to as LtL. The LtL is calculated by dividing the gross potential rent minus the actual rent collected by the gross potential rent.

 

M

 

Market Rent: The rent amount a willing landlord might reasonably expect to receive and a willing tenant might reasonably expect to pay for tenancy, which is based on the rent charged at similar apartment communities in the area. The market rent is typically calculated by conducting a rent comparable analysis.

Metropolitan Statistical Area (MSA): A geographical region containing a substantial population nucleus, together with adjacent communities having a high degree of economic and social integration with that core. Also referred to as the MSA. MSAs are determined by the United States Office of Management and Budget (OMB).

Model Unit: A representative apartment unit used as a sales tool to show prospective tenants how the actual unit will appear once occupied.

Mortgage: A legal contract by which an apartment is pledged as security for repayment of a loan until the debt is repaid in full.

 

N

 

Net Operating Income (NOI): All the revenue from the property minus the operating expenses. Also referred to as the NOI.

 

O

 

Operating Account Funding: A reserves fund, over and above the purchase price of an apartment, to cover things like unexpected dips in occupancy, lump sum insurance or tax payments or higher than expected capital expenditures. The operating account funding is typically created by raising extra capital from the limited partners.

Operating Agreement: A document that outlines the responsibilities and ownership percentages for the general and limited partners in an apartment syndication.

Operating Expenses: The costs of running and maintaining the property and its grounds. For apartment syndications, the operating expense are usually broken into the following categories: payroll, maintenance and repairs, contract services, make ready, advertising/marketing, administrative, utilities, management fees, taxes, insurance and reserves.

 

P

 

Passive Investing: Placing one’s capital into an apartment syndication that is managed in its entirety by a general partner.

Permanent Agency Loan: A long-term mortgage loan secured from Fannie Mae or Freddie Mac. Typical loan terms lengths are 3, 5, 7, 10, 12 or more years amortized over up to 30 years.

Physical Occupancy Rate: The rate of occupied units. The physical occupancy rate is calculated by dividing the total number of occupied units by the total number of units at the property.

Preferred Return: The threshold return that limited partners are offered prior to the general partners receiving payment.

Prepayment Penalty: A clause in a mortgage contract stating that a penalty will be assessed if the mortgage is paid down or paid off within a certain period.

Price Per Unit: The cost per unit of purchasing a property. The price per unit is calculated by dividing the purchase price of the property by the total number of units.

Private Placement Memorandum (PPM): A document that outlines the terms of the investment and the primary risk factors involved with making the investment. Also referred to as the PPM. The PPM typically has four main sections: the introductions (a brief summary of the offering), basic disclosures (general partner information, asset description and risk factors), the legal agreement and the subscription agreement.

Pro-forma: The projected budget with itemized line items for the revenue and expenses for the next 12 months and five years.

Profit and Loss Statement (T-12): A document or spreadsheet containing detailed information about the revenue and expenses of a property over the last 12 months. Also referred to as a trailing 12-month profit and loss statement or a T-12.

Property and Neighborhood Classes: A ranking system of A, B, C or D assigned to a property and a neighborhood based on a variety of factors. For property classes, these factors include date of construction, condition of the property and amenities offered. For neighborhood classes, these factors include demographics, median income and median home values, crime rates and school district rankings.

Property Management Fee: An ongoing monthly fee paid to the property management company for managing the day-to-day operations of the property.

 

Q

 

R

 

Ration Utility Billing System (RUBS): A method of calculating a tenant’s utility usage based on occupancy, unit square footage or a combination of both. Once calculated, the amount is billed back to the tenant.

Recourse: The right of the lender to go after personal assets above and beyond the collateral if the borrower defaults on the loan.

Refinance: The replacing of an existing debt obligation with another debt obligation with different terms.

Refinancing Fee: A fee paid to the general partner for the work required to refinance an apartment.

Rent Comparable Analysis (Rent Comps): The process of analyzing the rental rates of similar properties in the area to determine the market rents of the units at the subject property.

Rent Premium: The increase in rent demanded after performing renovations to the interior and/or exterior of an apartment community.

Rent Roll: A document or spreadsheet containing detailed information on each of the units at the apartment community, including the unit number, unit type, square footage, tenant name, market rent, actual rent, deposit amount, move-in date, lease-start and lease-end date and the tenant balance.

 

S

 

Sales Comparison Approach: A method of calculating an apartment’s value based on similar apartments recently sold.

Sales Proceeds: the profit collected at the sale of the apartment community.

Sophisticated Investor: A person who is deemed to have sufficient investing experience and knowledge to weigh the risks and merits of an investment opportunity.

Subject Property: The apartment the general partner intends on purchasing.

Submarket: A geographic subdivision of a market.

Subscription Agreement: A document that is a promise by the LLC that owns the property to sell a specific number of shares to a limited partner at a specified price, and a promise by the limited partner to pay that price.

 

T

 

U

 

Underwriting: The process of financially evaluating an apartment community to determine the projected returns and an offer price.

 

V

 

Vacancy Loss: The amount of revenue lost due to unoccupied units.

Vacancy Rate: The rate of unoccupied units. The vacancy rate is calculated by dividing the total number of unoccupied units by the total number of units.

Value-Add Property: A stabilized apartment community with an economic occupancy above 85% and has an opportunity to be improved by adding value, which means making improvements to the operations and the physical property through exterior and interior renovations in order to increase the income and/or decrease the expenses.

 

W

 

X

 

Y

 

Yield Maintenance: A penalty paid by the borrower on a loan is the principal is paid off early.

 

Z

 

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apartment investing offer

How the General Partner Submits an Offer on an Apartment Deal

Generally, the general partner (referred to as GP hereafter) in an apartment syndication has certain investment criteria to determine which deals to submit offers on. This criteria could be as sophisticated as requiring a projected internal rate of return and cash-on-cash return above a certain threshold, which is what my company does, or as basic as a cash flow per door.

 

Regardless of their investment criteria, an experienced GP will perform underwriting on tens, if not hundreds, of deals before finding one that qualifies for an offer. And once they do, there is a four-step process for submitting an offer.

 

Understanding this process is obviously important for those striving to syndicate their own apartment deals in the future. But it is important for those passively investing in apartment syndications to understand as well. If they are entrusting the GP with their hard-earned capital, they should know how the offer price and terms are calculated.

 

1. Pre-Offer Conversation

 

Before completing the underwriting process and submitting an offer, the GP will likely need to reach out to the listing real estate broker and their property management company.

 

If questions arise during the course of the underwriting process, the GP will need to get the answers from the listing broker before submitting an offer. For example, there might be a discrepancy between the rent roll and the offering memorandum in regards to the number of units renovated by the current owner. Or the properties used by the listing broker for the rental comparable analysis are too dissimilar to the subject property. Or the GP needs more information on the exterior capital expenditures completed by the current owner over the past few years. The GP should leave no stone unturned before determining an offer price.

 

Similarly, the GP should review the underwriting with the property management company who will manage the deal after acquisition in order to confirm the assumptions there were made.

 

Additionally, the GP should visit the property in-person. Ideally, the GP visits the property with their property management company and, if they plan on performing renovations after acquisition, a general contractor. Together, they should look at the condition of the big ticket exterior items, like the roofs, siding, parking lots, clubhouse, amenities (i.e. pool, fitness center, playground, etc.), landscaping and signage. They should interview the onsite property management company to understand the historical operations of the property. They should tour a handful of units, preferably the “best” and “worst” unit. Then, they should leave the property and drive a 2-mile radius around the property, making note of nearby retail centers, restaurants, employment hubs and other apartment communities. Lastly, they should visit these other apartment communities to gain an understanding of the local competition.

 

Based on the feedback from the real estate broker and property management company, and the in-person visit, the GP should update or revise any underwriting assumptions in preparation for submitting an offer. At this point, the GP will have better assumptions than those that were made by simply reviewing the rent roll and profit and loss statement. But, if they are awarded the deal, the GP will conduct more detailed due diligence in order to finalize their assumptions.

 

2. Determine an Offer Price

 

During the underwriting and pre-conversation phase, the GP will usually have an idea of the price at which the owner is wanting to sell. Sometimes, the sales price is explicitly stated but this is usually only the case for smaller apartment deals. For deals with 50 to 100 or more units, the listed purchase price will likely say “to be determined by the market.” If that is the case, the GP can usually get a ballpark number from the listing real estate broker or the owner. If not, then they may use the current market cap rate  and the current net operating income to get an estimated sales price.

 

However, the sale price the owner desires is fairly irrelevant when determining an offer price. Experienced GPs will set an offer price that results in projected returns that meet their investment criteria. For example, my company will set an offer price that results in, at minimum, a 8% cash-on-cash return and a 16% 5-year internal rate of return to the limited partners.

 

If the GP’s offer price differs greatly from the listed, stated or estimated sales price, it may be due to an error on the GP’s side or due to the seller making too aggressive of assumptions. If it is the latter, the GP can either walk away from the deal or submit their offer along with an explanation for why the offer is much lower than what the seller desires.

 

In addition to determining an offer price, the GP should also have a conversation with their lender or mortgage broker to obtain estimated loan terms to include in their offer.

 

3. Submit an LOI

 

At this point, if the results of the underwriting meet their investment criteria, the GP will submit an offer in the form of a letter of intent (referred to as LOI hereafter). The LOI should be prepared by the GP’s real estate attorney.

 

The LOI is not legally binding. Its purpose is to show the GP’s intent to purchase the apartment at the stated price and terms, which includes the purchase price, down payment amount, earnest deposit and the due diligence timeline.

 

For the earnest deposit, 1% of the purchase price is standard and goes hard (i.e. is non-refundable) once the inspection period is completed (30 to 45 days). However, if the GP is in a competitive offer situation, the earnest deposit terms can deviate from the norm, whether it is a higher deposit amount and/or a shorter time frame before it goes hard (with the most competitive offers having the earnest deposit go hard day 1). For example, on a recent deal, my company had a $200,000 earnest deposit go hard day 1.

 

The GP can have a conversation with their real estate broker about what they are seeing in the current market for earnest deposit and its terms. Or, the GP can base the earnest deposit amount and terms on their previous acquisitions in the same submarket.

 

After submitting the LOI, the GP may be invited to a best and final call with the sellers. This is when the sellers ask for the interested investors’ best and final offer. Then, the investors with the most competitive offers will be invited to a call with the sellers, which is basically an interview so that the seller can determine if the investor is capable of closing on the deal.

 

4. Submit a Formal Offer

 

If the sellers accept and sign the GP’s letter of intent or they are awarded the deal after the best and final round, the GP will submit a formal offer in the form of a purchase sales agreement. Similar to the LOI, this sales agreement should be prepared by the GP’s real estate attorney. The purchase sales agreement is a detailed contract that outlines all of the terms of the sale.

 

Funding the upfront costs

 

In addition to the earnest deposit, other fees paid prior to closing are the upfront bank fees. Since the earnest deposit is due soon after closing, the GP needs to know where these funds will come from prior to putting the property under contract. The GP may front these costs and reimburse themselves at the close. Another option is for the GP ask an investor to fund the earnest deposit and upfront bank fees and create a promissory note so that the GP is responsible for paying the investor back if they lose the money (which happens if the contract is cancelled after the earnest deposit goes hard). Or, the GP could partner with someone on their team that has those funds. Ideally, the party who funds the earnest deposit will fund the other upfront banks fees as well.

 

In terms of how much upfront cash is needed, a good estimate is 2.5% of the purchase price (1% for the earnest deposit and 1.5% for the bank fees). For example, a $10 million purchase price would require an estimated $3.5 million in equity (25% down payment, GP fees, closing costs and cash reserves) at close. Of that $3.5 million, the GP would need approximately $250,000 in cash to cover the earnest deposit and upfront bank fees to get the deal to the closing table.

 

To learn more about the apartment syndication process from the perspective of a passive investor, visit my passive investor resources page here.

 

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REIT vs. Apartment Investing

Apartment Vs. REIT: Which Is The Better Passive Investment?

Originally Featured on Forbes.com here.

 

In real estate investing, there are two major strategies to choose from, and each can be used to pursue a variety of different opportunities. In passive real estate investing, two of the most popular investment opportunities are apartment syndications and real estate investment trusts, or REITs.

 

REIT is a company that owns, operates or finances income-producing real estate that generates revenue, which is paid out to shareholders in the form of dividends. An apartment syndication is when a syndicator (i.e., the general partner) pools together capital from passive investors (i.e., the limited partners) to purchase an apartment community while sharing in the profits.

 

In both cases, the passive investor is investing in real estate. However, the investment structures differ, which means that there are distinct pros and cons for each strategy. From my experience syndicating over $300,000,000 in apartment communities, when compared to REITs, I’ve found six pros and cons of passively investing in an apartment syndication.

 

1. Liquidity

 

With REITs, you have the ability to buy and sell like a standard stock. If you find yourself needing to pull out your capital, you can do so relatively quickly. Conversely, a passive apartment syndication is less liquid. Your initial investment is locked in until the end of the projected hold period. However, depending on the syndicator, there may be exceptions to this rule.

First, the syndication may have a clause that allows you to sell your shares of the company with the written consent of the general partnership. It is not as fast or as simple as selling shares of a REIT, but if an emergency were to arise and the syndication has such a clause, there is a process for reclaiming your investment. But overall, the passive apartment syndication is less liquid than a passive REIT investment.

 

In regards to liquidly, REITs win. REITs 1, apartments 0.

 

2. Barrier To Entry

 

To invest in a REIT, a large sum of capital isn’t required. Most REITs have no minimum investment, although they may require that you purchase blocks of 10 or 100 shares. That means you can invest in a REIT with less than $1,000, whereas apartment syndications have a higher barrier to entry.

 

First, you may need to be accredited, which means having an annual income of $200,000 or $300,000 for joint income for the last two years, or an individual or joint net worth exceeding $1 million. Additionally, apartment syndication may require a minimum investment. For example, my company requires a first-time minimum investment of $50,000 and then $25,000 thereafter. You can find syndicators that don’t require a minimum investment or for which you meet the accredited investor qualifications, but regardless, the financial barrier of entry is higher for apartment syndications than REITs.

REITs 2, apartments 0.

 

3. Diversification

 

With REITs, you invest in a diversified portfolio of properties that provide a blended return. Because the risk is shared across a pool of assets, you will not see major fluctuations in your returns and portfolio value. With a passive apartment investment, your return is directly tied to the performance of a single asset. If something negative happens to the property or the submarket in which the property is located, your projected returns will be reduced accordingly. However, the same logic applies to the upside as well.

Of course, this risk can be greatly reduced by only investing with apartment syndicators who follow the Three Immutable Laws of Real Estate Investing. Additionally, you can make up for the lack of diversification by investing in multiple apartment syndication deals, essentially creating your own personal REIT.

 

I’m calling this one a draw. So, the score remains: REITs 2, apartments 0.

 

4. Returns

 

The major benefit of passively investing in apartment syndications is the higher average returns. The total REIT return over the last five years (May 2013 to 2018) is 25.213%, including dividends and distributions. If you initially invested $100,000 in May 2013, your total profit by May 2018 is $25,213. As a comparison, my company does not purchase an apartment community unless the average annual return exceeds 9% and the five-year internal rate of return exceeds 16% to our passive investors. On a deal we purchased in 2015, we projected a 13.5% average annual return and a 20% five-year IRR to our passive investors, which would result in a total five-year profit of $102,805. As of this writing, not only are we on pace to exceed these projections, but we were able to refinance the property into a new loan and return about 40% of our passive investors initial capital. That is the power of apartment syndications.

 

Money is the crux of why people invest in real estate at all, so I’m giving apartments three points on this consideration. REITs 2, apartments 3.

 

5. Ownership

 

When investing in an apartment syndication, you also benefit from having direct ownership of the underlying asset. The major benefit of direct ownership is transparency — you see the actual asset you are investing in. As the general partnership progresses through the business plan, you will receive updates where, again, you can to see the actual asset, along with pictures of the updates and a variety of KPIs (rents, occupancy, etc.).

 

Another — and essential — benefit is having the direct contact information of the person calling the shots. If you have a question, you won’t have to worry about speaking with customer service or an automated phone service. Instead, you have direct access to the general partner who is managing the asset.

 

Another point for apartments: REITs 2, apartments 4.

 

6. Taxes

 

From a tax perspective, both REITs and apartment syndications will pass the depreciation benefits through to the passive investor. However, where these two strategies differ is with the profit at sale. For a passive apartment syndication investment, you have the opportunity to utilize the 1031 exchange tax instrument, which allows you to defer the taxes on your profit at sale by reinvesting in another deal with the same syndicator.

 

The final tally: REITs 2, apartments 5.

 

While the returns on both REITs and apartments have historically exceeded those of regular stocks as long as you are financially qualified and willing to tie up your capital for five to 10 years, passively investing in apartment syndications is, overall, the superior strategy.

 

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“tax” written in check book with pen

The Five Tax Factors When Passively Investing in Apartment Syndications

DISCLAIMER: THIS IS FOR YOUR INFORMATION ONLY. SINCE I AM NOT A TAX ADVISORY FIRM, I REFER ALL GENERAL TAX-RELATED REAL ESTATE QUESTIONS FROM PASSIVE INVESTORS BACK TO THEIR ACCOUNTANTS. HOWEVER, I WILL SAY THAT INVESTORS OFTEN SEEK REAL ESTATE OPPORTUNITIES TO INVEST IN DUE TO THE TAX ADVANTAGES THAT MAY COME FROM DEBT WRITE OFF AND LOSS DUE TO DEPRECIATION. BUT I DON’T INCLUDE ANY ASSUMPTIONS ABOUT THESE TAX ADVANTAGES IN OUR PROJECTIONS.

 

In addition to the capital preservation and cash flow benefits, one of the main reasons that passive investors seek to invest in real estate opportunities, and apartment syndications in particular, is because of the tax benefits of rental property.

 

When a passive investor invests in a value-add apartment syndication, they will generally receive a profit from annual cash flow and the profit at sale. Being a profit, this money is taxable. However, for apartment syndications, there are five pieces of tax information that the syndicator and the passive investor need to understand in order to determine the tax advantages of investing. These are 1) the depreciation benefits, 2) accelerated depreciation via cost segregation, 3) depreciation recapture, 4) bonus depreciation, and 5) capital gains tax at sale.

Depreciation

Investment property depreciation is the amount that can be deducted from income each year as the depreciable items at the apartment community age. The IRS classifies each depreciable item according to its useful life, which is the number of years of useful life of the item. The business can deduct the full cost of the item over that period.

 

The most common form of depreciation is straight-line depreciation, which allows the deduction of equal amounts each year. The annual deduction is the cost of the item divided by its useful life. The IRS considers the useful life of real estate to be 27.5 years. So, the annual depreciation on an apartment building worth $1,000,000 (excluding the land value) is $1,000,000 / 27.5 years = $36,363,64 per year.

 

As one of the tax benefits of apartment syndications, the depreciation amount is such that a passive investor won’t pay taxes on their monthly, quarterly, or annual distributions during the hold period. They will, however, have to pay taxes on the sales proceeds.

Cost Segregation

Cost segregations is a strategic tax planning tool that allows companies and individuals who have constructed, purchased, expanded, or remodeled any kind of real estate to increase cash flow by accelerating depreciation deductions and deferring income taxes. A cost segregation study performed by a cost segregation engineering firm dissects the construction cost or purchase price of the property that would otherwise be depreciated over 27.5 years, the useful life of a residential building. The primary goal of a cost segregation study is to identify all property-related costs that can be depreciated over 5, 7, and 15 years

 

For example, my company performed a cost segregation on our portfolio for 2017. On one of the properties, we showed a loss from investment property depreciation of greater than 412% than we would have seen with the straight-line depreciation using the 27.5-year useful life figure.

 

To perform a cost segregation, the syndicator will need to hire a cost segregation specialist. This can cost anywhere between $10,000 and $100,000, depending on the size of the apartments.

Depreciation Recapture

Depreciation recapture is the gain received from the sale of depreciable capital property that must be reported as income. Depreciation recapture is assessed when the sale price of an asset exceeds the tax basis or adjusted cost basis. The difference between these figures is “recaptured” by reporting it as income.

 

For example, consider an apartment that was purchased for $1,000,000 and has an annual depreciation of $35,000. After 11 years, the owner decides to sell the property for $1,300,000. The adjusted cost basis then is $1,000,000 – ($35,000 x 11) = $615,000. The realized gain on the sale will be $1,300,000 – $615,000 = $685,000. Capital gain on the property can be calculated as $685,000 – ($35,000 x 11) = $300,000, and the depreciation recapture gain is $35,000 x 11 = $385,000.

 

Let’s assume a 15% capital gains tax and that the owner falls in the 28% income tax bracket. The total amount of tax that the taxpayer will owe on the sale of this rental property is (0.15 x $300,000) + (0.28 x $385,000) = $45,000 + $107,800 = $152,800. The depreciation recapture amount is $107,800 and the capital gains amount is $45,000.

Bonus Depreciation

One of the major changes with the Tax Cuts and Jobs Act of 2017 was the bonus depreciation provision, where business can take 100% bonus depreciation on a qualified property purchased after September 27th, 2017. This is definitely one of the tax benefits of rental property you should learn more about, so click here for more information on the qualifications and benefits of the change in bonus appreciation.

Capital Gains

When the asset is sold and the partnership is terminated, initial equity and profits are distributed to the passive investors. The IRS classifies the profit portion as long-term capital gain.

 

Under the new 2018 tax law, the capital gains tax bracket breakdown is as follows:

 

Taxable income (individual or joint)

  • $0 to $77,220: 0% capital gains tax
  • $77,221 to $479,000: 15% capital gains tax
  • More than $479,000: 20% capital gains tax

Annual Tax Statements

At the beginning of the following year, the syndicator will have their CPA create Schedule K-1 tax reports for each passive investor. The K-1 is a tax document that includes all of the pertinent tax information that the passive investor will use to fill out their tax forms.

 

If you’re interested in partnering with me and potentially gaining from these tax benefits of rental property, please fill out the form here.

Secure Passive Investor Commitments

5 Step Process for Securing Passive Investor Commitments for Apartment Syndications

There are three main steps to take an apartment deal from contract to close. First, the apartment syndicator performs detailed due diligence to confirm or update the underwriting assumptions. Next, the apartment syndicator secures a loan to finance the deal. Lastly, and the focus of this blog post, the apartment syndicator secures financial commitments from passive investors in order to fund the deal.

For apartment syndications, and the value-add investment strategy in particular, the syndicator will get a loan to cover the majority of the project costs. Generally, the costs that are not covered by the loan are the down payment for the loan (which is 20% to 30% of the purchase price or the purchase price plus renovations, depending on the loan), general partnership fees charged by the syndicator, financing fees (which are approximately 1.75% of the purchase price), closing costs (which are approximately 1% of the purchase price) and an operating account fund (which is approximately 1% to 3% of the purchase price).

In total, a syndicator should expect to require 30% to 40% of the total project costs in order to close on the deal. These remaining costs come from a combination of the general partners (i.e. the syndication team) and the limited partners (i.e. passive investors), with the majority generally coming from the limited partners.

The purpose of this blog post is to outline the 5-step process for securing financial commitments from passive investors after an apartment deal is under contract in order to cover this 30% to 40% of the project costs and close on the deal.

 

1 – Investment Package

From the syndicator’s perspective, one of the first steps towards securing commitments from passive investors is creating an investment package. Before closing on the deal, the syndicator underwrote the property, conducted a rental comparable analysis, visited the property in-person and negotiated a purchase price. During this time, they become extremely familiar with the property and the surrounding area. The purpose of the investment package is to take all of this knowledge gained by the syndicator from initially qualifying the deal and consolidating it into a digestible form so that the passive investors can review the deal and make an educated investment decision.

The form of and the information included in an investment package will vary from syndicator to syndicator, depending on their experience and the business plan. At the very least, the investment package will include the main highlights of the deal that are relevant to the passive investor. These highlights include the purchase price, the projected returns for the project and to the passive investors, an explanation of the business plan including the exit strategy, and the partnership structure. However, ideally the investment package includes much more about the underlying assumptions behind these investment highlights.

For example, my company creates an investment summary package which includes the following sections:

  • Executive Summary: a summary of the information that is relevant to the passive investor, which is expanded upon in later sections. This includes things like purchase price, return projections and the business plan
  • Investment Highlights: an explanation on why this apartment deal is a solid investment. This includes things like our value-add business plan, the debt terms, the exit strategy and anything unique to the specific deal or market
  • Property Overview: an overview of the property details. This include things like the community amenities, unit features, a property description, the unit mix and floorplans, and a site map
  • Financial Analysis: shows the underlying analysis and assumptions of the return projections. This includes things like the offering summary, debt summary, projected returns to the investor and the detailed proforma
  • Market Overview: an overview of the submarket and market in which the apartment deal is located. This includes things like job growth, demographic data, nearby transportation of developments and the rental and sales comparables that were used to calculate the projected rents

Mostly everything that a passive investor needs to know in order to make an educated investment decision should be included in the investment package.

 

2 – Passive Investors Notified about New Deal

Once the investment package is created, which could take anywhere from a few days to a week, the next step is for the syndicator to notify their investor database about their deal.

I highly recommend that a syndicator gets verbal commitments from passive investors and creates an investor database prior to looking for deal (here are over 20 blog posts on how to find passive investors). In fact, understanding how much money they can raise will determine the size of deal a syndicator should pursue. For example, understanding the they will require approximately 30% to 40% of the project costs to close, a syndicator with $1 million in verbal commitments can look for apartment deals in the $2.5 to 3.3 million range.

For my company, once we put a deal under contract and creates the investment package, we notify our passive investors about the new opportunity via email. In this email, we include the top two to three highlights of the deal, include a link to the investment package and invite them to a conference call where we will go over the deal in more detail. We set up the conference call using www.FreeConferenceCall.com and include the date and call-in information in this email.

 

3 – New Investment Offering Call

A few days to a few weeks after sending the notification email, my company hosts a new investment offering conference call. Here is a blog post I wrote that outlines my 7-step approach to preparing and conducting a successful new investment offering call. Read this post for more details, but the 7-step approach is:

  1. Get in the right mindset
  2. Determine your main focus
  3. Introduce yourself and your team
  4. Provide an overview of the deal, the market and the team
  5. Go into more detail on the deal, the market and the team
  6. Questions and answers session
  7. Conclude the call and send the recording to the investors

This is my company’s approach, but it will vary from syndicator to syndicator. Some syndicators will structure their presentations differently. Some syndicators may host a video webinar. Others might just send the investment package and/or a recording to their investors.

 

4 – Secure Commitments

After the new investment offering presentation, however the syndicator decided to approach it, the next step is to secure financial commitments from the passive investors.

If you are a passive investor, if the deal aligns with your investment goals, you can verbally commit to investing in the deal. How you make your commitment will vary for syndicator to syndicator. For my company, we send our investors a recording of the conference call and ask them to send us an email with their commitments (and whether they are investing as an individual or LLC) and we hold their spot until they review and sign the required documentation, which I will outline in the next section.

If you are an apartment syndicator, this process will vary depending on your experience level. When you are first starting out, you will need to be more proactive when securing commitments. A good strategy is to send emails to your investor database every week or two, inviting them to invest in the deal and providing them a new piece of positive information. You don’t want to send them an email that only asks them to invest. You want to provide a new piece of positive information like a due diligence report came back clean, a new development that was recently announced down the street, the rental comparable report came back and the rents are higher than what you projected, etc. Then, as you gain more experience and credibility from passive investors, they will come to you. Your goal should be to have 100% of the funding 30 days before closing. And once the deal is fully funded, don’t turn away interested investors. Instead, tell them that the deal is fully funded but that you will put them on a waiting list.

 

5 – Complete Required Documentation

The last step is for the passive investors to make their investments official by reviewing and signing the required documentation. There are five main documents that the syndicator needs to prepare (with the help of their real estate and securities attorney) and the passive investors need to sign in order to make the investments official. We will send our investors these documents to sign via Adobe Sign.

 

  1. Private Placement Memorandum (PPM)

The PPM is a legal document that highlights all the legal disclaimers for how the passive investor could lose their money in the deal.

Generally, a PPM will include two major components. One is the introduction, which includes a summary of the offering, description of the asset being purchased, minimum and maximum investment amounts, key risks involved in the offering and a disclosure on how the general partners are paid. The other section covers basic disclosures, which includes general partner information, offering description and a list of all the risks associated with the offering.

The PPM should be prepared by a securities attorney for each apartment deal. 

The PPM will also include funding instructions. Once the investor has signed the PPM and sent their funds, we will send them an email confirmation within 24 to 48 hours.

 

  1. Operating Agreement

For each apartment deal, my company forms a new limited liability company (LLC). My company is a general partner (GP). Our investors will purchase shares in that LLC and become a limited partner (LP). However, every syndicator should speak with a real estate attorney to determine which approach is best for them.

The operating agreement outlines the responsibilities and ownership percentages for the GP and LP.

The operating agreement should be prepared by a real estate attorney for each apartment deal.

 

  1. Subscription Agreement

Simply put, the subscription agreement is a promise by the LLC to sell a specified number of shares to passive investors at a specified price, and a promise by the passive investors to pay that price. For example, a passive investor that is investing $50,000 would purchase 50,000 shares of the LLC at $1 per share.

Like the operating agreement, the subscription agreement should be prepared by a real estate attorney for each deal.

 

  1. Accredited Investor Qualifier Form

The accredited investor form required is based on whether the offering is 506(b) vs. 506(c). Most likely, the general partner is either selling private securities to the limited partners under Rule 506(b) or 506(c). One key difference is that 506(c) allows for general solicitation or advertising of the deal to the public, while 506(b) offerings do not. But the other difference is the type of person who can invest in each offering type. For the 506(b), there can be up to 35 unaccredited but sophisticated investors, while 506(c) is strictly for accredited investors only. That being said, a syndicator should have a conversation with a securities attorney to see which offering is the best fit for them.

If the general partners are doing a 506(c) offering, they must verify the accredited investor status of each passive investor, which requires the review of tax returns or bank statements, verification of net worth or written confirmation from a broker, attorney or certified account. The accredited investor qualifications are a net worth exceeding $1,000,000 excluding a personal residence or an individual annual income exceeding $200,000 in the last two years or a joint income with a spouse exceeding $300,000.

If the general partners are doing a 506(b), they are not required to verify the accredited investors status – the passive investor can self-verify that they are accredited or sophisticated. In addition, for the 506(b) offering, to prove that the general partners didn’t solicit the offering, they must be able to demonstrate that they had a relationship with the passive investor before their knowledge of the investment opportunity, which is determined by the duration and extent of the relationship.

This form should also be prepared by a securities attorney, but only on one occasion (unless the accredited investor qualifications change).

 

  1. ACH Application

Lastly is the ACH application. This document is optional but recommended. It will allow the passive investor to receive their distributions via direct deposit into a bank of their choice.

Once a passive investor has committed to investing in a deal, the general partners should them these five documents to make the partnership official.

 

Want to learn how to build an apartment syndication empire? Purchase the world’s first and only comprehensive book on the exact step-by-step process for completing your first apartment syndication: Best Ever Apartment Syndication Book.

luxury apartment building

How a Syndicator Secures Financing for an Apartment Deal

Once a syndicator puts an apartment deal under contract, concurrent with the due diligence process is the process of securing investment property loans. Generally, debt is a part of the apartment syndicator’s business plan because of the benefits that arise from leverage. Rather than purchasing the apartment community with all cash, they obtain a loan for upwards of 80% of the value while benefiting from 100% ownership.

However, not all debt and apartment financing are the same. The type of debt and financing an apartment syndicator puts on the asset is highly dependent on the business plan. Also, different types of financing bring different levels of risks. Therefore, as a passive investor or an apartment syndicator, it is important to understand 1) the different types of debt and 2) the different types of financing. In doing so, you will be able to identify which combination of debt and financing is in your best interests based on the business plan.

Two Types of Debt: Recourse and Nonrecourse

Before diving into the two main types of loans, it is important to first distinguish the two types of debt – recourse and nonrecourse. According to the IRS, with recourse debt, the borrower is personally liable while all other debt is considered nonrecourse. In other words, recourse debt allows the lender to collect what is owed for the debt even after they’ve taken the collateral (which in this case is the apartment building). Lenders have the right to garnish wages or levy accounts in order to collect what is owed.

On the other hand, with nonrecourse debt, the lender cannot pursue anything other than the collateral. But, there are exceptions. In the cases of gross negligence or fraud, the lender of investment property loans is allowed to collect what is owed above and beyond the collateral.

Apartment syndicators almost universally prefer nonrecourse debt, while lenders almost universally prefer recourse debt. But, while nonrecourse is advantageous to the borrower for the reasons stated above, it generally comes with a higher interest rate and is only given to individuals or businesses with a strong financial history and credit.

Two Types of Financing: Permanent and Bridge Loan

Generally, an apartment syndicator will secure one of two types of loans when seeking apartment financing: a permanent agency loan or a bridge loan.

Bridge Loans:

The other most common type of investment property loan is the bridge loan. A bridge loan is a short-term loan that is used until the borrower secures long-term financing or sells the property. This loan is ideal for repositioning an apartment, like with the value-add or distressed apartment strategy.

Typically, bridge loans have a term of 6 months to 3 years, with the option to purchase an extension of a year or two. They are almost exclusively interest-only. For example, with a 2-year bridge loan, the investor would make interest-only payments for two years, at which point the investor must pay off the loan, refinancing, purchase an extension, or sell the property.

The bridge loan is an LTC (loan-to-cost) loan at 75% to 80%, which means the lender will provide funding for 75% to 80% of the total project cost (purchase price + renovation costs) and the syndicator provides the remaining 20% to 25%.

Generally, bridge loans are nonrecourse to the borrower and have a faster closing process. Also, since they are interest-only, the monthly debt service is lower. However, the disadvantages are that they are riskier than permanent loans because they are shorter-term in nature. Before the end of the term, which will likely occur before the end of the business plan, the syndicator must refinance or sell. And if the market is such that permanent financing isn’t available or if the business plan didn’t go according to plan, the syndicator is in trouble.

Permanent Agency Loans:

A permanent agency loan is secured from Fannie Mae or Freddie Mac and is longer-term compared to bridge loans. Typically loan term lengths are 5, 7, or 10 years amortized over 20 to 30 years. For example, with a 5-year investment property loan amortized over 25 years, the syndicator would make payments for 5 years at an amount based on a loan being paid off over 25 years. At the end of the loan term, the syndicator will either have to pay off the remaining principal, refinance into a new loan, or sell the asset.

The permanent agency loan is an LTV (loan-to-value) loan at 75% to 80%, which means the lender will provide funding for 75% to 80% of the value of the apartment and the syndicator provides the remaining 20% to 25%.

Generally, permanent agency loans are nonrecourse. However, value-add or distressed investors likely won’t be able to have the renovation costs included in the loan. Additionally, depending on the physical condition and operations, the asset may not qualify for permanent financing.

Compared to bridge loans, the interest rate is lower, and you may be able to get a few years of interest-only payments. Also, since these loans are longer-term in nature, they are less risky. The permanent loan is a set-it-and-forget-it-loan where you won’t have to worry about a balloon payment or refinancing before the end of your business plan.

Closing Thoughts

When securing apartment financing, the most important thing is that the length of the loan exceeds the projected hold period, which is law number two of the Three Immutable Laws of Real Estate Investing. In doing so, as long as the syndicator follows the other two laws (buy for cash flow and have adequate cash reserves), the business plan is maintainable during a downturn. This law will usually be covered with the permanent loan. However, if the syndicator secures a bridge loan that will come due in the middle of the business plan, they better have a plan in place well ahead of time, whether that’s an early refinance or purchasing an extension.

 

Overall, the type of debt and financing a syndicator secures is based on their business plan. Bridge loans can be great for value-add investors, as long as they buy right, plan ahead and have an experienced team in place. And permanent financing is great because it is less risky and is a set-it-and-forget-it type of loan.

 

But regardless of the business plan and type of investment property loans, the syndicator should always have a conversation with a lending professional before securing financing for a deal.

person opening the door of a hotel room

18 Creative Ways to Market Apartment Rental Listings

One of the 11 responsibilities an apartment syndicator has as the asset manager of an apartment community is maintaining and maximizing the economic occupancy. For value-add investors, this involves renovating the units and upgrading the community amenities in order to increase the rents, thus increasing the cash flow and returns.

 

However, no matter how beautiful the newly upgraded apartment community is, the syndicator still needs to implement a marketing strategy in order to fill the units with high-quality residents. Ideally, the syndicator hires a property management company that already applies the best marketing practices. But it is still their responsibility to oversee the management company and make sure the marketing strategy is being implemented properly.

 

Therefore, whether you are an apartment syndicator or a passive investor in syndications, it is helpful to understand the main ways to effectively market rental listings to attract the desired resident – one who pays rent on time and is courteous to their neighbors – and increase overall economic occupancy.

 

Here is a list of 18 creative ways to market an apartment rental listing to accomplish the above stated goals:

 

  1. Create a landing page, either standalone or as a part of your website, that captures the information of potential residents
  2. Create a direct mailing campaign and send it out to people living in similar buildings, inviting them to move into yours by offering some sort of concession (i.e. reduced rent for the first month, reduced security deposit, waive the application fee, etc.) and highlighting the major selling point of your community compared to theirs (i.e. direct garage access, new fitness center, BBQ pit, etc.). This strategy could anger local owners, so if you decide to do this, don’t expect to be popular and expect others to do it to your residents
  3. Contact the Human Resources departments at all the major employers in the area, letting them know that you own an apartment in the area and asking if they can direct new hires to your community
  4. Create a resident referral program where you offer current residents a flat fee ($300 is standard) if they refer someone that signs a lease
  5. Set up an open house and invite members of the local community to attend. Having a model unit and offering refreshments is helpful
  6. Offer special pricing to soldiers, police and first responders, like 50% off the first month’s rent
  7. Design a “for lease” banner and put it near the entry of your property, or near an area that has high foot or car traffic
  8. Design and place flyers at local establishments that are frequented by your resident demographic, like laundry mats, hair salons, nail salons, gyms, coffee shops, etc.
  9. Purchase advertisements in the local newspaper
  10. Post “for rent” listings to Craigslist, Zillow, Realtor.com, Apartments.com and other free online rental listing services
  11. Partner with a real estate broker or agent and advertise your apartment community on the MLS
  12. Create a Facebook advertisement, which allows you to select criteria to hyper-target your preferred resident
  13. Create a Facebook page for your apartment community, posting weekly content to generate a following and posting your rental listings
  14. Pay close attention to the nearby landmarks to cater to that audience, like colleges, military bases, large corporations, etc.
  15. Provide good old-fashioned customer service. Be responsive and timely with requests and questions. If doesn’t matter if you are a marketing wizard and get hundreds of responses to your rental listings if you don’t pick up the phone or respond quickly to emails, politely answer their questions and get them one step closer to viewing the property and signing the lease
  16. Call all residents who have previously notified you that they plan on leave at the end of their lease, asking them about their reason for leaving to see if it is something that can be addressed
  17. Send marketing material or gift baskets to businesses and employers surrounding your community
  18. Follow-up with old leads that are older than 90 days

 

Some of the strategies are free and just require effort on the part of the syndicator and/or property management company. Others will require an upfront investment or result in a short-term reduction in income. Therefore, it is important that the syndication team understands the marketing strategy prior to closing on the deal so that they account for these expenses in the underwriting.

 

What about you? Comment below: What strategies do you implement to fill vacancies at your rental properties?

 

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apartment building during fall

The Ultimate Guide to Performing Due Diligence on an Apartment Building

After putting a deal under contract, the due diligence process for an apartment building is much more involved and complicated in comparison to that of a single-family residence or smaller multifamily building. For the real estate due diligence process on an SFR or smaller multifamily building, the lender will likely only require an inspection report and an appraisal report in order to provide you with financing. Then, for your own knowledge, you’ll perform your own financial audit, comparing the leases and rent rolls with the historical financials to make sure the rental rates are in alignment.

When you scale up to hundreds of units, the increase in the number of potential risk points is such that the lender will require additional reports prior to financing the deal, and you will want to obtain additional reports before deciding to move forward with the deal.

For the apartment community due diligence process, you’ll want to obtain and analyze the results of these 10 reports:

  1. Financial Document Audit
  2. Internal Property Condition Assessment
  3. Property Condition Assessment
  4. Market Survey
  5. Lease Audit
  6. Unit Walk
  7. Site Survey
  8. Environmental Site Assessment
  9. Appraisal
  10. Green Report

In this ultimate guide, I will outline the contents of each report, how to obtain them, the approximate cost of each (for apartment communities 100 units or more) and how to analyze the results. This should be a great introduction to how to do due diligence on real estate, and you can build on this for your unique deals.

1 – Financial Document Audit

The financial document audit is an analysis that compares the apartment’s historical operations to your budgeted income and expense figures you set when underwriting the deal.

For the audit, a consultant will collect detailed historical financial reports from the sellers, including the last one to three years of income and expense data, bank statements, and rent rolls. The output of the analysis is a detailed spreadsheet of the asset’s historical income, operating expenses, non-operating expenses, and net cash flow which are compared to the budgeted figures you provided.

The summary will take on a form that is similar to a pro forma, with the income and expenses broken down into each individual line item for an easy comparison on your end. They will also provide you with an executive summary document, which will outline how to interpret the audit, what data was used to create the audit spreadsheet and an explanation of any figures that deviate from your budget.

To obtain this document, you will need to hire a commercial real estate consulting firm that specializes in creating financial document audits. An approximate cost for this report is $6,000.

When you initially underwrote the deal, you set the income and expense assumptions based on how you and your team will operate the property once you’ve taken over. These assumptions came from a combination of the trailing 12 months of income and expense data and the current rent roll provided by the seller and the standard market cost per unit per year rates for the expenses.

Once you receive the results of the financial audit report, part of your real estate due diligence is to go through each income and expense line item and compare them to the assumptions in your underwriting model. Ideally, the consultant that performed the audit already compared the results to your provided budget, made adjustments based on their expertise and any inputs you provided, and commented on any discrepancies.

If any discrepancies were found or if the consultant recommended any adjustments, discuss them with your property management company to see if you need to update your budget. If you and your management company come to the conclusion that the budget needs to change, make the necessary adjustments to your underwriting model.

2 – Internal Property Condition (PCA) Assessment

The internal property condition assessment (PCA) is a detailed inspection report is an integral part of your real estate due diligence because it outlines the overall condition of the apartment community.

A licensed contractor will inspect the property from top to bottom. Based on the inspection, he or she will prepare a report with recommendations, preliminary costs, and priorities for immediate repairs, recommended repairs, and continued replacements, along with accompanying pictures of the interiors, exteriors, and the items needing repair.

Being an internal report, you will be responsible for hiring a licensed commercial contractor to perform the assessment. An approximate cost for this assessment is $2,500.

During the underwriting process, you created a renovation/upgrade plan for the interior and exterior of the apartment community, which included the estimated costs. Once you receive the internal PCA, compare the results to your initial renovation budget.

The results of the internal PCA are preliminary costs, not exact costs. However, they will most likely be more accurate than the assumptions you made during the underwriting process. Therefore, if there are discrepancies between the contractor’s estimated renovation costs and your renovation budget, update the underwriting model to reflect the results of the internal PCA.

Hopefully, your initial renovation assumptions were fairly accurate. And ideally, if you made very conservative renovation cost assumptions, you discover that you over-budgeted and can reduce the costs in your underwriting model.

3 – Property Condition Assessment

The property condition assessment is the same as the internal property condition assessment, except this one is created by a third party selected by the lender. The cost is approximately $2,000.

Analyze this reports the same way that you analyzed the internal PCA. Then, compare and contrast the results of the two PCAs. Maybe the lender’s contractor caught something that your contractor did not, and vice versa.

4 – Market Survey

The market survey is a more formal and comprehensive rental comparison analysis than the one you performed during the underwriting phase, which is why it is a necessary part of your real estate due diligence.

For the market survey, your property management company will locate direct competitors of the apartment community. Then, they will compare your apartment community to each of the direct competitors over various factors to determine the market rents on an overall and a unit type basis. A few key points on the market survey analysis is to make sure that your property management company uses apartment communities that are upgraded similarly to how your apartment community will be post-renovations and not in its current condition. These should also be in similar neighborhoods and built within a similar time period.

When initial underwriting the deal, you set your renovated rental assumptions based on a combination of performing your own rental comparable analysis and, if the sellers had initiated an upgrade program, proven rental rates. Compare the results of the market survey to your initial renovated rent assumptions. If there are any discrepancies, update your underwriting model to reflect the results of the market survey and complete this portion of the real estate due diligence.

5 – Lease Audit

Your property management company will collect all of the leases of the current residents at the apartment community and perform an audit. They will analyze each lease, recording the rents, security deposits, concessions, and terms. Then, they will compare the information gathered from the leases to the rent roll provided by the owner, recording any discrepancies.

Unless the current property management company was extremely incompetent, the discrepancies should be minor, if there are any at all, and it should affect your financial model.

6 – Unit Walk

A question my apartment syndication clients ask a lot is “when I am performing real estate due diligence, do I need to walk every single unit?” The answer is a resounding yes! And that is the purpose of the unit walk report.

During the unit walk, your property management company will inspect the individual units. The purpose of the unit walk is to determine the current condition of each. So, while conducting the unit walk, they will take notes on things like the condition of the rooms, the type and condition of appliances, the presence or absence of washer/dryer hookups, the conditions of the light fixtures, missing GFCI outlets, and anything else that stands out as a potential maintenance or resident issue.

Once you receive the unit walk report, compare the results to your interior renovation assumptions to determine the accuracy of your interior business plan.

Do the number of units that require interior upgrades match your business plan? Is there unexpected deferred maintenance that wasn’t accounted for in your budget? Are there a high number of residents who will need to be evicted once you’ve taken over the operations?

Using that data, you can create a more detailed, unit-by-unit interior renovation plan and calculate a more accurate budget. Make any adjustments to your interior renovation assumption on your financial model.

Most likely, your property manager will perform the market survey, lease audit, and unit walk report, and they will usually do it for free. However, ask the property manager how much they will charge you for these three reports if you do not close on the deal. And if you have to hire a 3rd party to create these three reports, the cost is approximately $4,000.

7 – Site Survey

A site survey resembles a map and shows the boundaries of the property, indicating the lot size. It also includes a written description of the property.

There are a lot of third-party services that can conduct a site survey. A quick Google search of “site survey + (city name) will do the trick. I recommend reaching out to multiple companies to get a handful of bids for your project. The approximate cost for the site survey is $6,000.

The site survey report will list any boundary, easement, utility, and zoning issues for the apartment community. Generally, if a problem is found during the site survey, the bank will not provide a loan on the property. So, if something does come up during this real estate due diligence report, your options are limited and should be addressed on a case-by-case basis. If the problem can’t be resolved, you will have to cancel the contract.

8 – Environmental Site Survey

The environmental site assessment is an inspection that identifies potential or existing environmental contamination liabilities. It will address the underlying land, as well as any physical improvements to the property, and will offer conclusions or recommendations for further investigations of an issue is found. The environmental site assessment is also performed by a 3rd party vendor selected by your lender. The approximate cost is $2,500. Similar to the site survey, if the vendor identifies an environmental problem, the lender will not provide a loan for the property. Again, these issues should be addressed on a case-by-case basis.

9 – Appraisal

The appraisal report is created by an appraiser selected by your lender and determines the as-is value of the apartment community. The cost is approximately $5,000.

The appraiser will inspect the property, and then calculate the as-is value of the apartment community. The two appraisal methods that will be used to determine the value of the property are the sales comparison approach (i.e. comparing the subject property to similar properties that were recently sold) and the income capitalization approach (i.e. using the net operating income and the market cap rate).

Once you receive the appraisal, you should compare the appraised value to the contract purchase price as part of your real estate due diligence. The lender will base their financing on the appraised value, not the contract price. Therefore, if the appraisal comes back at a value higher than the contract price, fantastic! That’s essentially free equity. However, if the appraised value is lower than the contract price, you will have to either make up the difference by raising additional capital or renegotiate the purchase price with the seller.

10 – Green Report

The Green report is an optional assessment that evaluates potential energy and water conservation measures for the apartment community. The report will include a list of all measures found, along with the associated cost savings and initial investment.

The report is created by a 3rd party vendor selected by your lender. The approximate cost is $3,500.

The green report, which is the only document that won’t disqualify a deal, will outline all of the potential energy and water conservation opportunities. It will list all of the opportunities that were identified, the estimated initial investment to implement, the associated cost savings and the return on investment. Deciding which opportunities to move forward with should be based on the payback period and the projected hold period of the property.

An Example of Green Options

For example, the following energy efficient opportunities were identified at an apartment project my company assessed:

  • Dual pane windows
  • Wall insulation and leakage sealing
  • Roof insulation
  • Programmable thermostats
  • Low-flow showerheads and toilets
  • Interior and exterior LED lighting
  • Energy Star rated refrigerators and dishwashers

After analyzing the investment amount and cost savings, the opportunities we implemented, and the associated savings and payback periods were:

  • Low-flow showerheads: 1-year payback, $16,827 annual savings
  • Exterior LED lighting: 14.4-year payback, $3,236 annual savings
  • Pool cover: 1.5-year payback, $409 annual savings

The reasoning behind the low-flow showerheads and pool cover was that we planned on holding the property for 5-years, so, once we paid back the initial investment amount, it was pure profit. We ended up losing money on the exterior LED lighting project. However, we installed these lights to increase resident safety.

You will find that the green report will list ALL opportunities, even if the payback period is absurdly long. If we implemented all the opportunities identified in the example above, the overall payback period would have been 91.9 years, with the longest payback period being 165 years for the Energy Star rated dishwashers. Unless we decided to hold onto a building until we died or unit they’ve discovered an immortality serum, we stuck to the opportunities that either resulted in a payback period lower than our projected hold time or address a resident safety concern.

How to Pay for the Due Diligence Reports

Usually, the costs of the real estate due diligence reports will not be due until closing. So, when underwriting the deal, make sure you are taking these costs into account when determining how much equity you need to raise.

Other times, you will need to pay for a due diligence report upfront. If this is the case, you can do one of two things. You can pay out-of-pocket and reimburse yourself at close. Or, you can take a loan from a third-party (maybe one of your passive investors) and reimburse the initial loan amount with interest at close.

Review the Results of Your New Underwriting Model

Based on the financial document audit, market survey report, lease audit report, and green program report, you will either confirm or update your income assumptions. The financial document audit will help you confirm or update your expense assumptions. The two property condition assessments and the unit walk report will lead you to confirm or update your renovation budget assumptions. Based on the appraisal report, you will either confirm the accuracy of the purchase price or determine that you have the property under contract at a price that is below or above the as-is value. And based on the site survey and environmental survey, you will determine if there is anything that disqualifies the deal entirely.

Once you have received the results of all 10 real estate due diligence documents and made the necessary adjustments to your underwriting model, you need to re-review your return projections. If you had to make drastic changes to the income, expenses or renovation budgets in the negative direction, then the new return projections will be reduced. In some cases, the return projections will be reduced to such a degree that the deal no longer meets the return goals of you and your investors. Also, if an issue came up during the site survey or the environmental site assessment, which is rare, it will need to be resolved prior to closing. If the seller is unwilling or unable to address these issues, your lender will not provide financing on the property, which means you will have to cancel the contract.

If the updated return projections fall below your investor’s return goals, adjust the purchase price in your underwriting model until the projected returns meet your investor’s goals again. Then, explain to your real estate broker that you want to renegotiate the purchase price and state the reasons for doing so.

If the seller will not accept the new contract terms, don’t be afraid to walk away from the deal. At the end of the day, it is your job to please your investors, which means providing them with their desired return goals.

working team bumping fists

How a Passive Investor Qualifies an Apartment Syndicator’s Team

One of the three main risk points associated with passively investing in apartment syndications is the syndication team (the other two are the deal itself and the market). The best deal, from a projected returns standpoint, in the best market in the country may result in failure if the team cannot successfully execute the business plan. Therefore, prior to committing to a particular apartment syndicator or to a particular deal, a passive investor should qualify the main team members involved in the deal.

 

Before asking these questions, however, you need to qualify the actual apartment syndicator. Click here for a blog post for how a passive investor qualifies an apartment syndicator.

 

There are the 7 team members involved in syndication process: property management company, real estate broker, CPA, mortgage broker, real estate attorney, securities attorney and a consultant (optional). But the main team member is the property management company.

 

The property management company is the boots-on-the-ground force that is responsible for overseeing the ongoing, day-to-day operations of the apartment community. This includes marketing efforts to attract new residents, resident relations (like hosting resident events), managing turnovers, fulfilling maintenance requests, maximizing rents and occupancy levels, etc. If the syndicator is following a value-add or distressed investment strategy, the property management company will also oversee the renovation process.

 

Prior to investing with an apartment syndicator, you want to determine the credibility of the property management company, which you can accomplish by asking the following 8 questions:

 

  1. How long have they been in business?

 

A relatively new property management company might not have enough experience managing certain sized or types of apartments. Generally, the longer they’ve been in business, the better. For example, the property management company that we use has been in business for over 75 years.

 

  1. What geographic areas do they cover?

 

The property management company MUST have a presence in the market in which the apartment syndicator is investing. That means the company must be local to the market or, if they are a national property management company, must have a regional office located in the market.

 

  1. How many units do they manage?

 

Similar to the question 1, the property management company should manage multiple apartment communities in the same market. However, bigger isn’t always better, because if they manage too many units, they might not be able to provide the highest quality service. Also, if they have been in business for decades but only manage a handful of communities, that could be a red flag.

 

  1. How many units do they own?

 

If the property management company owns other apartment communities in the same market, it could be a conflict of interest. If the syndicator’s property and their property have a vacant 2 bed, 1 bath unit at the same time, which one are they likely to fill first? Not a deal breaker, but this is definitely something that you want to be aware of.

 

  1. What asset class do they specialize in?

 

The property management company MUST have experience implementing the same business plan that the syndicator is pursuing. For example, If the syndicator is following a value-add investment strategy, the property management company must have experience with value-add apartment communities.

 

  1. What are some of the names of nearby properties they are currently managing?

 

This proves that they are actually managing apartments in the local market. But it will also allow you to perform some research to see how the apartment communities are maintained. If you are local to the market, you can visit these properties in person. If not, you can perform online research by looking at the website and by looking at the property on Google Maps. Also, you can look up the apartment community on Google or Apartments.com to read resident reviews and see the overall rating.

 

  1. Have you worked with this company in the past?

 

Since you are ideally investing with a syndicator who has previous apartment experience, this shouldn’t be the first time they used their property management company. If the property management company doesn’t manage the majority of their portfolio in their target market, that could be red flag. So, if that is the case, a follow-up question would be to ask them why this management company doesn’t manage the majority of their portfolio.

 

  1. Is the property management company showing alignment of interests?

 

Alignment of interests are always important, but they are especially important if the syndicator doesn’t have a long, successful track record with apartment communities. There are five main ways that the property management company can show alignment of interest.

 

The lowest level of alignment of interests is the management company has a proven track record managing apartment communities that are located in the local market, has worked with the syndicator in the past and has followed the same investment strategy that the syndicator is implementing. Regardless of the experience level of the apartment syndicator, this level of alignment of interest should be shown.

 

The next level up is when the property management company has an equity stake in the general partnership.

 

The third level of alignment of interest is when the property management company invests their own capital in the deals.

 

The fourth level of alignment of interest is when the property management company invests their own money in the deal AND brings on their own passive investors.

 

And the highest level of alignment of interests is when the property management company signs on the loan.

 

Again: it is ideal that the syndicator has previous experience with apartments, but if they don’t, having alignment of interests with the property management company – or with other team members, like the real estate broker or a local apartment owner/consultant – can offset their lack of experience. If the syndicator does have experience, then the level two to five alignment of interests are less important.

 

 

Over the course of your communication with a prospective apartment syndicator, these are the eight questions you want to ask in order to determine the credibility and experience of their property management company.

 

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qualify an apartment syndicator

How a Passive Investor Qualifies an Apartment Syndicator

The syndicator, also referred to as the sponsor or general partner, is an individual or a group of individuals that puts an apartment syndication together. And, this entails a lot of responsibilities.

Their main responsibilities include creating the syndication team, selecting and evaluating a target market, finding a deal, qualifying or disqualifying the deal through underwriting, submitting an offer and negotiating the purchase price and terms.

Once a deal is under contract, their main responsibilities are to manage the due diligence process, confirm the underwriting assumptions, create the business plan, arrange the debt, secure the equity from passive investors and coordinate with the real estate and securities attorney to structure and create the partnership.

Once the deal is closed, they are responsible for the ongoing asset management of the project, which includes implementing the business plan, distributing the returns to the passive investors, communicating updates to the passive investors, visiting the property and frequently analyzing the competition and the market.

Essentially, they are responsible for managing the entire process from start to finish. Because of their heavy involvement in the process, the success or failure of the deal rests mostly on their shoulders. Therefore, rather than investing with the first apartment syndicator you find, you need to qualify them by asking questions.

 

The Business Plan

One of the first things you want to know is the general business plan they implement. Click here to learn more about the three apartment syndication options. This will segue into the next question, which is what is their past experience with this particular business plan? In particular, you want to know if they have taken a deal full cycle (from acquisition to sale) following this business plan and whether or not they were successful (which is determined by how the projected returns compared to the actual returns distributed to the passive investors).

 

Alignment of Interests

If the syndicator does not have previous experience implementing the business plan, that is not an automatic disqualifier. However, their lack of experience must be made up for by having a credible team and strong alignment of interests. And for the experienced syndicator with a proven track record of successfully implementing their business plan, having a partnership structure that promotes alignment of interests is the icing on the cake.

There are many other team members that are involved in the syndication process, but the three team members with the most involvement in the deal are the property management company, the real estate broker and – if the syndicator doesn’t have previous apartment experience – a consultant. And each of these team members bring different levels of alignment of interests to the deal. Generally, an experienced property management company results in the most alignment of interests, followed by an experienced syndication consultant or local owner who is active in the apartment industry, followed by an experienced real estate broker.

The syndicator themselves can also promote alignment of interests. For example, one of the common fees the syndicator charges in an ongoing asset management fee. If they put that fee in second position to the preferred return, that promotes alignment of interests. If you don’t get paid, they don’t get paid.

Additionally, they can promote alignment of interests by investing their own capital in the deal, whether that’s is their personal funds, company funds or by allocating a portion or all of their acquisition fee into the deal. By not having money in the deal, the syndicator isn’t exposed to the same level of risks as you are. If the deal performs poorly, they won’t get paid but they also won’t lose any capital either. Whereas, by having their own skin in the game, they are incentivized to maximize returns.

Another way to promote alignment of interest is for the syndicator, or a member of the team, to personally guarantee the loan as a loan guarantor.

 

Transparency

Another characteristic of a good syndicator is transparency. To determine the level of transparency, ask them about their ongoing communication process. How often do they send updates on the deal? Will they provide you with financial reports so you can review the property’s operations?

You also want to ask them what the communication process is when you have a question. Will they provide you with their cell phone number or direct email address? And if you do have a question, what will be the turn-around time?

You are trusting the syndicator with your hard-earned capital, so having transparency in regards to what they are doing with your money and how the deal is progressing is a must.

 

Credibility

A good question to determine the syndicators track record is to ask them how many of their passive investors have invested in multiple assets. Syndicators who have investors that continue to come back deal after deal is an indication that they have a proven track record of meeting and/or exceeding the projected returns. While the opposite may be true if the syndicator has a poor investor retention rate.

Similarly, ask the syndicator what percentage of their new investors come in the form of referrals. If they have a lot of referrals, that indicates satisfied investors who are motivated to share their success with friends and colleagues.

You can also gauge the reputation and credibility of a syndicator by their online presence. Are they easily found when you perform a Google search? Do they have a website? Do they create content in the form of a podcast or blog? You can learn a lot about a syndicator by performing online research prior to actually speaking with them.

 

The syndicator’s past experience with the apartment business plan, level of alignment of interests, transparency and credibility are important factors to understand when determining whether or not to passively invest in their deal.

 

If you are a current passive real estate investor, what do you think? Comment below: what do you look for when qualifying an apartment syndicator?

 

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building with open windows

How the General Partner Makes Money from an Apartment Syndication

The types of fees and the range of each fee will vary from syndicator-to-syndicator. But every fee that is charged should be directly tied to a task that is explicitly adding value to the apartment deal.

 

In order to identify the fairness and reasonableness of the GP compensation structure, you need to understand 1) the types and standard ranges of the general partnership fees for the industry, 2) what tasks they are performing in return for those fees and 3) if each of those fees promotes alignment of interests between the LP and GP.

 

There a lot of different fees that the syndicator could charge, but here is a list of the seven fees that you will come across most often. An important disclaimer to make is that this is not a list of the fees that every syndicator will charge every single time. Rather most syndicators will mix-and-match the types of fees that charge, depending on the project.

 

1 – Profit Split

 

Depending on the type of LP compensation structure, the general partnership may earn a portion of the remaining profits after the preferred return is distributed.

 

For example, the LP may receive an 8% preferred return and the profits thereafter are split between the LP and GP. This split can be anywhere from 50/50 to 90/10 (LP/GP)

 

If the LP invested $1,000,000 into a property that cash flowed $100,000 for the year, assuming an 8% preferred return and a 50/50 split thereafter, the LP would receive $80,000 as a preferred return, plus another $10,000 as a profit split. Then, the GP would receive the remaining $10,000.

 

The profit split promotes alignment of interests because the GP is financially incentivized to operate the apartment community such that the annual return exceeds the preferred return. Because if they don’t, they are missing out on an opportunity to make money. Then for the passive investor, when the annual returns exceed the preferred return, the LP receives a higher annual distribution and – since the net operating income is directly tied to the property value – a higher distribution at sale.

 

On a related note, you want to confirm that at sale, the profit split is calculated based on the remaining profits AFTER the LP’s initial equity is return. Also, when the GP is outlining the LP return projections, you want to confirm that those projections are net of the GP fees. This means that you want to make sure that the projections they show you are AFTER the GP has taken their fees, because if not, the actual returns will be less than what they are showing you.

 

2 – Acquisition Fee

 

Nearly every apartment syndicator will charge an acquisition fee. The acquisition fee is an upfront, one-time fee paid to the GP at closing. The acquisition fee ranges from 1% to 5% of the purchase price, depending on the size, scope, experience of team and profit potential of the project.

 

Think of the acquisition fee as a consulting fee paid to the GP for putting the entire project together. It is a fee that pays the GP for their time and money spent on market research, creating a team (lawyers, CPAs, real estate brokers, etc.), finding the deal, analyzing the deal, raising money, securing financing, performing due diligence and closing.

 

3 – Asset Management Fee

 

The asset management fee is an ongoing annual fee paid to the GP in return for overseeing the operations of the property and implementing the business plan. The asset management fee is either a percentage of the collected income or a per unit per year fee. The standard percentage range is 2% to 3% while the standard per unit per year is $200 to $300.

 

The range of the asset management fee is usually based on the business plan. If the plan is to perform interior renovations and exterior renovations/upgrades, a higher asset management fee may be justified, because the GP will be heavily involved in ongoing oversight of the business plan. But the opposite is true if the property is already stabilized and up-to-date from day one. In other words, the more effort and time required by the GP, the higher the asset management fee. And since the asset management fee is directly tied to the collected revenue, if the business plan isn’t implemented effectively, the GP doesn’t maximize what they could make, which helps with alignment of interests.

 

Additionally, there is a higher alignment of interests with the percentage-based fee as opposed to the unit-based fee. Since the percentage-based fee is tied to the actual collected income, the lower the collected income, the lower the asset management fee. So, the GP is incentivized to maximize the income, which in turn will maximize your returns. Whereas the unit-based fee is a flat fee that remains the same regardless of the amount of collected income.

 

For another level of alignment of interest, the GP will put the asset management fee in second position behind the preferred return. That means that if the preferred return isn’t distributed, they won’t receive the asset management fee. Not every GP will have a compensation structure with the asset management fee in second position. So, for the ones that don’t, the alignment of interests is lower than that of the GP that does.

 

4 – Refinance Fee

 

A refinancing fee is a fee that is paid to the GP for the work required to refinance the property. Of course, if the business plan doesn’t include a refinance, the GP will not charge such a fee.

 

At the closing of the new loan, a fee of 1% to 3% of the total loan amount is paid to the GP. However, to promote alignment of interests, this fee should only be charged if a specified equity hurdle is reached. For example, the return hurdle may be returning 50% of the LP’s initial equity. If only 40% is returned, while that is still beneficial to the LP, the GP will not collect the fee. Therefore, this type of refinance fee structure incentivizes the GP to maximize the property value such that they will hit the equity return hurdle at refinance. And the LP benefits by receiving a large portion of their equity back and – again, since the property value is directly tied to the net operating income –  higher ongoing returns.

 

5 – Guaranty Fee

 

The guaranty fee is typically a one-time fee paid to a loan guarantor at closing. The loan guarantor guarantees the loan. The GP may bring on an individual with a high net-worth/balance sheet to sign on the loan to get the best terms possible. Or, the GP may sign the loan themselves, collecting the fee or deciding to forgo it.

 

At close, a fee of as low as 0.5% to 1% and as high as 3.5 to 5% of the principal balance of the mortgage is paid to the loan guarantor. The riskier or more complicated the deal, the higher the guaranty fee. If the GP doesn’t have a good relationship with the loan guarantor, that individual will charge a higher fee as well. In some instances, the GP will offer the loan guarantor a percentage of the GP (10% to 30%) in addition to the one-time upfront fee.

 

Also, the size of the fee depends on the type of loan. Generally, there are two types of debts: recourse and nonrecourse. Recourse debt allows the lender to collect what is owed for the debt even after they’ve taken collateral. Nonrecourse debt does not allow the lender to pursue anything other than the collateral (with a few exceptions or “carve outs,” like in instances of gross negligence or fraud). So, the guaranty fee will be higher for recourse loans compared to nonrecourse loans.

 

Since the loan guarantor is personally guaranteeing the loan, this promotes alignment of interests. Because if they project fails, the GP is personally liable.

 

 

6 – Construction Management Fee

 

The construction management fee is an on-going annual fee paid to the company overseeing the capital improvement process. If the GP has a hands-on role in the renovation process or if the GP has their own property management company, they may charge a construction management fee.

 

This fee ranges from 5% to 10% of the renovation budget, depending on the size and complexity of the improvement plan.

 

For some syndicators, this fee will be built into the asset management fee, while others will charge a construction fee on top of the asset management fee. When a GP charges both an asset management and construction management fee, it may reduce your ongoing returns, especially while renovations are being performed.

 

7 – Organization Fee

 

The organization fee is an upfront fee paid to the GP for putting together the group investment. This fee ranges from 3% to 10% of the total money raised, depending on the amount of money raised.

 

For some syndicators, this fee will be built into the acquisition fee, while others will charge an organization fee on top of the acquisition fee. When a GP charges both an acquisition and organization fee, your overall return may be reduced.

 

 

These are the seven type of fees you will most commonly come across as a passive apartment investor.

 

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active vs. passive

Active Vs. Passive: Which Is the Superior Real Estate Investment Strategy?

 

Originally featured in Forbes here.

 

When the average person thinks of real estate investing, they might imagine a billionaire who develops massive commercial properties, or an HGTV fix-and-flipper who turns a profit by converting a run-down property into someone’s dream home. With this mental representation, it’s no wonder more people aren’t real estate investors.

 

Obviously, this isn’t the case in reality. There are thousands of different real estate investing strategies from which to choose. The difficult part — aside from shedding the false belief that real estate investing is only for the rich —  is identifying the ideal investment strategy that fits one’s current economic condition, abilities and risk tolerance level.

 

Generally, entry-level investment strategies fall into two categories: passive and active investing. The question is, which one is best for you?

 

For our purpose here, I will define active investing as the acquisition of a single-family residence (SFR) with the goal of utilizing it as a rental property and turning over the ongoing management to a third-party property management company. Alternatively, passive investing is placing one’s capital into a real estate syndication — more specifically, an apartment syndication — that is managed in its entirety by a sponsor.

 

In order to determine which investment strategy is best for you, it is important to understand the main differences between the two. Based on my personal experience following both of these investment strategies and interviewing thousands of real estate professionals who have done the same, I’ve discovered that the differences between passive and active investing fall into three major categories: control, time commitment and risk.

 

Control

 

As a passive investor, you are a limited partner in the deal. You give your capital to an experienced sponsor who will use that money to acquire and manage the entire apartment project. You have no direct control over any aspect of the business plan, so you are putting a lot of trust into the sponsor and their team. However, this trust is established by not giving your money to a random, unqualified sponsor but through an alignment of interests. For example, the sponsor will offer you a preferred return, which means that you will receive an agreed-upon return before the syndicator receives a dime. Therefore, the syndicator is financially incentivized to achieve a return above and beyond the preferred return.

 

As an active investor, you can directly control the business plan. You decide which investment strategy to pursue. You decide the type and level of renovations to perform. You decide the quality of tenant to accept and the rental rate to charge. You determine when to refinance or sell. With for passive investing, all of the above is determined by the apartment syndicator.

 

Time Commitment

 

As an active investor, the advantage of more control comes with the disadvantage of a greater time commitment. It is your responsibility to educate yourself on the ins and outs of single-family rental investing. Then, you have to find and vet various team members. Once you have a team in place, you have to perform all the duties required to find, qualify and close on a deal. After closing, as long as you have a good property management company, it should be pretty hands-off. Although, if (really, when) something unexpected occurs, you’re responsible for making those decisions, which can come with a lot of stress and a lot of headaches.

 

Of course, it is indeed possible to automate the majority, if not all, of the above tasks. But that requires a certain level of expertise and a large time investment to implement effectively.

 

Passive investing is more or less hassle-free. You don’t have to worry about any of the actions described above. You just need to initially vet the apartment syndicator and vet the deal. From there, you simply invest your capital and read the monthly or quarterly project updates.

 

Risk

 

You are exposed to much less risk as a passive investor. You are plugging into an already created and proven investment system run by an experienced apartment sponsor who (preferably) has successfully completed countless deals in the past. Additionally, there is more certainty on the returns. You will know the projected limited partner returns — both ongoing and at sale — prior to investing. And assuming the syndicator conservatively underwrote the deal, these projected returns should be exceeded.

 

Active investing is a much riskier strategy. However, with the higher risk comes a higher upside potential. You own 100% of the deal, which means you get 100% of the profits. But, you also have to bear the burden of 100% of the losses. For example, a turnkey rental will likely cash flow a few hundred dollars a month depending on the market. The costs associated with one large maintenance issue or a turnover could wipe out months, or even years, of profits. A value-add or distressed rental has a huge upside potential. However, a common tale among distressed or value-add investors, especially the newer or less experienced ones, is projecting a certain renovation budget but finding an unexpected issue during the rehab process that drastically increases their budget, resulting in a lower or negative overall return.

 

Additionally, failing to accurately calculate a post-renovation unit’s rental premium will also result in the reduction or elimination of profits. While these profit reduction or elimination scenarios could technically occur with a passive investment, the risk is spread out across many investors, and a sponsor with a proven track record and a qualified team will mitigate these risks.

 

Real estate investing is for everyone, not just the moguls of the world. However, not all investment strategies are the same. It’s important to understand the pros and cons associated with each to determine which strategy will set you up for success.

black and white image of apartment building

What is Your Ideal Passive Apartment Investment?

Last Updated: February 2019

 

After reviewing the differences between active and passive real estate investing, assessing your current economic condition, ability and risk tolerance level, you’ve decided to passively invest in apartment syndications. Great! You are one step closer to investing in your first deal. So, what’s next? Read on to learn how to make passive income from real estate.

Similar to determining your ideal general investment strategy (i.e. active vs. passive), you need to establish your ideal situation for investing in rental properties. And, in order to establish your ideal passive investment, you need to know what your options are first. In particular, you need to learn about the different types of apartment syndications in which you can passively invest your money and the benefits and drawbacks of each. Generally, apartment syndications fall into one of three categories: turnkey, distressed, or value add.

 

Turnkey Apartment

Turnkey apartments are class A properties that require minimal to no work after acquisition. These properties are fully updated to the current market standards and are highly stabilized with occupancy rates exceeding 95%. Therefore, the turnkey business model is to take over the operations and continue managing the asset in a similar fashion to the previous owners. No renovations. No tenant turnover. Nothing fancy.

Of the three apartment syndication strategies, investing in rental properties that are turnkey has the lowest level of risk. The property is fully updated and fully stabilized at acquisition. The risks associated with performing renovations, which include overspending, unexpected capital expenditures, bad contractors, incorrect rental premium assumptions, etc., and turning over a large percentage of tenants are minimized. Additionally, the asset will achieve the projected cash flow from day one, because the revenue pre- and post-acquisition remains the same.

The drawbacks of the turnkey apartment syndication strategy are the lower ongoing returns and the lowest upside potential compared to the other two apartment types. Because the property is fully updated and stabilized, there isn’t room to increase the revenue of the property. Therefore, the ongoing returns are and remain in the low to mid-single digits. Additionally, since the value of the asset is calculated using the net operating income and the market cap rate, unless the overall market naturally appreciates, the property value will remain relatively stable. As a result, there is little to no upside potential at sale. Most likely, you will receive your initial equity investment back with minimal to no profit.

 

Distressed Apartment

On the opposite of the end of the spectrum is the distressed apartment. Distressed apartments are class C or D assets that are non-stabilized with occupancy rates below 85% and usually much lower due to a whole slew of reasons, including poor operations, tenant issues, outdated interiors, exteriors, common areas and amenities, mismanagement and deferred maintenance. Generally, apartment syndicators will take over and, within a year or two, stabilize the asset by addressing the interior and exterior deterred maintenance, installing a new property management company, finding new tenants, etc. Then, they will either continue their business plan to further increase the apartment’s occupancy levels and/or rental rates or they will sell the property.

The major advantage of investing in rental properties that are distressed is the upside potential at sale. Once the asset is stabilized the revenue – and therefore the value – will increase dramatically, resulting in a large distribution at sale.

The drawbacks of distressed apartments compared to the other two types are being exposed to the highest level of risk and receiving the lowest ongoing returns. The high upside potential at sale also comes with the risk of losing ALL of your investment. There are a lot of variables to take into account with a distressed apartment, which means there are a lot more that could go wrong. Additionally, since the asset is not stabilized at acquisition, there will be little to no cash flow – and maybe even negative cash flow. That means you won’t receive ongoing distributions unless the syndication structure is such that you receive interest on your investment before the sale.

 

Value-Add Apartment

Lastly, we have value-add apartments to consider when investing in rental properties. Value-add apartments are class C or B assets that are stabilized with occupancy rates above 85% and have an opportunity to “add value.” Generally, the value-add apartment syndicator will acquire the property, “add value” over the course of 12 to 24 months and sell after five years.

Adding value” means making improvements to the operations and physical property through exterior and interior renovations in order to increase the revenue or decrease expense. These renovations are different than the ones performed on a distressed apartment. Typical ways to add value are updating the unit interiors to achieve higher rental rates, adding or improving upon common amenities to increase revenue and competitiveness (like renovating the clubhouse or pool area, adding a dog park, playground, BBQ pit, soccer field, carports or storage lockers), and implementing procedures to decrease operational costs like loss-to-lease, bad debt, concessions, payroll, admin, maintenance, marketing, etc.

Compared to the other two apartment types, value add apartments have a lower level of risk, the highest ongoing returns, and a high upside potential at sale. At acquisition, the property is already stabilized and generating a cash flow. So, at the very least, the property will continue to profit at its current level and your passive investment is preserved. That also means that you will receive an ongoing distribution (typically around 8%, depending on the syndication partnership agreement) during the renovation period. Once the value add projects are completed, the ongoing distribution will increase to the high single digits, low double digits and remain at a similar level until the sale. Additionally, the increase in revenue and decrease in expenses from the value add business plan will increase the overall value of the asset, which means there is the potential for a lump-sum distribution at sale.

 

What’s Your Ideal Passive Investment?

Your ideal passive investment will be in an apartment type with the benefits and drawbacks that align most with your financial goals.

Are you content with tying up your capital for a year or two with minimal to no cash flow and willing to risk losing it all in order to double your investment? Then I would consider passively investing with an apartment syndicator that implements the distressed business plan.

Are you more interested in capital preservation and receiving a return that beats the inflation rate? Then I would consider passively investing in rental properties with an apartment syndicator that purchases turnkey properties.

Are you attracted to the prospect of receiving an 8% to 12% cash-on-cash return each year with the prospect of a sizable lump sum profit after five or so years? Then I would consider passively investing with an apartment syndicator that implements the value-add business model.

Want to learn how to build an apartment syndication empire? Purchase the world’s first and only comprehensive book on the exact step-by-step process for completing your first apartment syndication: Best Ever Apartment Syndication Book.

stop sign

When to NOT Work with a Passive Investor on an Apartment Deal

When I first started raising money from investors to purchase apartment communities, as long as the individual was interested in a passive investment and met the accredited qualifications, I accepted their capital without hesitation. And if you are just launching your syndication career, perhaps you’re doing the same. However, as you begin to gain experience and your list of private investors grows, it is beneficial to be aware of the red flags that may indicate the potential for future disputes and, if necessary, to not add or remove the investor from future new investment offering correspondences.

 

To understand these red flags, it is first important to define the ideal syndicator/passive investor relationship. The typical life cycle of an apartment syndication is 5 years. Therefore, when forming a relationship of this length, I want a passive investor who both trusts me as a person and treats me as a partner, as opposed to considering me as their vendor. Based on my experience from hundreds of accredited investor conversations and completing more than ten apartment syndications, I’ve found that there are two main factors that indicate to me that our relationship will not meet these requirements.

 

Red Flag 1 – Contempt

 

A famous study published in 1998 by marriage researcher John Gottman videotaped newlywed couples discussing a controversial topic for 15 minutes with the purpose of measuring how the fought over it. Then, three to six years later, Gottman and his team checked in on these couples’ marital status – were they together or were they divorced? As a result, they determined that they could predict with an 83% accuracy if newlywed couples would divorce. The study found that there are four major emotional reactions that are destructive to marriages and of the four, contempt is the strongest.

 

If there is contempt in a marriage, it will not last. And I believe that the same applies to business relationships.  According to Dictionary.com, contempt is the feeling that a person or a thing is beneath consideration, worthless, or deserving of scorn.

 

How I identify contempt is based on my initial gut reaction. Do I get the feeling that this person sees me as an equal and as a partner? Or do they look down on me and see me as a vendor? For example, I recently had an email correspondence with a potential investor. He led off the conversation by saying, “My standards are high. My patience for slick marketing is low.” Then, after I provided him some information about my company, including past case studies of the returns I provided to my investors, his reply was, “So what I need to hear is why do some deals with you as opposed to (the company with which he currently invests)?” I felt that this individual’s replies had traces of contempt and politely explained that we wouldn’t be a good fit. If I was earlier on in my career, I would have likely brought this individual on as a partner, but since I already have strong relationships with my current investors, I didn’t find the potential issues worth pursuing the relationship any further.

 

If you are having a conversation with an investor and your gut is telling you that this person holds you in contempt, I would consider passing on the relationship. To set the relationship up for success, only work with investors who treat you as an equal and who want a mutually beneficial partnership.

 

Red Flag 2 – Lots of accusatory questions that don’t convey that they trust me

 

The second red flag I’ve come across is when a potential investor asks a laundry list of questions in an accusatory tone. For example, I have an investor who literally sends me a list of 50 or more questions that are written in an accusatory fashion for every new investment offering. After taking the time to answer each question on multiple deals, they have yet to invest. Because they are asking questions in that manner, regardless of my answer, they will still be suspicious.

 

An important distinction to make here is that I have no issue with my investors sending me a list of questions, no matter how long. In fact, that is encouraged, because the more information I can provide about the deal, the more confidence they will have in the investment. The red flag is when the questions are asked in an accusatory manner. That conveys that they don’t have trust in me and that they’ll likely never invest in a deal. At the end of the day, the key to a successful, long-term relationship is trust, and when my instincts are telling me that there is a lack of trust, I decide to no longer pursue the relationship.

 

Conclusion

 

The two red flags to look for when having conversations with investors is contempt and the asking of a long list of questions in an accusatory tone that conveys that they don’t trust me.

 

Keep in mind that both these factors are highly subjective. Each syndicator and each investor has a different personality and will get along with different types of people. Just because you get the feeling that someone holds you in contempt or asks questions in an accusatory tone does not mean that they are a bad person. However, what it does indicate is that you will have an issue connecting in such a way that builds a relationship that is capable of surviving the course of a syndication deal. So, if either of these red flags arise, be polite, but strongly consider not working with that investor on your apartment deal.

 

If you have had a rocky business relationship in the past that came to an unfortunate end, what did you identify as the cause?

 

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If you have any comments or questions, leave a comment below.

 

 

aparment real estate from the ground

The 3 Secrets to Attract and Keep Your Passive Apartment Investors

Before raising money for my first deal, I thought the primary reason accredited investors would passively invest in my deal would be because of the return. However, after raising $1 million for that deal, I discovered that the return on investment was not the major concern. Because there are other syndication and investment avenues to which an investor can go, offering solid returns cannot be the driving factor.

 

So, if returns aren’t their primary motivation, what is?

 

Since my first deal, I’ve partnered with hundreds of accredited investors on more than ten apartments communities worth nearly $200,000,000. From this experience, I have narrowed down the passive investors’ three primary reasons for investing in an apartment syndication:

 

  • My money is in good hands
  • I will be updated on relevant information on the deal
  • The process is hassle-free

 

Need #1 – Is my money in good hands?

 

My first need is to know that my money is in good hands. First and foremost, that means I want to know that – at the very least – you won’t lose my money. Billionaire investor Warren Buffett has two rules for investing: 1) Never lose money. 2) Never forget rule number 1. Therefore, your main focus when managing other people’s money should be capital preservation.

 

Like any investment, there are never guarantees – not for returns or the preservation of capital. So, I need to know that you are proactively mitigating any major risks. The syndicator accomplishes this by adhering to the three principles of apartment investing:

 

  • Don’t buy for appreciation
  • Don’t overleverage
  • Don’t get forced to sell

 

Follow these three principles and I will be confident that you will not only preserve my capital, but maximize my return as well.

 

Along with this, I want to know that my money is in the hands of an experienced syndicator. So, before you’re ready to raise money for your first deal, you must establish a solid educational foundation and have a track record in business and/or real estate. If you are lacking in either or both of these areas, you can make up for your deficiencies by surrounding yourself with a trustworthy, credible team, like a mentor, property management company and broker who have experience in the apartment industry and have successfully completed syndications. For me to invest in your deals, I must be confident in you and your team’s ability to return my capital and provide me with the projected return.

 

I also need to trust you as a person. I need to have a good feeling about you and truly believe that you have my best interests in mind. This trust is established by the length and quality of our relationship and by you demonstrating your expertise through your experience, your team or your thought leadership.

 

With this trust, I will be confident that you will have common sense, make good decisions, conservatively underwrite the deal, perform all the required due diligence before purchasing an apartment and at a minimum, meet the projected returns you outlined.

 

Finally, I want to know that you are a responsive communicator. If there is a problem with the deal, I want you to not only notify me of the issue, but have a proposed solution as well. And if I reach out to you with a question or concern, I expect that same lightning quick response with an answer.

 

Overall, I want to know that my money is in good hands. The syndicator will convey this to me by proactively mitigating the risks, having the relevant experience, building a trusting relationship and being a responsive communicator.

 

Need #2 – Will I be provided with status updates on the deal?

 

Additionally, I want to be provided with ongoing status updates of the project. On a consistent basis, I want a director level – not a CEO or entry-level employee level – update on the deal with supporting data.

 

To accomplish this, the syndicator needs to provide their investors with a monthly email update (I use MailChimp) that includes the following information:

 

  • Distribution details
  • Occupancy and pre-leased occupancy rates
  • Actual rents vs. projected rents
  • (If you are a value add investor) actual rental premium vs. projected rental premiums
  • Capital expenditure updates with pictures of the progress
  • Relevant market and/or submarket updates
  • Any issues, plus your proposed solution
  • Any community engagement events

 

Then, on a quarterly basis, provide me with the profit and loss statement and rent roll so if I want, I can review the operations of the property and dig deeper into the details. My company actually provides monthly distributions – as opposed to quarterly or annual distributions – so our investors are not only provided with updates on a monthly basis, but are paid as well.

 

Need #3 –  Is the process hassle-free?

 

Finally, I want a hassle-free process. The reason I am a passive investor is because I want to park my money in an investment and not have to worry about doing any of the day-to-day operations. I am busy making money with other business endeavors, so I want to minimize my time investment in the deal.

 

After performing my initial due diligence on the deal prior to investing, I want a boring investment with little to no surprises. All I want to do is read the monthly email updates and receive my distributions. So, to effectively provide investor distributions, set up a direct deposit, as opposed to sending checks in the mail, so all I need to do is look at my bank account rather than going to the bank each month to deposit a check.

 

If I do reach out with a concern, I want a quick resolution with minimal back and forth. Therefore, you should proactively address potential concerns in your monthly updates and if an investor has a concern, have a solution in place prior to replying.

 

Conclusion

 

In summary, I’ve completed nearly $200,000,000 worth of apartment syndications with hundreds of passive investors, and if you set your business/deals up so your investors answer YES to these 3 questions, you’ll be well on your way to closing more deals:

  • Is my money in good hands?
  • Will I be provided with status updates on the deal?
  • Is the process hassle-free?

 

If you use private money investors for you deals, what have you found to be their top motivations for investing with you and not with another qualified investor?

 

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If you have any comments or questions, leave a comment below.

 

 

 

chic apartment buildings

3 Essential Factors of Diversification in Passive Real Estate Investing

Jeremy Roll, who is currently an investor in more than 70 deals across over $500 million worth of real estate and business assets, is one of many speakers who will be presenting at the 1st annual Best Real Estate Investing Advice Ever Conference in Denver, CO February 24th to 25th.

In a conversation with Jeremy last year, he provided his Best Ever Advice, which is a sneak preview of the information he will be presenting at the conference.

 

What was Jeremy’s advice? He explains the three essential factors to take into account when approaching diversification in passive real estate investing – geography, asset-class, and operators.

 

Geographic Diversification

 

Some investors like to invest locally, which can be defined as a location that is within an hour or two-hour drive. Others will invest out-of-state, but all in one sub-market. There are thousands of different ways to invest and most of them are effective. However, there is a problem with having all of your properties concentrated in one geographic location: you are much more susceptible to economic, weather, and other geographically related risks.

 

If there is a major earthquake, for example, and you own 10 properties within 3 miles of each other that are all destroyed, you are in trouble. I know this is an extreme example, but it is still a risk. Since earthquakes and similar risks are such a rarity, Jeremy calls them 1% risks.

 

In last months of 2016, Florida was hit by hurricanes, which most likely had a major affect on some real estate. While it might be okay to own real estate in Florida, if you were heavily invested in one Floridian location and one hurricane wiped out half of your properties, again, you are in trouble.

 

Another weather related example – Jeremy invests in six different funds with some very large mobile home park operators, with one being the 5th largest in the world. This operator shared a story about why they have no issue with investing in areas that have tornados, but they avoid hurricane areas. The reasoning was that when a hurricane hits, it typically wipes out a massive territory. As a result, the different governmental agencies and insurance companies are too overwhelmed and can’t handle it, so it takes forever to repair the damage. But for tornadoes, a more isolated area is affected, so FEMA will come in immediately and help. Isolated areas are much more manageable. In this specific situation, these mobile home operators had all of their homes that were damaged or destroyed by a tornado replaced for free. The lesson here is that tornados are manageable and hurricanes are unmanageable.

 

Besides weather related risks, another reason to diversify across different geographical areas is that each has it’s own unique economies and as a result, it’s own unique challenges. If you are invested in a city that relies heavily on a specific employer and they decide to relocate their plant across the country, you are in trouble.

 

There are countless other examples, so all in all, it is important to spread your investments out across different geographical areas.

 

Asset-Class Diversification

 

It is also important to diversify across different asset classes, both from an asset-type and tenant perspective. For example, Jeremy won’t invest in apartments unless they are 100 units of more. For a 100 unit building, when one person leaves his vacancy rates increases by 1%. On the other hand, if you invest in a 4plex and one tenant leaves, your vacancy rate increases by 25%!

 

Diversifying across asset-types is key because certain types perform better in a growing economy while others perform better, or are at least more manageable, during a downturn. For example, office and retail don’t perform as well during a good economy, but can go through a recession relatively well. Specifically, retail with anchor tenants – big grocery stores, CVS, Walgreens. Mobile home and self-storage – can perform even better during a down turn. In 2009, self-storage vacancy only increased by 1%. This is probably due to the increase in demand that came from homeowners who were foreclosed on and needed a place to store all their personal belongings.

 

In the long-term, you want to be as diversified as possible. In doing so, whether we are in a good economy or a bad economy, the cash flow is still going to come in. This is especially important if, like Jeremy, you are dependent on cash flow to live off of.

 

Jeremy does not recommend that you invest in every asset class. For example, he personally doesn’t invest in hotel or industrial space. On average, these asset classes tend to do really well in an upturn or positive economy. However, they tend to have really quick revenue reductions during a downturn. He doesn’t want to be exposed to that volatility.

 

Therefore, it is important that you diversify as much as possible, but make sure that you are comfortable and knowledgeable in all the asset classes you select.

 

Operator Diversification

 

Whenever you invest passively, you are trading control for diversification. You are giving someone else control of the day-to-day operations and you are probably investing with multiple different investors, so your control is minimized. Therefore, if you are going to give up control, you better trade it for diversification. Jeremy finds that there is always a 1% risk with operators, due to the possibility of mismanagement, fraud, a Ponzi Scheme, etc. You are increasing your risk inherently by being a passive investor. To mitigate that risk, diversify across operators. Don’t have too many eggs in one basket.

 

Everyone has their own take on the maximum exposure an investor should have in terms of number of operators. The common number that Jeremy sees is that people don’t like to be exposed to an operator with more than 5% to 10% of their total capital. The same applies to geography and asset-classes as well.

 

It is also important to keep in mind that proper diversification takes a long time, but it is the best way to reduce risk. The more diversified, the better. Jeremy recommends that you shouldn’t invest more than 5% of your capital into an opportunity. This means that your goal should be to diversify across at least 20 different opportunities. At that point, you can determine how many operators you are comfortable with – 1, 3, 5 or more, depending on the person. It is very subjective and depends on what you are comfortable with.

 

Conclusion

Diversification in real estate investing is a must to ensure long-term success and reduce risk. Jeremy Roll diversifies his investments by keeping three essential factors in mind:

  1. Geography
  2. Asset-class
  3. Operators

 

Jeremy believes your ultimate investment goal should work towards investing no more than 5% of your overall capital into a single opportunity and to expose no more than 10% of your capital to a single geography, asset-class, or with a single operator.

 

 

What are some stories of problems you have come across that were a direct result of not being diversified enough?

 

 

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Related: Best Ever Speak Brie Schmidt Sneak Peek How to Avoid the Shiny Object Syndrome in Real Estate Investor

 

Related: Best Ever Speaker Kevin Bupp Sneak Peek Lessons Learned From Losing Everything During the Financial Crash

 

Related: Best Ever Speaker Theresa Bradley-Banta Sneak Peek Don’t Invest in Real Estate on Unfounded Optimism and Emotions

 

Related: Best Ever Speaker Linda Libertore Best Ever Success Habit of the Nation’s #1 Landlord Aid

 

Related: Best Ever Speaker Kevin Amolsch Why Moving at a STEADY Pace is the Secret to Real Estate Success

 

Related: Best Ever Speaker Bob Scott and Jimmy Vreeland How to Acquire over 100 Properties in 24 Months Utilizing the Lease-Option Strategy

 

 

two tall buildings from the ground

The Importance of Diversification in Passive Real Estate Investing

Putting all of your eggs into one basket can be very dangerous in real estate investing. Jeremy Roll, who currently invests in more than 70 opportunities across over $500 million worth of real estate and business assets, is a firm believer in creating a diversified investment portfolio. In our conversation on the podcast, he explains how he personally approaches diversification by breaking it down into the 3 most essential pieces – geography, asset-class, and operators.

 

Geography Diversification

 

Some investors like to invest locally, somewhere that they can drive to within an hour or two. Others will invest out-of-state, but all in one sub-market. Everyone has their different investment strategies and most of them are effective. However, the problem with having all of your properties concentrated in one geographic location is that you are much more susceptible to weather and economic related risks.

 

For example, if there is a major earthquake (or volcanic eruption) and you own 10 properties within 3 miles of each other that are all destroyed, you are in trouble. While this is extreme, it is still a risk (Jeremy calls these 1% risks).

 

Certain parts of the United States, like Florida, are frequently bombarded with hurricanes, which have a major impact on real estate. While it might be okay to own real estate in Florida, if you were heavily invested in one Floridian location and one hurricane wipes of half of your properties, again, you are in trouble. On a related note, if you are impacted by a hurricane, make sure you follow the SOS approach, especially when you have private investors.

 

Another weather related example – Jeremy invests in 6 different funds with some very large mobile home park operators, with one being the 5th largest in the world. This operator shared a story about why they have no qualms with investing in areas that have tornados, but they avoid hurricane areas. The reasoning was that when a hurricane hits, it typically wipes out a massive territory. As a result, the different governmental agencies and insurance companies are too overwhelmed, so it takes forever to repair the damage. Whereas for tornadoes, a more isolated area is affected, so FEMA will come in immediately and help. Isolated areas are much more manageable. In this specific situation, these mobile home operators had all of their homes replaced for free. The lesson here is that tornados are more manageable than hurricane.

 

Asides from weather related risks, another reason to diversify across different geographical areas is that each has it’s own economies and applicable challenges. If you are invested in a city that relies heavily on a specific employer, if they decide to relocate their plant across the country, you are in trouble. Job and economic diversity is just one of the many factors to look at when selecting a target market.

 

There are countless other examples, so all in all, it is important to spread your investments out across different geographical areas.

 

Asset-Class Diversification

 

It is also important to diversify across different asset classes, both from an asset-type and tenant perspective. For example, Jeremy won’t invest in apartments unless they are 100 units of more. If one person leaves, his vacancy rate increases by 1%. On the opposite end, if you invest in a 4plex and one tenant leaves, your vacancy rate increases by 25%.

 

Diversifying across asset-types is key because some perform better in a growing economy, while others perform better, or are at least more manageable, during a downturn (and, of course, you should always follow the Three Immutable Laws of Real Estate Investing to thrive in any market condition). For example, office and retail don’t perform as well during a good economy, but can remain consistent during a downturn – specifically, retail with anchor tenants like big grocery stores, CVS, Walgreens, etc. Mobile home and self-storage can perform even better during a down turn. In 2009, self-storage vacancy only increased by 1%. This is due in part to the increase in demand that came from homeowners who were foreclosed on and needed a place to store all their items.

 

In the long-term, you want to be as diversified as possible. In doing so, if we are in a good economy or a bad economy, the cash flow is still going to come in. This is especially important if, like Jeremy, you are dependent on passive cash flow to live off of.

 

Jeremy does not recommend that you invest in every asset class. He doesn’t invest in hotel or industrial space, for example. On average, these asset classes tend to do really well in an upturn or positive economy. However, they tend to have really quick revenue reductions during a downturn. He doesn’t want to be exposed to that volatility. Therefore, it is important that you diversify as much as possible, but make sure that you are comfortable in all the asset classes you select.

 

Operator Diversification

 

Whenever you invest passively, you are trading control for diversification. You are giving someone else control of the day-to-day operations and you are probably investing with multiple different investors, so your control is minimized. Therefore, if you are going to give up control, you better trade it for diversification. Jeremy finds that there is always a 1% risk with operators, due to the possibility of mismanagement, fraud, a Ponzi Scheme, etc. You are increasing your risk inherently by being a passive investor. To mitigate that risk, diversify across operators. Don’t have too many eggs in one basket.

 

Everyone has their own take on maximum exposure an investor should have in terms of number of operators. The common number that Jeremy sees is that people don’t like to be exposed to an operator with more than 5% to 10% of their total capital. The same applies to geography and asset-classes as well.

 

It is also important to keep in mind that proper diversification takes a long time, but it is the best way to reduce risk. The more diversified, the better. Jeremy recommends that you shouldn’t invest more than 5% of your capital into an opportunity. This means that your goal should be to diversify across at least 20 different opportunities. At that point, you can determine how many operators you are comfortable with – 1, 3, 5 or more, depending on the person. It is very subjective and depends on what you are comfortable with.

 

 

What about you? Comment below: What are some stories of problems you have come across that were a direct result of not being diversified enough?

 

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