STEPS WHEN REVIEWING A PASSIVE REAL ESTATE INVESTMENT OPPORTUNITY

Real estate investors need to be aware of the risks of investing in private real estate deals. I’ve create a real estate crowdfunding investor checklist and compiled a list of 10 questions to ask sponsors prior to investing in a deal.

In this post Jeremy Roll, who’s been a full-time passive income investor for the past 13 years and invested into more than 50 separate opportunities, shares his top 10 steps when reviewing a passive real estate investment opportunity.

Enter Jeremy:

Disclaimer: Jeremy is not a Financial Advisor. Everything he is sharing below is from his perspective as a passive investor with over 13 years of experience.

Passive investments can be a great way to diversify your investment portfolio and those that provide cash flow, in particular, can truly be life-changing. For example, I was able to leave the corporate world in 2007 thanks to cash flow from passive opportunities after I moved all of my savings from unpredictable stocks and bonds into more predictable low-risk passive cash flow opportunities. But, while passive investments can be great, some are definitely more attractive than others and some are outright bad opportunities that present high risks for investors. From aggressive projections to less-than-conservative assumptions, there are many opportunities out there that investors should avoid, which is why it’s absolutely critical that any passive investor be able to properly evaluate the merits and risks associated with an opportunity so that they can make a well-informed investment decision. And if you’re a relatively new investor reading this then I would strongly caution you not to participate in any passive opportunity until you’re 100% confident you can evaluate all of the merits and risks associated with it.

With that in mind, here are the Top 10 steps (in my experience) when reviewing a passive real estate opportunity / syndication:

1. Determine whether the type of opportunity you’re reviewing (development, value-add, stabilized) is the right fit for you. The first thing to consider when reviewing a passive opportunity is whether it’s the right profile for you. For example, while I strongly prefer lower-risk stabilized opportunities, you might prefer a high-risk but higher-return opportunity like a development opportunity. If the opportunity isn’t the right profile for you then you will probably want to move on to the next one.

2. Assess the experience level of the Manager(s). If the opportunity is the right profile for you then the next step is to evaluate the experience level of the Manager(s) to ensure that they are experienced enough for you. While there are clearly many exceptions to this rule (ie. someone you know well and trust, a particularly attractive opportunity, etc), generally more experienced Managers have a higher probability of success than beginners so this is something important to consider. Bonus tip: While there are many exceptions to this rule, the wealthier the Managers the more likely it is that they will be able to help (financially) if something doesn’t go as planned, which essentially means that wealthier Managers have a higher probability of success if more capital is needed than originally planned.

3. Search for a preferred return. Most experienced passive investors will tell you that they won’t consider a passive opportunity unless it includes a preferred return for investors. A preferred return essentially ensures that investors will receive the first portion of any available profits available for distribution before the Manager(s) get their split and therefore helps investors to recoup their original investment as a priority. Preferred returns can vary depending on the experience level of the Manager(s) but the most common preferred return is 8%. Anything above that is considered particularly favorable for investors and anything below that is a potential yellow flag for investors (at least for cash flowing opportunities). Use extreme caution when considering an opportunity that does not have a preferred return for investors unless the profit splits are immensely favorable for investors (see the next point for more on profit splits).

4. Review the profit splits. Profits splits are arguably one of the biggest factors that will determine your return on investment (ROI) and are therefore a very important item to review when considering a passive opportunity. Profits splits vary depending on the experience of the Manager(s) and how much work they have to do throughout the projected lifespan of the opportunity. For example, Managers typically have much more work to do for a ground-up development compared to a stabilized existing property so they would normally command a larger profit split for the former. The maximum profit split you should consider is 50/50 and it’s unlikely you will find a better profit split than 80/20 (in favor of investors). Be sure that the opportunity falls within this range and is a fair split when taking everything into account compared to other opportunities. Bonus Tip: Some opportunities have more than one “level” of splits, as is the case when someone pools investors together and then invests the proceeds in an opportunity they aren’t directly managing (aka “joint venture”), so be sure to consider your split net of both levels (each level will likely have its own split) to ensure that it falls within the range (both levels of splits aren’t always disclosed so you might need to ask for them). If the investor’s net profit split falls below 50% then that would raise a red flag that you’ll need to seriously consider.

5. Look for conservative assumptions in the projections (aka Pro Forma). One of the best ways to quickly understand whether you’re dealing with conservative or aggressive Manager(s) is to review the assumptions that they used in the Pro Forma, as the assumptions will allow you to get a much better feel for the likelihood that the opportunity will perform as projected. Remember, your goal is to find a conservative Manager who is using conservative assumptions so they can under-promise and over-perform to build long-term relationships with you and other investors (not the other way around!). If the assumptions are aggressive then you might want to pass on the opportunity.

6. Assess the Manager’s business plan and overall strategy. Understanding and assessing the Manager’s business plan and overall strategy is absolutely critical, as you may or may not agree with the proposed plan for the property. For example, if you’re reviewing a ground-up development of an apartment complex that will be comprised entirely of 1 bedroom units and you believe the surrounding area is mostly comprised of families who need 2 or 3 bedroom units then you might want to pass on the opportunity. While most experienced Managers will propose a business plan and strategy that makes sense for the asset class associated with a specific opportunity, it’s always best to take the time to review the business plan and strategy to ensure that you agree with what the Manager is proposing. After all, it only makes sense to invest in an opportunity that you think makes sense!

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