How Passive Is Passive Investing, Really?

The truth of the matter is that no one cares about your money more than you do.  Therefore, you need to put in time and effort to maximize your passive investment opportunities and minimize your risks.

I used to think there were some investments that were 100% passive.  I literally thought, I could set it and forget it when it came to passive investing.  Although multifamily syndication investing is incredibly passive and provides investors with the benefits of real estate ownership without the hassle of actually managing the property, there is still due diligence required as a passive investor.

Nobody should relax and not watch their investment, and as a passive investor you need to educate yourself on your investment.  In reality, you will spend most of your time as a passive investor vetting the opportunity upfront, but once you learn these key questions to ask when evaluating an apartment deal, your passive investment opportunity will require very little time and provide you with mailbox money and time to pursue other interests!

Now…how do you evaluate a passive multifamily opportunity?

If you’ve made the decision to put your money in multifamily as a passive investor, there are a number of questions you should ask any syndicator who’s pitching a deal so that you can properly:

  • Vet the integrity of the sponsor and their team,
  • See if their overall investment strategy fits with your goals, and
  • Learn more about the market where a potential investment is located.

In a perfect world, the answers to most of these questions will be found in their offer package. In fact, I would hesitate to invest with a team that doesn’t provide most of this information up front. But use this section as a guide to help you understand what additional questions you may need to ask and how to make an informed investment decision.

Vetting the Sponsor Team

Here are the questions to ask your sponsors and some of the answers to look for.

Why should I invest with your company? What differentiates you from other apartment syndicators?

The passive investors who choose to invest with us at Crown Capital do so because of our conservative approach, transparency, and trustworthiness.  Unlike some other sponsors, we’re conservative when we underwrite deals to protect our investors from any type of market correction. We have plenty of reserves at closing and grow that reserve while we hold the property. We always buy for cash flow from day one and use long-term debt to ride out a recession if necessary, and we’re projecting higher interest rates (and lower values) when it’s time to sell.

We are transparent, sending investors progress reports around the status of our business plan. We also make ourselves available to our passive investors, responding to email within a few hours, if possible.  We also align our interests with our passive investors. Each Crown Capital GP invests capital in each deal. We become investors alongside our passive investors which helps to achieve alignment of interests.

Finally, we build trust with our passive investor community by way of an educational platform. I lead over 50 real estate investor meetups nationwide and in Canada, host monthly and quarterly meetups, hold multifamily bootcamps and make myself available to investors.  I consistently engage with prospective investors, so they tend to feel like they already know me through these means.  And I’ve created this resource to help you make better decisions about investing in multifamily syndications!

The reasons why you trust one GP with your money over another is, of course, based on your personal preferences, so look for one who aligns with your goals and makes you feel comfortable.

Who’s on your team?

Having the right team in place to run a property is crucial to the performance of multifamily. If you are dealing with an inexperienced or incompetent operator, they are liable to make mistakes. Mistakes that can cost you a lot of money. To mitigate the risk, learn about the background and experience of the real estate attorney, mortgage lender and CPA the sponsor works with.

Most importantly, ensure that their property manager has a strong track record. How many units do they manage? How long have they been in business? Has the GP worked with them before? Do they have tenant screening systems in place? What is their policy around routine maintenance and inspections? How well do they communicate with renters and ownership?

The property management team plays a fundamental role in finding the right tenants and maintaining the property—which translates to consistent cash flow and the ultimate success of your investment.

Do you use the same property management company for all your properties?

The benefit to GPs who work with a single management company is that processes are streamlined, and reporting is consistent.  On the other hand, a GP may need to use more than one property management company if they source deals in multiple markets. If this is the case, ask if they are using a single asset manager across all their properties and get to know that individual’s experience and track record.

Who is my point person?

You should have a point of contact in the general partnership to reach out to with questions or concerns. Best case, they are an experienced team member who is actively involved in the deal.

Evaluating the Sponsor’s Investment Strategy

Here are some questions to bring to your sponsor regarding the investment strategy:

How do you source deals?

GPs can look for on-market deals (advertised publicly on the MLS) or find them off-market through a broker. The benefit to off-market deals is that they are less competitive and leave more room for negotiation—which translates to better purchase terms and higher cash-on-cash returns.

What is your reporting or communication schedule?

Perhaps the most crucial trait to look for in a deal sponsor is strong communication or ‘investor relations.’   We send monthly updates to our investors; however, some GPs provide quarterly or annual reports.  The information included in an update will vary from GP to GP. Our monthly reports include occupancy rates, updates on the number of renovated units, details on our rental premiums and how they compare to our projections, capital expenditure updates, relevant updates on the market, and resident events.  Generally speaking, you want to stay on top of the investment’s performance and be informed right away should things not go according to plan.

Can you guarantee a return?

If you’re dealing with a credible GP, the answer to this question will be no. Any return they offer should be a projection rather than a promise.

What is your policy for establishing reserves to cover potential shortfalls? How much capital are you setting aside for reserves each year?

The GP should ALWAYS have a contingency fund to cover shortfalls, especially if they do value-add or distressed deals that require renovations.

Syndicators should also have money set aside to cover unexpected dips in occupancy or unforeseen maintenance issues.  A smart GP will save $250-300 per unit per year, minimally, for reserves to cover shortfalls or unexpected CapEx projects. (If they fail to do this and unforeseen expenses pop up, they may come to you for additional capital.)

How do you make money on a deal?

Usually, GPs receive an acquisition fee and earn money for ongoing asset management and equity ownership.  The GP should only charge fees based on the value they provide, but it is up to you to keep them honest! (The GP’s comprehensive list of fees should be included in the PPM for any given deal.)

What are the major risks associated with this project?

Beware of a GP who claims that there are no risks. A competent syndicator should be familiar with any potential issues related to the deal itself, the market, or their team—and have a plan in place to mitigate those risks.

Have you inspected the major systems of the multifamily property?

The GP (or qualified member of their team) needs to have examined the plumbing, roof, siding, windows and HVAC themselves, rather than relying on the current owner or a real estate broker for accurate information. This is important in putting together the capital expenditures budget, and if one or more of these things needs work, that is a risk you need to be aware of.

How long will my money be tied up in the deal?

The GP should have a projected timeline and be able to articulate the hold period and exit strategy for the project at hand. An “exit” could be a cash-out refinance (where most or all of the investor’s principal is returned) or an outright sale. Multifamily business plans typically take 3 to 7 years to execute.

What is the minimum investment?

A GP’s minimum investment tends to increase with their experience and/or the size of the project. Ask this question early on so you know whether you have the necessary capital to participate in the deal.

Understanding the Market

What factors do you use to qualify a market and what attracted you to the market(s) where you currently invest?

The market factors a GP should consider include unemployment, population growth, demographics, job diversity, top employers, and supply + demand. You’re ultimately looking for a market that is growing.

Is the market fairly stable? Or is it subject to strong up and down cycles? We prefer to avoid volatile markets and focus instead on stable markets that performed well in the last recession, which allows us to produce consistent and predictable returns for our investors.

What is the median income in this particular market?

Understanding the median income of an area is crucial in determining if prospective tenants make enough money to support the rent projections for a property. People typically spend 25% to 35% of their annual income on housing, so you can use the Census Bureau data to verify that median income is 3 to 4 times more than the annual projected rent.

What is the market vacancy rate and how was it calculated?

It is important to know the average vacancy rate (the # of unoccupied units divided by the total # of units in a multifamily building) in any market you are considering, so you can compare it to the assumed vacancy rate for a specific deal.

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