Are you searching for the best passive investment opportunities? Passive multifamily real estate investing is a tried-and-true method that lets you take advantage of real estate’s stability without the direct responsibilities of being a landlord. Steady cash flow and tax advantages are just a few of the great things about investing passively!
However, not all investments are equal, and many investors don’t know how to evaluate the quality of a passive investment opportunity.
When looking at properties, many people tend to only look at returns – but there are other parts to the puzzle! Here is our top advice for finding passive investment opportunities that will serve you well for years to come.
Know how to mitigate risk
Real estate is generally considered to be a low-risk investment in most cases. Property values can generally be trusted to increase year after year, and multifamily has historically performed better than many other asset classes during recessions.
That being said, no investment is devoid of risk, even if you’re working with a company that does everything it can to protect investors. So, what are the specific risks of the deal that you’re considering? And what is the operator of the deal doing to mitigate the risks?
There are different styles of underwriting, from aggressive to conservative. It’s often a good idea to work with a company that underwrites its deals conservatively. This gives you a margin of safety so that you can make more realistic plans. It’s smart to be conservative when it comes to debt structure, income projections, and budgeting for capital expenditures. This is far better than working with a company that will overpromise and underdeliver.
Understand cap rates
When looking for conservative underwriting, the capitalization rate – or cap rate – is one of the most important numbers to look at. This number helps to determine the value of the multifamily real estate property. Cap rate is calculated by dividing the property’s net operating income by its current market value.
The cap rate will depend heavily on how the market is doing, so it is subject to change over time. In many markets, the cap rate will be around 6%. Most likely, the cap rate will hold steady, but good financial projections will usually build in a margin of safety by projecting slightly lower cap rates in the future. Be wary of financial projections that show a steady cap rate 5 years in the future. While this is likely, it should not be promised. And, be especially wary if the cap rate is even lower in the financial projections.
Ask about reserves, cash flow management, and rent growth
Always make sure that there will be reserves at closing. In other words, make sure that there’s plenty of cash left at closing for renovation costs and a “safety net” for any unforeseen circumstances.
Ask about cash flow management and be sure that the company operating the deal operates above the line. In other words, ensure that they calculate the net operating income with plenty of room to take money out without hurting the bottom line. Keep in mind that this will reduce returns on paper, but it’s actually a good thing! You want to be wary of returns that seem too high to be true.
Also inquire about rent growth. When you’re investing in multifamily, the goal is to increase profit over time by improving the property and raising rental rates accordingly. Rent growth is definitely something that you’ll want to count on. Just be aware that it will take time. There’s no way to promise rent growth within the first year, because that would involve kicking out all the tenants and renovating the building instantaneously… which is clearly not realistic! Expect rent bumps to start no earlier than year two or three.
Work with a trusted syndicator
If you have already found a company that you want to work with, does the operator or syndicator of the deal have the chops for property management and passive investing? It takes a team of knowledgeable people to manage properties and make solid investment decisions. Make sure to find a team you can rely on with confidence!
Ask the syndicator questions. What’s their strategy for picking a good market, finding great deals, and operating multifamily properties to their highest potential? Will they conduct thorough due diligence? Do they take a scientific approach to real estate investing? Do they have good references from mentors or from real investors in their syndication? How will they work to protect their investors?
A trustworthy operator or syndicator will often put their money where their mouth is by passively investing in their own deals. You may want to consider working with someone who trusts their process well enough to invest in it themselves.
If the company is a large group of partners or a joint venture, then you may want to find out who has the bulk of the decision-making power in the group and determine whether they have a good track record. Property managers, attorneys, and board members are all important parts of the team.
And lastly, it is very important that the sponsor is willing to guide you through the passive investing process and answer all your questions with transparency. This will help you decide whether this is the right deal for your specific needs. If you’re putting your hard-earned money into the venture, you deserve to understand the process fully.
Go forward with confidence!
As you can see, the best passive investment opportunities will always come down to the syndicator of the deal. There’s no substitute for finding a good syndicator who will answer all your questions, make smart and educated decisions, and work to protect their investors.
A little bit of knowledge goes a long way when it comes to selecting a long-term partnership with a multifamily syndicator. When you’re prepared to ask questions and delve into the financials, you can confidently select the investment that is right for you!