{"id":164294,"date":"2024-01-08T16:33:38","date_gmt":"2024-01-08T23:33:38","guid":{"rendered":"https:\/\/www.biggerpockets.com\/blog\/?p=164294"},"modified":"2024-01-19T08:12:08","modified_gmt":"2024-01-19T15:12:08","slug":"biggest-risk-to-passive-real-estate-investors","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/biggest-risk-to-passive-real-estate-investors","title":{"rendered":"Do You Know What Your Number One Risk Is as a Passive Investor? It&#8217;s Fraud"},"content":{"rendered":"\n\n      <iframe loading=\"lazy\" frameborder=\"0\" height=\"200\" scrolling=\"no\" src=\"https:\/\/playlist.megaphone.fm\/?e=BIGPOC6015716075\" width=\"100%\"><\/iframe>\r\n  \n\n\n\n\n<p><span data-preserver-spaces=\"true\">You\u2019re undoubtedly wondering what the answer to this question is. I was, too.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">As a due diligence partner for over 800 investors, we think about&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/what-are-investors-ignoring\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">risks<\/span><\/a><span data-preserver-spaces=\"true\">&nbsp;all the time. Since our default is to say no, we probably think about risks more than most people do.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">In&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.amazon.com\/Road-Less-Stupid-Keith-Cunningham\/dp\/0984659269\" target=\"_blank\" rel=\"noopener\"><em><span data-preserver-spaces=\"true\">The Road Less Stupid<\/span><\/em><\/a><span data-preserver-spaces=\"true\">, author Keith Cunningham says (I\u2019m paraphrasing):<\/span><span data-preserver-spaces=\"true\">&nbsp;<\/span><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong><span data-preserver-spaces=\"true\">Rookie investors:&nbsp;<\/span><\/strong><span data-preserver-spaces=\"true\">\u201cHow much can I make?\u201d<\/span><\/li>\n\n\n\n<li><strong><span data-preserver-spaces=\"true\">Seasoned investors:<\/span><\/strong><span data-preserver-spaces=\"true\">&nbsp;\u201cHow much can I lose?\u201d<\/span><\/li>\n\n\n\n<li><strong><span data-preserver-spaces=\"true\">Professional investors:<\/span><\/strong><span data-preserver-spaces=\"true\">&nbsp;\u201cCan I afford to lose that much?<\/span><\/li>\n<\/ul>\n\n\n\n<p><span data-preserver-spaces=\"true\">We believe the best investors think about risk more than return.&nbsp;<\/span><\/p>\n\n\n\n\n\n\n  <div class=\"lg:block\" x-data=\"{ ad_block_block_659c85f46f8ab: popAds(1) }\">\n      <template x-for=\"ad in ad_block_block_659c85f46f8ab\">\n        <a\n          :href=\"ad.linkURL\"\n          class=\"no-underline text-black\"\n          x-on:click=\"adClicked('https:\/\/www.biggerpockets.com\/blog\/biggest-risk-to-passive-real-estate-investors', ad.sponsor, ad.title, ad.id, 'blockAdClicked', 'blockAd', '')\"\n          target=\"_blank\">\n          <div\n            class=\"py-4 border-b flex flex-col flex-nowrap text-sm border-t px-0 rounded-none\"\n            x-init=\"\n              analytics.track('blockAdLoaded', {\n                referrer: 'https:\/\/www.biggerpockets.com\/blog\/biggest-risk-to-passive-real-estate-investors',\n                sponsor: ad.sponsor,\n                ad_title: ad.title,\n                ad_page_location: ''\n              })\n            \"\n            x-intersect:enter.once=\"adViewed('https:\/\/www.biggerpockets.com\/blog\/biggest-risk-to-passive-real-estate-investors', ad.sponsor, ad.title, ad.id, 'blockAdViewed', 'blockAd', '')\">\n            <div><span class=\"text-xs text-slate-light block bg-slate-50 p-1 inline-block rounded-md\">Sponsored<\/span><\/div>\n            <div class=\"flex items-center text-sm space-x-4\">\n                <img :src=\"ad.imageURL\" :alt=\"ad.imageAlt\" class=\"h-10 w-10 object-cover rounded-full\">\n\n                <div clas=\"text-sm\">\n                    <span class=\"font-bold block\" x-text=\"ad.sponsor\"><\/span>\n                    <span class=\"text-slate\/80\" x-text=\"ad.description\"><\/span>\n                <\/div>\n            <\/div>\n\n            <div>\n                <span class=\"font-bold\" x-text=\"ad.title\"><\/span>\n                <p class=\"mt-2 text-slate\/80\" x-text=\"ad.body\"><\/p>\n                <span class=\"mt-2 text-themeBlue block mt-2 underline\" x-text=\"ad.linkTitle\"><\/span>\n            <\/div>\n          <\/div>\n        <\/a>\n      <\/template>\n  <\/div>\n\n\n\n\n<p><span data-preserver-spaces=\"true\">Anyway, our due diligence team is constantly assessing risks. We have a 28-point checklist we use to screen operators and deals. And all the actions on that list are attempting to uncover risks\u2014and trying to find reasons to say&nbsp;<\/span><em><span data-preserver-spaces=\"true\">no<\/span><\/em><span data-preserver-spaces=\"true\">.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">So, what is your No. 1 risk as a&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/passive-real-estate-investing\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">passive real estate investor<\/span><\/a><span data-preserver-spaces=\"true\">? Is it:<\/span><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><span data-preserver-spaces=\"true\">Risky levels and structure of debt?&nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Lack of sponsor skin in the game?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Lack of track record in this asset type?&nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Lack of a capable team?&nbsp;<\/span><\/li>\n<\/ul>\n\n\n\n<p><span data-preserver-spaces=\"true\">These are huge risks\u2014and you should analyze every one of them. I\u2019ve heard each of these convincingly argued as the No. 1 risk in real estate investing.&nbsp;&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">But there\u2019s a worse one. Is it:<\/span><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/breaking-down-the-location-location-location-principle-in-real-estate\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">Location (location, location)<\/span><\/a><span data-preserver-spaces=\"true\">?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Lack of cash reserves?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Poor property managers?&nbsp;<\/span><\/li>\n<\/ul>\n\n\n\n<p><span data-preserver-spaces=\"true\">Yes, these are massive risks. But I don\u2019t believe these are the worst risks.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">I think your most significant risk is likely this one:<\/span><\/p>\n\n\n\n<p><strong><span data-preserver-spaces=\"true\">FRAUD!<\/span><\/strong><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Why?&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Because many of your investments will be into great assets, and many of the operators have decent experience, a respectable track record, and a talented team.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">And much of the debt will be safe, while many of the operators will put skin in the game.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Many assets will be in stellar locations. Operators will keep cash in reserve. And property managers will manage well.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">If this is all true\u2014and it is usually at least partially true\u2014your deal is destined to pay you both the return&nbsp;<\/span><em><span data-preserver-spaces=\"true\">of<\/span><\/em><span data-preserver-spaces=\"true\">&nbsp;principal (top priority) plus a return&nbsp;<\/span><em><span data-preserver-spaces=\"true\">on<\/span><\/em><span data-preserver-spaces=\"true\">&nbsp;principal.&nbsp;&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">So why do so many deals fail to do that? Fraud.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">And sometimes, the fraud will never be identified. Some of the bad guys won\u2019t make headlines or go to prison. Sometimes it will result in you receiving 11% rather than the 15% actual returns from the asset.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Because even when everything I just listed goes perfectly well, one fraudulent player can ruin a deal. I know\u2014I was a victim of fraud myself back in 1999.&nbsp; &nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">So, What Can You Do to Protect Against Fraud?&nbsp;<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">Here are some things to consider. Some of these items will be appropriate for all investors. Others will be for larger investors (such as family offices and funds).&nbsp;<\/span><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><span data-preserver-spaces=\"true\">Third-party net operating income audits<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Deep background checks on principals and key staff<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Background checks on other parties in the deal (like small lenders)<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Gut checks<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Reference checks<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Death by Google&nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Review and audit of skin in the game<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Site visits<\/span><\/li>\n<\/ul>\n\n\n\n<p><span data-preserver-spaces=\"true\">After all, you have a lot to protect: your hard-earned capital. It is a massive lift to regain what is lost when the principal evaporates. Fraud can devastate your portfolio, and I don\u2019t want to see this happen to you.&nbsp;&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Final Thoughts<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">Most investors who invest over decades are victims of fraud at some point in their journey. For all our due diligence efforts, it is impossible to know when a good apple will turn bad along the way. So, what can you do to ensure fraud doesn\u2019t permanently wreck your portfolio?&nbsp;<\/span><\/p>\n\n\n\n<p><em><span data-preserver-spaces=\"true\">Avoid concentration through&nbsp;<\/span><\/em><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/how-the-best-real-estate-investors-diversify-their-portfolios\" target=\"_blank\" rel=\"noopener\"><em><span data-preserver-spaces=\"true\">diversification<\/span><\/em><\/a><em><span data-preserver-spaces=\"true\">.&nbsp;<\/span><\/em><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">The most sophisticated investors I know well are obsessed with diversification\u2014which takes a lot of discipline.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Why? Because we have all seen those \u201cdeals of a lifetime.\u201d You know, the deal that couldn\u2019t fail. The game changer that will allow you to retire\u2014<\/span><strong><em><span data-preserver-spaces=\"true\">if<\/span><\/em><\/strong><span data-preserver-spaces=\"true\">&nbsp;you invest enough.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">It can be tempting to bet the farm on these deals\u2014max out your home equity line and cash in liquid assets.&nbsp;<\/span><em><span data-preserver-spaces=\"true\">Be very careful.<\/span><\/em><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Many of these deals work well, but they are just as prone to fraud as others. I\u2019m not even talking about adjusting your projected returns for risk, which is another issue.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">I\u2019m just recommending that you don\u2019t concentrate your investments too heavily on one operator or on one deal. Broad diversification protects your portfolio against fraud. And as we\u2019ve discussed, many believe this is the No. 1 overlooked risk in passive real estate investing.&nbsp;<\/span><\/p>\n\n\n\n    \n  <div id=\"visibility-group-block_f05ee728c83f288859ba2bbc2c690f9a\" class=\"visibility-group alignwide  hidden\">\n        \n\n<div id=\"hero-block_3ce1792602812b41290e583851223115\" class=\"first:mt-0 hero-block py-4  alignwide   has-background has-slate-200-background-color has-text-color has-theme-gold-color\">\n    <div\n        class=\"gap-10 lg:gap-20 flex flex-wrap lg:flex-nowrap max-w-screen-xl mx-auto px-4 relative lg:items-center \">\n\n        <div class=\"relative z-30 lg:w-1\/2 \">\n            <main class=\"py-4\">\n                \n\n<p class=\"has-slate-800-color has-text-color has-large-font-size\" style=\"font-style:normal;font-weight:800\">Find the Right Agent, Close the Best Deal<\/p>\n\n\n\n<p class=\"my-3 md:my-5 lg:my-8 has-slate-900-color has-text-color\" style=\"font-size:18px\">Step #1: Use Agent Finder to match with top <em><strong>investor-friendly<\/strong><\/em> real estate agents to help you find, analyze, and close your next deal.<\/p>\n\n\n\n<div id=button-custom-event-block_49b3dd7307ada517768adbea02573de2 class='button-custom-event'>\n      <a href=\"https:\/\/www.biggerpockets.com\/agent\/match\" x-on:click=\"window.analytics.track(&#039;Blog Block | B2C Marketplace Agent Finder&#039;, {\n      referrer: &#039;https:\/\/www.biggerpockets.com\/blog\/biggest-risk-to-passive-real-estate-investors&#039;,\n    });\" class=\" btn-shape inline-block no-underline has-background has-theme-blue-background-color has-text-color has-white-color\" target=\"_blank\">Find an Agent<\/a>\n  <\/div>\n\n            <\/main>\n        <\/div>\n\n                <div class=\"lg:w-1\/2 first:mt-0 relative h-full lg:flex lg:items-center\">\n            <img decoding=\"async\" class=\"object-cover w-full relative z-20 my-0  rounded-md hidden lg:block\" src=\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2021\/08\/Marketplace-Blog-Blocks-Agent-v3.png\" alt=\"investor friendly real estate agent\" title=\"\">\n        <\/div>\n            <\/div>\n<\/div>\n\n  <\/div>\n  \n\n\n<div class=\"wp-block-group\"><div class=\"wp-block-group__inner-container is-layout-constrained wp-block-group-is-layout-constrained\">\n    \n  <div id=\"visibility-group-block_64dd31c79f00f\" class=\"visibility-group  \">\n        \n\n<div style=\"height:10px\" aria-hidden=\"true\" class=\"wp-block-spacer\"><\/div>\n\n\n\n<div id=\"hero-block_64dd2875dba9d\" class=\"first:mt-0 hero-block py-4    has-background has-slate-100-background-color has-text-color has-theme-slate-color\">\n    <div\n        class=\" flex flex-wrap lg:flex-nowrap max-w-screen-xl mx-auto px-4 relative lg:items-center \">\n\n        <div class=\"relative z-30 w-full \">\n            <main class=\"py-4\">\n                \n\n<h3 class=\"wp-block-heading my-0 tracking-tight font-extrabold has-theme-slate-dark-color has-text-color has-large-font-size\">Join the community<\/h3>\n\n\n\n<p class=\"my-3 md:my-5 lg:my-8 has-theme-slate-color has-text-color\" style=\"font-size:16px;font-style:normal;font-weight:400\">Ready to succeed in real estate investing? Create a free BiggerPockets account to learn about investment strategies; ask questions and get answers from our community of +2 million members; connect with investor-friendly agents; and so much more. <\/p>\n\n\n\n<div id=button-custom-event-block_64dd2888dba9e class='button-custom-event'>\n      <a href=\"https:\/\/www.biggerpockets.com\/signup\" x-on:click=\"window.analytics.track(&#039;Blog Block | Acquisition | Free Membership Signup&#039;, {\n      referrer: &#039;https:\/\/www.biggerpockets.com\/blog\/biggest-risk-to-passive-real-estate-investors&#039;,\n    });\" class=\" btn-shape inline-block no-underline has-background has-theme-blue-background-color has-text-color has-white-color\" target=\"_blank\">Sign Up<\/a>\n  <\/div>\n\n            <\/main>\n        <\/div>\n\n            <\/div>\n<\/div>\n\n\n<div style=\"height:10px\" aria-hidden=\"true\" class=\"wp-block-spacer\"><\/div>\n\n\n  <\/div>\n  <\/div><\/div>\n\n\n\n<p><em>Mr. Moore is a partner of Wellings Capital Management, LLC, the investment advisor of the Wellings Real Estate Income Fund (WREIF), which is available to accredited investors. Investors should consider the investment objectives, risks, charges, and expenses before investing. For a Private Placement Memorandum (\u201cPPM\u201d) with this and other information about the Wellings Real Estate Income Fund, please call 800-844-2188, visit wellingscapital.com, or email invest@wellingscapital.com. Read the PPM carefully before investing. Past performance is no guarantee of future results. The information contained in this communication is for information purposes, does not constitute a recommendation, and should not be regarded as an offer to sell or a solicitation of an offer to buy any security in any jurisdiction where such an<\/em> <em>offer or solicitation would be in violation of any local laws. All investing involves the risk of loss, including a loss of principal. We do not provide tax, accounting, or legal advice, and all investors are advised to consult with their tax, accounting, or legal advisors before investing.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Being a passive investor sounds great until its ugly side creeps up on you. Here&#8217;s your number one risk.<\/p>\n","protected":false},"author":214608,"featured_media":164296,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[7363,7119],"tags":[],"class_list":["post-164294","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-reits-passive-investing","category-biggerpockets-daily"],"acf":[],"comment_count":0,"_links":{"self":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/164294","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/users\/214608"}],"replies":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/comments?post=164294"}],"version-history":[{"count":0,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/164294\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media\/164296"}],"wp:attachment":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media?parent=164294"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/categories?post=164294"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/tags?post=164294"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}