How To Invest Passively

Question

We created a there--step framework for investors to be able to invest passively in any type of real estate. You an use this if you are either looking to invest passively, or, if you are raising capital, refer back to it, and focus on these three pillars:

The biggest mistake I see passive investors make is they focus on the deal, what's my return, when in reality, that is the last pillar they need to focus on. First, focus on the sponsor. Then, your alignment of interests with the sponsor. Finally, after both of these have been satisfied, let's start underwriting deals.

1. The Sponsor: Track record, their experience in the asset, their assembled team, any full cycle deals. The sponsor is the one driving the ship, the one making decisions, the one who has to communicate, the one who is the bearer of good and bad news!

2. Alignment of interests: HAs the sponsor properly conveyed the risk in investing in real estate? Have they told you it probably isn't a good idea to invest money you need to pay your rent and groceries? Have they spent time learning about your goals and objectives with investing? Does your time line line up with the deal you're investing in? Does the sponsor have skin in the game? (They better, in my opinion). Your interests need to align with the sponsor, and if not, take a hard pass.

3. The Deal: Now, let's look at the deal and how to Buy Right Manage Right & Finance Right®.

These are all heard lessons I learned on my first passive investment. I can blame the Sponsor all I want, and believe me, he was negligent, incompetent, among other things. BUT...., if I had applied my alignment, along with doing better due diligence, and learning how to underwrite, I may have never come up with this framework.

If you are raising capital, take the time to learn if your interests and deal align with the investor, and if they don't, tell them thank you but take a pass. You can always ask them if they know someone who would be interested.

What are you looking out for as a passive investor?

Chris Seveney · Answer

@Gino Barbaro

Agree as most just look at the shiny number and ignore the sponsor and the deal.

As you mention the sponsor is last in many occasions when they should be the first thing reviewed.

Gino Barbaro · Answer

@Evan Polaski

Great input. Fees, waterfall structure, is a huge alignment of interest piece. For those who are just starting ut and don't understand the business, they need a good sponsor driving the ship

Gino

Jim Pfeifer · Answer

Great stuff here! I agree that the sponsor and alignment of interests are critical. The deal comes after that in my opinion. But I would agree with @Evan Polaski that it becomes easy - after all of your sponsor due diligence and alignment work - that you become tempted to think the deal offered by your vetted sponsor will be a "good" deal. What's good for me, might not be good for you! I think it is important to make sure the sponsor and the deal also align with your investing goals. I made this mistake when I was starting out - I got excited about the returns of a development deal - but I didn't pay attention to the fact that I needed to be a cash flow investor because I did not have a W2 income, nor did I have sufficient passive income yet.

It is critical for investors to understand the relative importance of evaluating the sponsor, alignment of interests and the deal. They are all important and must be evaluated appropriately - but that doesn't mean send the wire! These are long-term, illiquid investments that are completely out of your control. After (or before!) you have done all of your vetting, evaluations and due diligence you need to make sure that the particular deal is right for you.

Evan Polaski · Answer

@Gino Barbaro, this is a hard one because there are so many details to hit on.

I guess at a high level, I prioritize them a bit differently. In the heavily marketed syndication world, my first one is alignment of interest. No need to even look at a sponsor that is making millions from acquisition fees and also keeping 50% of profits on the back end.

And in the deal by deal syndication space, the deal will have a bigger impact on my returns than the sponsor. The deal is more directly impacted by macro-economic factors than anything the sponsor can control.

But at the end of the day, the biggest take away is to understand that even though these are listed in an order, it does not mean that one has a higher priority than another. Unfortunately, human nature is such that if I do spend hours, days, months vetting a sponsor, and ultimately sign off on them, I will already be biased to accepting the next deal they offer, regardless of whether it is good or not. But, as Jay started to get into, a good sponsor or bad sponsor really can only control about 10-15% of the outcome. The market will control a much larger part.

And for a specific take away, ask how the fees, waterfall, overall structure of deals have changed overtime. I.e. the value-add player that has moved to more core deals, or heavier performance alignments shifting overtime to more fee heavy structures.

Gino Barbaro · Answer

@Chris Seveney

I agree the sponsor is the most important factor, but passive investors can not ignore what they are trying to accomplish, and have a deep understanding of the business.

The trinity!

Gino

Gino Barbaro · Answer

@Jay Hinrichs

Words of wisdom and someone who appears to have experience with both types of sponsors!

Gino

Jay Hinrichs · Answer

Agreed one simple adage.. A great sponsor can save a deal that goes a little wonky.

A poor sponsor will screw up the best of deals.

Sponsor number one consideration in my mind.

Gino Barbaro · Answer

@Jim Pfeifer

I think those of us that have made the mistake see the importance of a good sponsor, but also taking into consideration our investor goals.

Passive investors NEED to learn the business of investing in real estate, and have to approach it as if they would be managing the deal themselves actively.

That means there needs to be work done on the front end, like underwriting, selecting a market, understanding buy right criteria, etc.

You can't just focus on a good sponsor, and pray things work out.

Jay Hinrichs · Answer

Agreed one simple adage.. A great sponsor can save a deal that goes a little wonky.

A poor sponsor will screw up the best of deals.

Sponsor number one consideration in my mind.

How To Invest Passively

How To Invest Passively

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