Tips for getting into multi-family investing as passive investor
Real Estate Agent · Fremont, CA · Member since 2018 · 48 posts · 21 votes
Tips for getting into multi-family investing as passive investor
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Ian IppolitoBusiness Member
Investor · Tampa, FL · Member since 2015 · 1k+ posts · 1k+ votesOriginally posted by @Johnson Michael:
Hi BP family,
I am a relatively new real estate investor. I am about to get into a multi-family syndication as a passive(GP) investor. The minimum investment is $50K.
1. Is there anything specific I need to query/look for before I take the leap?
2. Should I invest under my LLC or as individual investor?
3. Any red flags I need to look for?
Thanks in advance,
Johnson
For vetting a syndication, different investors do it differently because every investor comes from a different financial situation and has different goals and risk tolerance. For me, I'm a very conservative investor and may look through a hundred deals a month, and at the end of the year only invest in 4-5. So things that are a red flag for me may be fine for someone more aggressive. Here's how I do my due diligence:
1) Portfolio matching: (takes 30 seconds per deal)
a) Have an educated opinion on where you think we are in the real estate cycles (financial and physical market cycles)
b) Then only then pick the strategies, capital stack, and specialized asset subclasses that make sense for that opinion. For example, I think we are late cycle, so I lean toward the safest part of capital stack which is debt (or debt free equity). I won't go with the riskiest opportunistic strategies, and will stick to core and core plus mostly with some value-added. I won't be investing in the riskiest/most supportable asset subclasses such as hotels, and tilt my portfolio the ones that have historically been more stable such as multifamily and single-family housing. I also don't want refinancing risk, so any deals with only 3 to 5 year debt are out for me. For someone that's not as conservative, or a different view on the next recession, they might have a different opinion than me on all of this
2) Sponsor quality check: (takes about 45 minutes per deal)
I believe that a great sponsor can take an average looking deal and make it great, and that in mediocre sponsor can take a fantastic looking deal and make it bad (especially if there is a severe recession). So I start with the sponsor first. Again, others might disagree.
a) Track Record: Get the entire track record for the strategy. As easy as this sounds, it's not simple and usually like pulling teeth. Many times they will claim it's wonderful and then try to hide their worst deals by only showing completed deals. Make sure to get unexited deals. Or if they are doing value-added multifamily, they will show you their hotel experience. That doesn't cut it for me. I want a specialist that's an expert, and not a jack of all trades and master of none. Also, in a mainstream asset class like value-added multifamily, I see no reason to take a risk on a sponsor that doesn't have full real estate cycle experience and didn't lose money. Again, other might feel differently here.
b) Skin in the game: as a conservative investor, I understand that the dirty secret of industries that the waterfall compensation is in the line with me and incentivizes sponsors to take more risk. So I require skin in the game (average is 5% to 15%) to offset this. Contrary to popular belief, this is not set because I believe it will give me a higher return. I believe it tends to give me a slightly lower return, because the sponsor is going to be more careful, and if there is a severe downturn will prevent me from taking catastrophic losses. Someone that is more aggressive, may want lesser even though skin in the game. Also, if the sponsor is new, I am fine with less skin in the game as long as it is significant to their net worth. On the other hand if they are a sponsor that is experienced in stopping a skin in the game, that's a huge red flag for me.
c) how open to scrutiny are they? I always discuss investments with others in an investor club because other people might think of things that I might miss. And even though virtually every sponsor agreement allows me to share investment information with others who might be advising me on it (especially when club members are bound by an NDA), I still ask the sponsor if I can share it, because it's a test. Most are fine with that, but a few will have problems with it and claim there are legal issues, etc.. That's a red flag for me.
d) death by Google: I Google everything I can about the sponsor. I check the SEC, FINRA, ratings websites for inside information on the principals in the company. I also look for lawsuits and see what happened in them. Many times it's an easy red flag. Sometimes it's ambiguous, but even then, why should I bother with the company that has numerous unresolved lawsuits, versus another company that is virtually the same but has none. Again, others might feel differently here.
3) property level due diligence: (takes seconds to weeks per deal): here is where I drill in with the low-level details.
a) pro forma popping: I examine all the assumptions, and see if they are overoptimistic or not. I look at every single item in the pro forma and imagine that it is complete BS, and see if I can challenge it. If there's a hole, it may be a red flag.
b) sensitivity analysis: I examine all the assumptions, and make sure I can live with the worst case scenarios.
c) "Stall and see": if they are getting money over multiple years, and there is no penalty for investing later, I would usually wait so I get some real performance data, versus having to look at theoretical pro forma information.
d) Recession stress test: I will not invest in anything, until I subject it to recession level stress and see if I can live with the result. And I take the worst recession I can find in the recent past. Sometimes there is only great recession data, and that recession was pretty mild on some asset classes, versus previous recessions. So I will usually 1.5x or 2.0x the stress. If the deal collapses and I would lose everything, I'm out. Others might be fine with taking risk, but least by doing this a person can get an idea of what might go wrong.
e) Legal document analysis: it will usually take a few days to go through the legal document properly, as almost inevitably there are tons of gotchas that either have to be explained, or mitigated with a side letter.
That is the very short summary of what I do. If you want more information, p.m. me and I can give you a lot more details.
The Real Estate Crowdfunding Review
14 Replies
- 5yMack BensonPro MemberRental Property Investor · Woodbury, MN · Member since 2018 · 299 posts · 299 votes
First you need to vet the sponsor and deal. What sort of track record does the sponsor have along with any other members of the GP. I glanced over this article and it looks like it has some good questions to ask of the sponsor and the deal. https://www.biggerpockets.com/... Regarding the deal, have you underwritten it yourself and has the sponsor answered all of your questions?
For the LLC question I do not see a reason to invest in an LP through an LLC but that question should be directed to your attorney. There could also be verbiage about that in the PPM about it but maybe not.
Red flags could come up while vetting the sponsor, do you know, like, and trust them? I've learned that I need to listen to my gut when I'm interviewing people and this is no exception. Obvious red-flags that are top of mind are if they have a history of doing capital calls or if they have lost any properties to foreclosure. There may be good reasons but it would give me cause for concern. Another red flag is a criminal record, again that may or may not be a deal breaker but if they refuse a background check I would be worried.
Good luck!
- 5yDanny RandazzoPro MemberApartment Syndicator · Charleston, SC · Member since 2016 · 973 posts · 728 votes
@Johnson Michael absolutely. @Dan Handford wrote a great article about red flags to look for before investing as a passive investor. You should read his article.
- 5yIan IppolitoBusiness MemberInvestor · Tampa, FL · Member since 2015 · 1k+ posts · 1k+ votes
Originally posted by @Johnson Michael:
Hi BP family,
I am a relatively new real estate investor. I am about to get into a multi-family syndication as a passive(GP) investor. The minimum investment is $50K.
1. Is there anything specific I need to query/look for before I take the leap?
2. Should I invest under my LLC or as individual investor?
3. Any red flags I need to look for?
Thanks in advance,
Johnson
For vetting a syndication, different investors do it differently because every investor comes from a different financial situation and has different goals and risk tolerance. For me, I'm a very conservative investor and may look through a hundred deals a month, and at the end of the year only invest in 4-5. So things that are a red flag for me may be fine for someone more aggressive. Here's how I do my due diligence:
1) Portfolio matching: (takes 30 seconds per deal)
a) Have an educated opinion on where you think we are in the real estate cycles (financial and physical market cycles)
b) Then only then pick the strategies, capital stack, and specialized asset subclasses that make sense for that opinion. For example, I think we are late cycle, so I lean toward the safest part of capital stack which is debt (or debt free equity). I won't go with the riskiest opportunistic strategies, and will stick to core and core plus mostly with some value-added. I won't be investing in the riskiest/most supportable asset subclasses such as hotels, and tilt my portfolio the ones that have historically been more stable such as multifamily and single-family housing. I also don't want refinancing risk, so any deals with only 3 to 5 year debt are out for me. For someone that's not as conservative, or a different view on the next recession, they might have a different opinion than me on all of this
2) Sponsor quality check: (takes about 45 minutes per deal)
I believe that a great sponsor can take an average looking deal and make it great, and that in mediocre sponsor can take a fantastic looking deal and make it bad (especially if there is a severe recession). So I start with the sponsor first. Again, others might disagree.
a) Track Record: Get the entire track record for the strategy. As easy as this sounds, it's not simple and usually like pulling teeth. Many times they will claim it's wonderful and then try to hide their worst deals by only showing completed deals. Make sure to get unexited deals. Or if they are doing value-added multifamily, they will show you their hotel experience. That doesn't cut it for me. I want a specialist that's an expert, and not a jack of all trades and master of none. Also, in a mainstream asset class like value-added multifamily, I see no reason to take a risk on a sponsor that doesn't have full real estate cycle experience and didn't lose money. Again, other might feel differently here.
b) Skin in the game: as a conservative investor, I understand that the dirty secret of industries that the waterfall compensation is in the line with me and incentivizes sponsors to take more risk. So I require skin in the game (average is 5% to 15%) to offset this. Contrary to popular belief, this is not set because I believe it will give me a higher return. I believe it tends to give me a slightly lower return, because the sponsor is going to be more careful, and if there is a severe downturn will prevent me from taking catastrophic losses. Someone that is more aggressive, may want lesser even though skin in the game. Also, if the sponsor is new, I am fine with less skin in the game as long as it is significant to their net worth. On the other hand if they are a sponsor that is experienced in stopping a skin in the game, that's a huge red flag for me.
c) how open to scrutiny are they? I always discuss investments with others in an investor club because other people might think of things that I might miss. And even though virtually every sponsor agreement allows me to share investment information with others who might be advising me on it (especially when club members are bound by an NDA), I still ask the sponsor if I can share it, because it's a test. Most are fine with that, but a few will have problems with it and claim there are legal issues, etc.. That's a red flag for me.
d) death by Google: I Google everything I can about the sponsor. I check the SEC, FINRA, ratings websites for inside information on the principals in the company. I also look for lawsuits and see what happened in them. Many times it's an easy red flag. Sometimes it's ambiguous, but even then, why should I bother with the company that has numerous unresolved lawsuits, versus another company that is virtually the same but has none. Again, others might feel differently here.
3) property level due diligence: (takes seconds to weeks per deal): here is where I drill in with the low-level details.
a) pro forma popping: I examine all the assumptions, and see if they are overoptimistic or not. I look at every single item in the pro forma and imagine that it is complete BS, and see if I can challenge it. If there's a hole, it may be a red flag.
b) sensitivity analysis: I examine all the assumptions, and make sure I can live with the worst case scenarios.
c) "Stall and see": if they are getting money over multiple years, and there is no penalty for investing later, I would usually wait so I get some real performance data, versus having to look at theoretical pro forma information.
d) Recession stress test: I will not invest in anything, until I subject it to recession level stress and see if I can live with the result. And I take the worst recession I can find in the recent past. Sometimes there is only great recession data, and that recession was pretty mild on some asset classes, versus previous recessions. So I will usually 1.5x or 2.0x the stress. If the deal collapses and I would lose everything, I'm out. Others might be fine with taking risk, but least by doing this a person can get an idea of what might go wrong.
e) Legal document analysis: it will usually take a few days to go through the legal document properly, as almost inevitably there are tons of gotchas that either have to be explained, or mitigated with a side letter.
That is the very short summary of what I do. If you want more information, p.m. me and I can give you a lot more details.The Real Estate Crowdfunding Review - Investor · Indianapolis, IN · Member since 2018 · 1k+ posts · 756 votes5y
@Johnson Michael As others have said, there are a ton of great articles and blogs that cover this topic in detail. Do your research and find a sponsor that has a reputable track record. Feel free to check out the blog on my website about the 5 things every new investor should do before investing in their first syndication.
- 5yAJ ShepardPro MemberReal Estate Syndicator · Portland, OR · Member since 2014 · 453 posts · 312 votes
@Johnson Michael
Your CPA should be the one giving you advice on whether you're want to invest individually or with an LLC.
If you have an LLC, my gut would be to use that. It's a lot easier to write off expenses for the investment if it's through a company. Such as spending time or money to vet deals.
- 5yRick MartinPro MemberRental Property Investor · Redondo Beach, CA · Member since 2017 · 411 posts · 477 votes
@Johnson Michael it looks like you have a lot of detail provided here in some of the answers. Definitely ask for at least three references. Ask them about the sponsors integrity, communication, and ability to deliver on their projections. Find out their relationship to the sponsor also. If it is his or her mother, then they might be a little bias. Google first, but you can also do a background check. Of course you want to check their level of experience, track record and if they have exited any deals.Re: the LLC. The deal itself will be within an LLC, so not sure it is necessary. If you have a RE holdings LLC, then maybe it is a good way to file your investments.
- Real Estate Agent · Fremont, CA · Member since 2018 · 48 posts · 21 votes5y
Thanks everyone for your valuable inputs.
Johnson
- Cincinnati, OH · Member since 2020 · 4k+ posts · 3k+ votes5y
@Johnson Michael are you an accredited investor? If so, all offerings are an option. If not, you have to look for 506b operators that can accept sophisticated investors. Any 506(c) offering will not be able to accept your investment if you are not accredited.
From there, come research of sponsors and deals. As mentioned: portfolio matching. What type of deals do you want? Core, value add, development? As you start vetting deals, after you have spoken to many sponsors and narrowed down those you feel confident with, talk to others to try to poke holes in it. Of course, the apocalypse could come and you could be wiped out, but I try to take a realistic approach. What happens if rates rise, rents fall, occupancy drops, etc, but within a certain range of reality. Are rents going to fall 20% in the next 12 months in a market with positive population and wage growth and net absorption? Likely not. Will they fall 20% in downtown SF, where all tech workers are generally leaving? Maybe.
Regarding the LLC, this is always best discussed with your attorney or CPA. As mentioned, you are coming in as an LP, so typically your liability will be limited to the amount invested. That being said, I have heard of others investing in the LLC to help liability protection from the other side. I.e. a physician investing through an LLC to protect his holdings from a malpractice suit.
- 5yTony AngelosPro MemberReal Estate Agent · Member since 2019 · 192 posts · 131 votes
Following... some great comments on this thread.
- Rental Property Investor · Member since 2019 · 31 posts · 36 votes5y
Hi @Johnson Michael,
All great points, which is why I love bigger pockets. Great recommendations and exceptional experience. Be sure to read those great articles, perform extensive due diligence on the sponsor and their track record. As stated, check with your attorney regarding using your LLC -- I use my LLC for liability protection and business activity under my LLC for tax purposes. Relationships and integrity are everything in this business, therefore, get to know your sponsor before investing with them. Talk with a few investors that have done business with them as well. Good luck!
Detra
- Rental Property Investor · St. Paul, MN · Member since 2016 · 3k+ posts · 3k+ votes5y
Find the GP's that actually know and understand their goals and the reason why they are investing in the asset class. What make it strong now and in the future. Find companies that are in this for the long run. Companies that aren't just doing deals to get the acquisition fees or to check the ego box.
I have an article here to read about what to look for when looking for an LP: https://www.biggerpockets.com/...
- Developer · Jericho, NY · Member since 2015 · 13 posts · 8 votes5y
Hi Johnson,
This is actually right up my alley since I am a GP/Sponsor for real estate syndications in NYC.
My recommendations are as follows:
1. Assuming that they're filed under 506(c), the following apply. Other filings should follow a similar trend. Review the PPM (asset capitalization and value, risk factors, and "the about the sponsor" section). It should be consistent with the investment prospectus they had given you. Verify the information in PPM you received is consistent with EDGAR.
2. This is a tax question. As an LP, your risk is limited to your investment. Tax wise, it may be better to invest under a company (primarily for the sake of bookkeeping and segregating expenses related to your LLC's operations; investing in this case).
3. I believe part 1 of my answer pretty much sums it up. I'd be happy to discuss this further if you have other questions!
With Regards,
Fahad
- Member since 2020 · 25 posts · 6 votes5y
Hi Johnson. I've invested in 5 different deals with 4 different sponsors. Some of the things that are a must for me is 1) Deal MUST have preferred return. 2) I have to trust the sponsor (go to their website and/or check their you tube page) 3) I don't invest in sponsors first or second deal. I wait until they have at least 3 properties under their belt. 4) Check that underwriting is conservative enough for you to sleep at night. 5) Check that they have reasonable fees (aquisition, asset management, refinance, disposition, etc) 6) I don't invest in deals with sponsors that need more than $50K investment for MY first investment with them. 7) Make sure sponsor has more than 1 partner. If they only have 1 partner and partner gets hurt, sick, or worse, that can cause you problems. 8) How is their communication? Do they get back to you in a timely manner? What about their reporting on their investments? Do they give you relevant data on property on a monthly/quarterly basis? (P&L, rent roll, occupancy, collections, etc)
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