Why is Successful Passive Investing in Real Estate So Difficult?

Question

Why is successful passive investing in Real Estate so difficult?  Well, two reasons

1. The passive investor is attempting to obtain a higher risk reward ROI than the general market allows. This can only be obtained by a superior ability to choose which passive investments to invest in. Almost all investors can do a rudimentary due diligence analysis or have an advisor who can. The few that are able to uncover the real "hidden gems" either have SUPERIOR analytical ability (very difficult) or do a much more thorough and time consuming analysis - which in itself raises the question of whether or not the investment is indeed "passive" .

2. By the nature of the investment structure (what used to be called a limited partnership, but now likely to be a non managing member LLC) the MONEY has no ability to “right the ship” should something go wrong, and has total reliance on the syndication or fund manager, who may or may not have aligned interests, positive incentives, and or the managerial expertise,  experience and motivation to protect, secure and enhance the subject investment.

Evan Polaski · Answer

@Don Konipol, I would argue that it is not so much "difficult" to succeed as it is to have a realistic definition of success.

If you are expecting 8 and 9% cash flow, net of fees, from a "value-add" multifamily, you are looking at, either, low income areas, rural areas, variable rate loans, IO periods, unfunded deferred maintenance, or bringing some level of risk into the equation that is likely not present on the 3-4% cash flow deals.

The biggest issue is investor expectations (and I am one).  "I want 7%+ cash flow, 18%+ Net IRR, high income, low leverage, fixed rate long term debt,  growing market with limited new supply..."  This is a unicorn.  And unfortunately, there are syndicators that telling LPs all of this is possible, and then sending out opportunities that "almost" match this.  They hit the return metrics, they try to convince investors that "70% LTV" is low leverage, and likely don't mention all the new supply that is being built within a couple miles, or that the MSA is growing, but the pocket they are buying in is declining, or some half truth like that.

Garret Rumbea · Answer

Appreciate you sharing Don. Yeah I can only speak to multifamily syndications, but I'd think LPs would want to thoroughly vet the team and each operator in it, and have a pretty good understanding of how to do their due diligence on the market and deal they're considering. So on the front end I'd say it's not passive, but after that, sure it is. In my opinion, I don't think an LP needs to underwrite at the same level the operator does, but they should know how to spot red flags and ask good questions, understand it's all about assumptions and do those assumptions fit what's actually happening, is the deal structured in a way they're okay with, does the operator have enough skin in the game, etc. All of which takes time and I think it should otherwise you wind up getting into something without fully understanding the risks. I'm still surprised when people don't even take the time to review a deal's subscription docs...smh

Bianca Barcelos · Answer

I'm with you!  I think that true "passive" investing in real estate is difficult because it misses the point of the asset itself. Real estate simply isn't a "passive" investment to just plop some money into; it's an active operational business with physical space with appliances, furniture, walls, floors, and people management to think about.

Even if you completely outsource to a property management company, you still can’t completely run this type of investment (to its most successful potential) if you're checked out. RE investing requires a level of asset management and check in's with your active partner (PM or otherwise).  Understanding the financial analysis, operating expenses, rent rolls, etc. is important as well as knowing the physical condition of the property, neighborhood, strategy, and tenant.

All of these things, coupled with the current environment where cash flow is harder to come by, the margin for error is shrinking and we can't afford underperformance in our investments.  Real Estate is a great investment but a tough one to do passively.  It's important not to completely gamble cash on someone else's management of your asset.

Ryan Rominger · Answer

I think there's some truth to that. Passive investing still requires active due diligence upfront not just on the deal, but on the operator. From what I've seen, the strongest outcomes usually come from investing with experienced teams that communicate well, have a solid track record, and have meaningful skin in the game alongside their investors.

Stuart Udis · Answer

Responding to point #1, part of the issue is that many syndicators market deals with unrealistic terms and projections. They're often the ones with the largest marketing budgets and the greatest visibility, so less experienced retail investors repeatedly see those offerings and begin to view them as the market standard. That ultimately contributes to unrealistic expectations.Just today I saw a capital raiser marketing investments in already constructed build-to-rent communities. The distributable cash flow being advertised doesn't appear achievable from the properties' operations alone. It makes me wonder whether they're raising more equity than the acquisitions require and using a portion of that capital to fund early distributions.

Dan H. · Answer

I have not found it challenging to obtain outstanding returns via lp in various syndications.

I do agree you need to vet the operator and the deal and this takes work or you can invest in a fund of funds and potentially give up return to have someone else do the getting on the projects (you need to vet the fund of funds operator).  Note I personally believe getting the operator is more critical than vetting the deal.

One of my current investments is in danger of losing investment for our first time,  a lot went wrong.

Our annual return at exit has been over 30%/year.

I also believe the other 3 I am currently invested in will achieve good returns.   One seems on track to return far better than 30%/year.   One is hard to judge but could be the best return of the 4 I am currently in,

Note my goal in non passive RE investment is to recover full investment in no more than 4 years.  This is a 20%/year and takes work.   The syndications take less work and have so far have easily met my 4 year rule.

I also think criticism related to no control is unwarranted.   You either have active or passive:; passive by definition implies no control.

Good luck

Why is Successful Passive Investing in Real Estate So Difficult?

Most Popular Reply