5 Things to Consider When Passively Investing in Multifamily Real Esta

Whether you’re an accredited investor or not, there are lots of opportunities out there for passive investing in the multi-family real estate space. But if you’re just getting started, there are lots of things for you to consider that will have a direct impact on your return and your investment.

Here are five things to consider when passively investing in multi-family real estate:

1. Structure

Structure is one of the things you have to consider before putting money into a deal. I have a three-step process to get started investing in multi-family real estate at shift, prime, and invest. This comes in the prime section, when you’re getting ready to invest in a deal.

Structure is tremendously important, as it can have legal and tax implications. Nobody wants to pay more tax than they have to. So as a passive investor, you want to be having these discussions with your lawyer and accountant to figure out the best structure for you.

Will you be investing in a syndication or fund? Let’s say you’re investing in a fund or a syndication as a limited partner. And that’s a passive sign that brings the capital to the deal. Maybe it’s best for you to invest under your own name. Maybe you have several other assets.

Maybe you have your own smaller real estate portfolio that you want to keep separate. Your lawyer may suggest that you create a separate entity to invest in the syndication or the fund. Maybe your accountant may have several different entities and your accountant finds it’s going to be most efficient if you use one of your existing entities to invest into the syndication or the fund. This is going to be a tailor-made solution for you.

Everybody’s different in this respect. So do all the legwork up front. Have those discussions with your professional team — your lawyers and your accountants — and really figure out the best structure that you can use to invest in these real estate opportunities. Not only to secure your investment against some hazards down the road, but also to make sure you’re doing it in the most tax-efficient way. At the end of the day, nobody wants to pay more tax than they have to.

2. Know the team

Why is this important? Well, the sponsor team will manage your capital, your investment, making sure that the deal runs smoothly. And there are different personalities, management styles, and investment styles out there. You need to find the mix that works best for you.

There are people that I speak with and I don’t feel the connection with them and vice versa. It happens. But then there are other people where we gel really well and it’s a good fit. So as a passive investor you need to make sure that you get to know the team that’s going to be managing the deal. And just make sure it’s a comfortable fit, because this is what happens.

Real estate investment is illiquid. You’re investing in these syndications or funds for five, six, seven, or sometimes 10 years. That’s a long time. Nobody knows what the future will hold.

Coronavirus is a great example of this. So this is why knowing the team personality is really important. Because let’s say in Year Two an unforeseen event happens. And the deal enters choppy waters. You need to make sure that you know the person at the helm of the real estate ship that’s going to be guiding the ship through the choppy waters.

Are they a type of person to give up easily? If so, that’s probably not somebody you want to invest in. Are they tenacious? Do they have “stick-to-itiveness,” as they say? If the person’s driven and they look for solutions and they’re able to problem-solve, that’s somebody you might want to consider investing with because they can handle problems and come up with solutions for the unforeseen things that will occur at some point along the real estate cycle.

We have lots of different personality types. Different people hold different values higher than others. It’s just the way it works. So just make sure you really get to know the people who you will be investing with. They’re going to be in charge of your investment and its returns. You want to make sure you have a good relationship and open communication.

Whenever problems do occur, you want to make sure that there’s more communication rather than less. You can’t over-communicate when there is an issue going on with the deal. And let’s face it, over a seven-year hold period, there’s going to be things that go wrong. It happens on every single deal — there is no perfect deal. By getting to know the sponsorship team, you can be ensured that you’re in good hands and can feel comfortable with the decision you’re making.

3. Underwriting

On my podcast, Real Wealth Through Real Estate, I talk with lots of passive investors and active investors as well. And the number one common mistake we see passive investors making is they don’t underwrite their own deals. They just trust the sponsor team even though they’re very experienced. They trust the sponsor to do all the underwriting on their own.

As a passive investor, you will get all the underwriting and know what’s going on with the deal and the opportunity the deal presents. But you’re investing a lot of capital in a deal. You might be investing one, two, three, or five hundred thousand dollars in this deal. You want to have the basic knowledge of how multi-family real estate works so you can take a look at the numbers.

The number one thing you were looking for is, do these numbers seem too aggressive, too far-fetched? Are they pie-in-the-sky types of things or are they being very conservative? As somebody investing in multi-family real estate, you want to make sure that the person underwriting the deal, the sponsorship team, is taking a very conservative approach. You never know what the future will hold, even though multi-family real estate has all these benefits.

But the fact remains that if you’re investing a large amount of capital, you need to have the basic underwriting skills to take a look at the deal. Nobody’s expecting a passive investor to become an expert in multi-family underwriting. That’s not what I’m saying here.

But you need to have that basic knowledge so you can look through the deal and say, “Hmm, this doesn’t seem right. Or this seems a little bit aggressive, based on what I’m seeing with other deals. Maybe I should ask this question or what can I ask the sponsorship team as to why they underwrote it this way?” There may be a very good explanation, but at least having that basic knowledge will allow you to ask that educated question and get a really good answer.

So how does one go about acquiring the basic knowledge to underwrite a multi-family real estate deal? There are lots of videos on YouTube, and lots of articles on the web.

I also have articles on my website. I have videos about underwriting. These are things that you want to absorb and really learn about as a passive real estate investor. Like I said, nobody is expecting you to become an expert, but at least you want to be able to look at the deals and ask the right questions to make sure that you are investing in solid, conservative opportunities.

4. Refinances (Refi)

This is going to be along the same vein as number three, but I thought it warranted its own section because this is very common.

So what will happen is that in the value-add opportunity, we take an underperforming asset, fix whatever problems we need to fix, and then we look to refinance the property at the higher valuation. Lots of times, when we’re underwriting — and this is why basic underwriting skills are very important — some people will put the refinance into their underwriting.

And what this does is it really jacks up the return the investor is earning because let’s say in Year Two, if the investor is able to get 30 percent of their investment back, obviously the return on the rest of the whole period will be a whole lot higher. But this is where problems start.

Refinances are never guaranteed. Markets can change. Maybe in Year Two, another corona version two will happen. And you can’t refinance the property. And this will affect your return.

So whenever you’re looking at a potential passive investing opportunity in a deal, you always want to make sure that the refinance — even though the refinance, we always push for a refi on a value-add deal and we always want to return investor capital because that’s going to pump up the returns — but if its worked into the actual basic underwriting, and that’s what’s being advertised to you as a return on the deal, you probably want to pump the brakes a little bit and be more cautious.

You never want to have the refinance or secondary financing putting on once the value is increased. You never want this worked into the original underwriting. So beware. And if this is popping up, ask some more questions. Ask the sponsor and the team running the deal what makes you guarantee that this will actually happen.

Because things pop up just like corona — even though I hate talking about corona — and it will affect your return. So never, never, never put refinancing into the underwriting.

5. Know your exit

Knowing your exit plan is extremely important. Real estate is illiquid. And what I tell all the investors that want to work with me is, “You are investing in the syndication for the next five to seven years, depending on the deal. Your money will be locked up and it is not coming out.”

But let’s say a worst-case scenario happens and you really need to access that cash. What can you do? This is where you need to be able to read through and understand the offering memorandum and know exactly what process must be followed to remove your money from that syndication if you really have to.

Some syndications will not allow it. Some funds will not allow it. Other funds will allow you to sell your shares and some syndications will. Some syndications allow you to pass it to immediate family members. So this is really common with folks nearing retirement age and it’s a longer hold period. They want their shares to be able to be passed down to let’s say their grandkids in case they die during the whole period.

These are important terms to understand. So this is something where your team will be able to help you with this. Your lawyer, your accountant, or the sponsorship team will be able to explain this, but you really want to know if you have to. If not, what is the process? Do you have to sell your shares in the real estate fund at a discount? Do the people currently investing in the fund have first crack at your shares, or can you sell it to an outside party?

Every sponsor is going to be different. Every deal is going to be different. Every fund is going to be different. But these are the questions you must ask upfront and know, so down the road, if something ever does come up, you know exactly what your exit plan is.

About 99.9 percent of the time, you’re going to hold throughout the whole period and then you’re going to exit with everybody else when the deal sells. And then, you move on to the next fund or syndication opportunity. But in that 0.1 percent chance, you need to know what the terms of the syndication or the fund allow just so you can make the most educated decision for your investment at the time when you put your capital in.

The Bottom Line

So to recap, here are the five really important things to consider when you’re passively investing in multi-family real estate:

1. The structure — ultra important.
2. Know the team — people matter especially in commercial real estate. The people running the deal have a big impact on the success of the deal.
3. Underwriting — get to know underwriting yourself. Basic knowledge is good, but at least that will prompt good educated questions for the sponsorship team.
4. Never put the refinance in the original underwriting. And if you see that, start asking more questions.
5. Know your exit — know your options. What do the terms of the syndication or the fund allow you to do?

I hope you found these points useful.