Are More Investors Moving from Rentals to Passive LP Opportunities?

Question

I'm curious if anyone else has been seeing this shift.

Over the last several months I've been working with a group of experienced operators focused on ground-up luxury residential development, and one trend has become pretty obvious.

A number of investors who traditionally owned rentals or self-managed flips are starting to move a portion of their capital into passive operator-led projects.

The operator I'm working with is currently raising capital for luxury residential development projects in Georgia and has structured multiple distribution options depending on an investor's income goals.

I'm curious...

For those of you already investing passively:

• What do you look for most in an operator?
• What level of transparency do you expect?
• Are you primarily investing for equity appreciation, cash flow, or a combination of both?

And for those who have never invested as an LP or in an operator-led development, what's been the biggest hesitation?

Always interested in hearing how other investors are thinking in today's market.

Chris Seveney · Answer

Investments in LP's is down over 40% this year from last year - so not sure more are moving in that direction.

Stuart Udis · Answer

As Chris pointed out it's an extremely difficult capital raising environment. I am not seeing many people move from active to passive investing particularly in the retail LP space. There are still some existing retail LP's who remain active, but most are on the sidelines.

If you want to raise retail LP capital, it's important to understand what they value. They value liquidity. They want cash flow and they want return of capital. Very difficult to provide either at the moment when reliant on the merits of the underlying real estate unless you are selling property. For a while syndicators were getting away luring LP capital with aggressive underwriting while using aggressive debt terms. We all witnessed the end result there. It's been well documented.

Higher end SFH developments that are already entitled in strong markets remain marketable because there's a clear exit and relatively short round trip on the investment. Most importantly the numbers aren't broken. Deals that pencil actually pencil. No underwriting manipulation required. The real estate can absorb today's cost of construction and the buyers, particularly the wealth downsizer market is quite strong. They are making lifestyle driven decisions. I see a lot of success raising capital in this particular space. The challenge of course is the entitlements. Developable SFH land in good locations in strong markets is scarce. That's why there's limited opportunities.

Where else I am seeing success raising capital has me concerned. Some are successfully over raising and using over raised capital as distributions. This is very different than allowing the underlying real estate to do the work. Don't see this ending well. Also seeing a lot of these evergreen "preferred income" or "cash flow" flow syndications being pushed. People like the liquidity they provide but at the end of the day this is just returning the next investors capital. What happens when the new capital starts slowing?  Also, bad outcomes ahead if they can't keep bringing money in.

Evan Polaski · Answer

@Joshua PatrickLike others noted, I would say far fewer are moving from active to passive.  But, there are always some.  From my limited exposure, I would say the active to passive path is very low.  The ones that continue to make passive investments are those that have always been passive, and are the true LP types. On these forums you have a ton of retail investors.  Yes, they are accredited either by net worth or income, but they are not the traditional LPs of yore.  Since 2017ish, the biggest growth in real estate LP investing has seemingly been the middle manager who did own a few rentals, makes $200-300ish k per year.  They had a good career, their rentals were doing well, but not moving the needle relative to their career prospects and the work needed to manage rentals and/or PMs.  Net worth was probably around $2-5mm.  They sold their rentals, found their syndicator on a podcast or here, invested once, made some money, invested again, made some more, invested a third time and lost most of it.  They are out of syndications forever, especially since SPY would have more than tripled their initial investment since 2017.  Many worked in tech and very well may be out of a job now.

The LPs I see coming into deals now look like they used to.  $500k+ incomes.  Net worth north of $5mm.  These individuals typically have longer term investment thesis.  They are not as susceptible to marketing.  They have portfolio allocations they look to make.  Private real estate is a percent of their allocation.  They invest/reinvest $200k+ per year and with these investments are reallocating accordingly to maintain portfolio balance.  Clearly this is stereotyping a lot of people.  There will always be someone who does a flip, makes good money but hates every minute, that allocates into syndications, or someone that puts their bonuses into syndications.

Mark Robertson · Answer

I think one of the biggest changes when you move from owning the property yourself to investing as an LP is that you’re really underwriting two separate things: the real estate and the operator.

For me, the operator comes first. I want to see a realized track record, not just deals currently marked at projected values. More importantly, I want to understand what happened on the deals that didn’t go according to plan. How did they handle lenders, capital shortfalls, investor communication and ultimately investor capital?

Then I look at alignment: meaningful GP capital at risk, the entire fee structure and waterfall, debt terms, refinancing assumptions and whether the deal still works without an aggressive exit cap or appreciation assumption.

Ground-up development deserves an especially high bar because you’re adding construction, timing and exit risk on top of the normal real estate risks.

I’m a big believer in passive real estate, but “passive” should describe the investor’s role after investing—not the diligence done before wiring the money.

G. Brian Davis · Answer

We’ve seen the hesitation firsthand in our co investing club. We’ve heard plenty of stories from investors who had painful losses in syndications, losing significants amount of money.

We’ve seen that hesitation start to turn around on our end. I think part of that is because we do things a little differently than traditional syndication investing. Many still want the passive exposure, but they’re being far more selective and cautious, understandably so.

Don Konipol · Answer

It runs in cycles.  Investors have success with experienced syndicators sponsoring good quality, low risk deals.  The market prices of real estate increase, cap rates compress, demand increases, and inexperienced, under capitalized, syndicators with little or no management depth raise funds for marginal deals where optimistic hopes are reported as likely forecasts.  The market turns, the optimistic forecasts aren’t met, the over leveraged deals sponsored by inexperienced syndicators default, the syndicators lack the knowledge, ability and capital to salvage the deals.  Investor inquiries to the syndicators are met with silence or a generic statement prepared by sponsor’s counsel.  Next thing they know investors are hit with a “capital call”, told that if the amount of capital isn’t raised their entire investment will be wiped out in foreclosure, and the sponsor blames “market conditions” “nobody” could have foresaw.  ‘Investors tell their sad stories on forums like BP, word spreads, and everyone but the experienced, well capitalized, and successful sponsors is out of the syndication game - until the next cycle.

V.G Jason · Answer

Right. That's because they're moving to public equities.

Mark Robertson · Answer

Recency bias is a well-documented behavioral tendency. Losses can feel particularly painful in the moment. Real estate has always been—and will continue to be—cyclical. For every downturn, a recovery and subsequent boom have followed. Avoid abandoning an asset class simply because it is currently underperforming; diversification remains one of the most reliable safeguards. Partnering with institutional-quality sponsors is consistently the most important factor in long-term success.

Denise Supplee · Answer

From my experience, the operator is just as important as the deal itself. I look for integrity, experience, and good communication, and I want to know they're willing to be transparent throughout the investment. I like both cash flow and long-term appreciation, but I also want to understand the risks before making a decision. That's one of the things I appreciate about our co-investing club: we spend a lot of time asking questions and getting to know the operators before anyone decides to invest. For me, doing that due diligence is always time well spent.

Michael S. · Answer

@Joshua Patrick

Nope - like @Chris Seveney noted, I've seen the exact opposite.

After what I've witnessed over the past 3 years, there is a 0.0% chance I'd buy into any syndication right now unless I personally know or have worked with the GP previously, or it is in a location I know extremely well and have a feel for the economy (for example, if I thought Huntsville was lacking in MF, then I might consider it - ironically, Huntsville is now overbuilt in MF).

Are More Investors Moving from Rentals to Passive LP Opportunities?

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