Blog Highlights:
Why did you decide to search “real estate syndications” today? Most likely, you heard how they can make your hard-earned money work for you, and create a good return, and grow your wealth over time all while really not having to have much involvement in the actual properties at all.
The number one question I get asked in our contact form is, “Are real estate syndications actually worth it?” Many investors want to know if they invest $100,000, how much money will they make in return?
Now, I love a good return as much as the next guy, and it is a big part of what I do. However, there’s an even more important aspect to focus on when evaluating potential deals.
I don’t like to give away all my secrets, but I can tell you it is not as exciting as passive income or returns that come in the double digits. It’s actually probably more boring than taxes and K-1’s.
The most important thing I focus on when working with real estate syndications is capital preservation. This means I focus on making sure the deal has multiple plans in place to protect my investors from any loss of capital. Yes, I want to make sure you make money and not lose money. That’s my number one priority, even though it is pretty boring.
Why It’s Important To Talk About Capital Preservation
Sure, capital preservation isn’t the most exciting part of investing in real estate syndications, but it is one of the most critical pieces.
It’s easy to just focus on cash flow returns, potential earnings, and brightly colored marketing packages, but when an unexpected situation arises, you’ll be thankful (for this article and) for a sponsor team that gives capital preservation the attention it deserves.
Capital preservation is all about mitigating risk, and as Warren Buffett puts it, there are two rules to investing:
Rule #1: Never lose money
Rule #2: Never forget Rule #1
No matter what you invest in or who you invest with, you should know what to ask and what to look for so you can invest confidently with a team that holds your best interest.
5 Capital Preservations Pillars
At the core of every investment in which I participate, capital preservation is my number one priority. There are 5 building blocks that make up the Stryker capital preservation strategy.
#1 – Raise money to cover capital expenditures up front
Imagine the avalanche of problems that can accumulate when capital expenditures (like renovations) must be funded purely by cash flow. In this case, cash-on-cash returns, which vary based on occupancy and maintenance costs, would have to fund sudden HVAC repairs instead of unit renovations according to the business plan. In this case, the business plan falls behind schedule, units aren’t ready as planned, and vacancy persists.
Instead, we ensure the funds for capital expenditures are set aside upfront. As an example, if we need $2 million for the down payment and $1 million for renovations, we will raise $3 million upfront. This means we have $1 million cash for renovations and won’t have to rely on monthly cash-on-cash returns.
#2 – Purchase cash-flowing properties
One great option to preserve capital is to purchase properties that produce cash flow immediately, even before improvements. If units don’t fill as planned or the business plan isn’t going smoothly, just holding the property would still allow positive cash flow.
#3 – Stress test every investment
Performing a sensitivity analysis on the business plan prior to investing allows us to see if the investment can weather the worst conditions. What if vacancy rose to 15% and what would happen if the exit cap rate was higher than expected?
Properties look wonderful when they’re featured in fancy marketing brochures with attractive proformas (i.e., projected budgets), but stress testing those numbers helps us take a look at how the performance of the investment may adjust based on potential variability in variables.
#4 – Have multiple exit strategies in place
In any disaster or emergency, you want to have several ways out. In case of a fire, you want a door and window. The same goes for real estate syndications.
Even if the plan is to hold the property for 5 years, no one really knows what the market conditions will be at that 5-year mark. So, it’s important to account for contingency plans, in case you need to hold the property longer, and the possibility of preparing the property for different types of end buyers (private investors, institutional buyers, etc.).
#5 – Put together an experienced team that values capital preservation
Possibly the most critical pillar of all is to have a team that values capital preservation. This includes both the sponsor and operator team(s) and the property management team. All of these people should be passionate about their role and display a strong track record of success.
The more experience they have in successfully navigating tough situations, the better and more likely they will be able to protect investor capital.
Why Some Of The Most Boring Tactics Bring The Most Benefit To You
Capital preservation is not the most interesting or exciting topic. However, it is certainly one of the most important building blocks of a solid real estate deal. You want to make sure every decision and plan made by your sponsor/operator has your best interest as the investor in mind, especially decisions that will affect the interest of your money.
The five capital preservation pillars used in real estate syndication deals I do include:
- Raise money to cover capital expenditures upfront
- Purchase cash-flowing properties
- Stress test every investment
- Have multiple exit strategies in place
- Put together an experienced team that values capital preservation
Since I implement these pillars, risk is minimized for my investors and I’m able to ensure that every decision around the investment property is made while still protecting your money.