There is a dirty secret that every passive investor should know about real estate syndications. And today, I’m going to share the truth.
Syndicators are wrong on projected returns 99.99% of the time.
It’s a guess at best. An educated, informed, well-intentioned… guess.
So stop using projected returns to make investing decisions.
You see, there are WAY too many factors impacting returns for us to provide an accurate projection. From rent growth to cap rates, there are numerous projections, and each assumption has an impact on returns. It’s hard enough to forecast next year’s projections, let alone the next five to 10 years! This is why you shouldn’t rely on projected returns to make investing decisions.
So instead of focusing on projected returns, focus on the fundamentals of the investment. In particular, there are four key areas to determine if an opportunity is actually a good investment.
The Four Keys for Passive Investing
When looking at markets, many people tend to focus on population growth. It’s an easy narrative. As more people move to an area, apartment demand increases, ultimately driving up rents. But in the words of ESPN’s Lee Corso, “Not so fast, my friend.”
Population is an important metric, but it is not the ONLY metric when looking at markets. You want to monitor employment growth and industry diversification as well. Other key metrics include rent growth and absorption rates. But these are just precursors to what you really want to know. Can you expect demand (and rents) to be higher in the future?
Population growth sheds some light at the macro level, but you’ll want to determine why demand will increase for the property you are targeting, opposed to somewhere else in the metro area. When selecting a submarket, pay attention to key drivers like proximity to interstates, nightlife, employment centers, and desirable schools.
The person controlling the key aspects of the deal is one of the most critical things to consider when investing. You want an operator or sponsor who has the knowledge, capability, character, and consideration to effectively lead the deal. It helps to find someone who has a risk tolerance that aligns with your own, a clear vision for their projects, and a proven ability to get results.
You will depend on this person for their market knowledge and investment leadership so be sure it is someone you know, like, and trust.
The tangible, physical property is certainly critical when investing. Older properties inherently require more maintenance. Lower-income properties typically encounter more wear and tear. Newer properties have fewer maintenance issues but often provide less cash flow. The age, condition, and upkeep of the building could mean the difference between a cash cow and a lemon in need of a little squeeze and some sugar.
The question is, do you prefer milk or lemonade?
It’s important to note that commercial acquisitions are actually business acquisitions. You are not just buying a physical structure, you’re buying a company. Because of this, you need to scrutinize the current performance and determine the upside potential.
The Business Plan
Speaking of potential, the business plan is the final area to explore when reviewing an investment opportunity. This plan should be well-constructed and deeply vetted, with a clear vision for execution. However, it should not be the only path to success. Even the best-laid plans can be forced to change, so it’s critical to work with an operator that has the ability, humility, and foresight to acknowledge that a change is needed and pivot accordingly.
Strong returns are driven by strong operators with a savvy business plan for a quality asset, in a good market. Not from OMs, spreadsheets, and pro formas. Stop focusing on projected returns and ensure you are investing with quality people and properties. When you do this, you are more likely to realize the returns you seek and mitigate some of the downside risks.
About the Author:
John Casmon has helped families invest passively in over $90 million worth of apartments. He is also the host of the #1 rated multifamily podcast, Target Market Insights: Multifamily + Marketing. Prior to multifamily, John was a marketing executive overseeing campaigns for Buick, Nike, Coors Light, and Mtn Dew: casmoncapital.comDisclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.