February 9, 2023

JF3080: 10 Questions to Ask Before Investing in a Deal | Passive Investor Tips ft. Travis Watts



Passive Investor Tips is a weekly series hosted by full-time passive investor and Best Ever Show host, Travis Watts. In each bite-sized episode, Travis breaks down passive investor topics, simplifying the philosophy and mindset while providing tactical, valuable information on how to be a passive investor.

In this episode, Travis outlines the top questions investors should ask themselves and the operator of a deal before making an investment in a real estate private placement or syndication.

“We learn from mistakes, but those mistakes do not have to be your own.”

10 Questions to Ask Before Investing in a Deal

  1. Ask yourself: Does this particular investment align with my goals and objectives? 
  2. What is your track record? Show me your past performance.
  3. Is this particular deal or property located in a growing and diversified market? 
  4. Is this particular property located in a tax-free state? 
  5. What kind of debt are you putting on the property? 
  6. What is the minimum investment? 
  7. When is the first distribution, and what is the frequency of distributions?
  8. Do you do monthly or quarterly reporting? 
  9. Does this particular deal or investment offer a preferred return?
  10. Ask about the K-1 tax forms that are generated.



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Travis Watts: Welcome back, Best Ever listeners. You're listening to Passive Investor Tips. I'm your host, Travis Watts. Today's episode is going to be a more practical episode. I'm gonna give you some specifics, some how-to's. What we're talking about is investing in real estate private placements, or what some refer to as syndications, and 10 questions to ask both yourself and the operator before partnering in a deal.

Disclaimers, as always - never financial advice, not telling you or anyone else what to do; informational and educational purposes only. And I want to start by saying this... If somebody 10 years ago had given me these 10 steps and 10 questions to ask, I would have had a lot better performance, a lot better outcomes; not saying that things were bad, but I certainly would have avoided a lot of mistakes... And that is specifically my purpose for recording this episode for you, is to help you avoid those same mistakes. As the saying goes, it's true that we humans learn from mistakes, but those mistakes do not have to be your own. So without further ado, let's go ahead and dive into the top 10.

And the first question is one that you actually want to ask yourself, and it's "Does this particular investment align with my goals and objectives?" So for example, if I'm looking to build passive income to live off of, then it needs to be producing passive income right out of the gate, and ideally, on a monthly basis. Again, that's my interpretation of it, but if your goal, for example, is "I could care less about cash flow in distributions, because this is going to be an IRA investment, and I have a 20-year time horizon, and I'm just looking to increase my net worth over time", then you may not look for something that's stabilized and cash-flowing day one. You might be in a new development deal, for example. So before you even start vetting a team and all the other things that we're going to talk about, you need to think first about your goals and objectives, and then find investments that are appropriate for helping you achieve those.

The second question to ask is, "What is your track record?" or "Show me your past performance." I recorded an episode here on Passive Investor Tips a while ago, I think it was episode 22. It's "The most important metric for passive investors" I believe it was the title. And I went into a lot more detail on it, but from a high level, if I only had one metric to look at when I was going into a deal, it would be the track record of the team. Have they done this before? If so, how many times have they had deals gone south? Have they had capital calls? What has been the overall outcome of this particular team? And again, how long have they been doing it? Have they gone through recessions? What did that look like? It's just really analyzing the track record of the general partnership.

The third question to ask is, "Is this particular deal or property located in a growing and diversified market?" Markets are very important; they can really boost or ruin a good deal as far as the bones of the deal itself. So I was in a deal years ago, and the operator bought a good deal in a growing market that was very diversified, but they, the general partnership could not execute on the business plan properly, so they ended up selling early just to get what equity they could out of the deal. And it was only because the market was so good, and the timing was so good, and the employment was so good in that surrounding area that we were able to exit profitably. If they had been in a bad market and then they couldn't execute on top of that, I'm sure we all would have lost money as limited partners. So pay attention to markets.

The fourth question is one that I seldomly hear anybody talk about, and it's "Is this particular property located in a tax free state?" Now, it doesn't mean, you should only do deals in tax free states, it doesn't mean that I do that... But the majority of my portfolio historically has been in Texas, and then in more recent years has been in Florida. And the reason is when the deal comes full cycle - let's assume you'd invested maybe 100 grand, and now you're exiting years later, and maybe you have $100,000 profit, let's say, if the deal went really well for you. Well, if you're in a state that has, let's say, a 6%, state income tax, then you just basically lost $6,000 right off the top upon sale, because you have to pay that tax... Whereas in Texas and Florida that would not be a factor. And I believe there's 12 or 13 states that are actually tax free. So look them up, do your due diligence, and see if those markets make sense for you.

And the fifth question, more important than ever in 2023, is what kind of debt are you putting on the property? What is your loan to value? What is your leverage? Is it fixed rate? Is it adjustable rate? What's the length? What's the term? Is there interest-only terms? There's a lot to know about debt, but in a general sense, when we're in a high interest rate environment or a rising interest rate environment, you want to have either a fixed rate debt that has a longer term than what you anticipate holding for, or if you go with adjustable loans, you want to make sure that the general partners have put an interest rate cap on that adjustable rate, so that their risk isn't unlimited to the upside.

Another thing that general partners often will do is get an assumable loan, which means that a potential future buyer can take over the existing loan, ideally at a lower interest rate than what they could otherwise get in the market at that time. That also helps to preserve capital in the deal.

Number six, you always want to ask what the minimum investment is ahead of time. You want to know what you're comfortable investing from the get go. And I was under the impression when I first got started with syndications that all these minimum investments were $100,000 or more, so I was seldomly looking for a lot of deals, because I didn't have a ton of capital to put to work at any given time. What I came to find, as I started networking more and more, is that often you can find operators with $25,000 or $50,000 minimum investments, or you can actually ask the general partners if they'd be willing to accept 50k instead of 100k on your first deal so that you can start the business relationship with them; done that a handful of times. And more often than not, the answer was "Absolutely, we'll do that for you."

So it's always worth asking - and this really gets back to how much liquidity you have, and how much you're looking to put to work. If you had to go put $20 million to work in syndications, this may not be a factor for you. But if it's taken you 5 or 10 years to save up your first 100 grand, you may not want to put 100% of that into one deal. You might prefer to diversify a bit and do 50k over here and 50k over here, or do four deals at 25,000 each. Everybody's different, not financial advice, but just know that that's an important factor to think about.

Break: [00:09:04.11]

Travis Watts: Number seven is "When is the first distribution, and what is the frequency of distributions?" So back to the goals of are you looking to build cash flow that you're inevitably going to be living on? Well, in that case, would you rather have a monthly paycheck or a quarterly paycheck? Most people would probably opt for monthly, but it may not be a factor for you. So again, you need to decide that upfront, what are your goals and objectives. And when is the first distribution is really important, because if a new deal gets presented to me today, and it's under contract, but not yet closed, it may take the group another month or two to close the deal, and then it may be another six months after that before the first distribution starts. So that's eight months out of the year that I had a 0% return. That's important to think about, versus the deal that maybe has a little bit lower yield, but starts cash flowing within the first 30 to 60 days. I'm inevitably going to have a higher return with that lower-yielding deal, and that's something to consider. Private placements are illiquid, so the last thing you want to do is wire funds, sign docs and then realize, "Oh, I'm not going to actually get a distribution till the mid part of next year."

Number eight is "Do you do monthly or quarterly reporting? In other words, how often do you communicate with your investors? How often do you show them the financials?" And does that group show the detailed financials? I remember partnering with one group, and it was just assumed that they were going to be transparent and show all the detailed financials at least on a quarterly basis, and they didn't, and they wouldn't. And I'm not saying that's a fraudulent group, or that that's illegal per se... But I really didn't like it, because I had to just put 100% faith and trust in what they were telling me, and there was nothing to verify or back that up.

So for me personally, that was an important metric to look at; it may not be for you, but I prefer working with groups that do monthly distributions, monthly reporting, and at a minimum, do quarterly financials that you can actually look through and verify the information.

Number nine is "Does this particular deal or investment offer a preferred return, or what some people refer to as a coupon?" That's never a promise or guarantee; what that is is the first available cash flow after paying the overhead expenses, debt etc. it comes to the investors before the general partner start sharing and splitting in the profits. It's simply just an incentive to entice investors to invest, and it gives them the first priority to get paid on a particular project.

I've done deals that didn't offer preferred returns; the majority have, and this is why I made this one of my top 10... Because in the deals that didn't have a preferred return, there was usually a hiccup of some sort in the distributions, where the general partner at some point either stopped distributions, or they reduced the distributions... So if it's important to you to have more stable, predictable income, I would recommend looking at deals that have a preferred return.

And 10, last but not least, you want to ask about the K-1 tax forms that are generated. You want to ask, "Am I going to be able to participate in the depreciation and tax benefits as a limited partner?" Not all structures allow for this. All the deals that I invest in do allow for this. And you want to ask them "When are your K-1's delivered historically?" Not what do you intend to do, because everybody intends to do everything on time, but what have they actually done? And the reason this is important is K-1's have a different tax deadline compared to 1099s, and W-2's, and stuff like that. So they kind of get the last priority from CPA firms. And if they don't get delivered on time, in other words if they get delivered after April 15th of the following year, you're going to have to extend or amend your tax return. That's either going to result in higher cost to you, or just the general inconvenience of not being able to file a tax return, because one of your deals had to extend.

I'm in a situation like this, where a group I failed to ask this question up front, and it turns out, they always extend their tax return, because there's so many different partnerships in this particular fund. So I don't get my K-1's until September or October of every year, so it's a big inconvenience of my wife and I having to extend our tax returns just waiting on these two K1's in this particular instance. So something to think about.

So by no means is this an all inclusive list. These are just top 10 that kind of came to mind as I've gone through the last seven, eight years doing private placements and syndications. There's a lot more, and if you guys want to connect and learn more, or get maybe my top 20 or 30, feel free to connect on social media @PassiveInvestorTips on Instagram and Facebook, or Travis Watts on Bigger Pockets, LinkedIn, or AshcroftCapital.com/Travis. You can sign up on my calendar.

So thank you guys so much for tuning into another episode of Passive Investor Tips. I hope you've found some value in this short episode. If you'd like to connect and learn more, feel free, and have a best ever week. We'll see you in the next episode.

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