Accredited Investor Looking for Advise

[Zach G.]

Hi BP Community -

I have been researching real estate investments for the past year and so far have invested passively through Crowdfunding platforms (Realtyshares, Peerstreet, etc.). Most of the investments have been debt investments and working out well so far. As I look forward, I am wondering whether I should expand on this strategy and continue investing passively through crowdfunding platforms into apartments and commercial real estate (both debt and equity). From what I have read or heard, apartment investing seems to be one of the best vehicles that most investors want to get into. I have a very busy career and with 2 small kids, don't have enough time to invest actively or search for good deals. I live in the expensive CA market so will have to look out of state should I try to do this on my own. I am hoping to generate enough passive income to start slowing down in the next 5 years. Would love to hear what you think of this strategy and what you would do if you were / are in a similar situation.

Thanks,

Zach

[Brian Burke]

@Zach G. the quality of the sponsor matters just as much as, if not more than, the deal itself.  If it were me, I'd take a lower return from someone I knew well than chase yield from someone that I know nothing about.  Trouble is, that is also an oversimplification, so I'll elaborate:

Let's start with the friend:  The pros are that you know him personally, he actually has a deal in contract (which is easier said than done), the property is possibly a quality asset (is it really??) and is in a growing market (but which one?).  The cons are that the pref is low. 

Then there are other things that are neither pro nor con: 1) The target IRR--this is just a target. Maybe your friend is really conservative and projects low IRRs and outperforms. Or maybe he doesn't and that target won't even be hit. This is where your due diligence comes in--study the market and his assumptions and formulate an opinion on whether you think that the IRR will be achieved. Key things to look for: not enough economic vacancy, overly-aggressive physical vacancy assumptions, too much rent growth, not enough expense growth, unrealistic exit cap rate assumptions, missing a future re-assessment of property taxes, and not enough of an expense budget (payroll is the one I most often see understated). 2) Conservative assumptions. This is neither pro nor con from my vantage point because everybody says they use conservative assumptions. But are they? Compare the assumptions to third-party forecasts and the property's own operating history. 3) He has a good reputation. This is more of a pro than a con, obviously, but the question you didn't answer is does he have a good (or any) track record?  By that, I mean has he done deals in that market before?  What was the outcome?  What does his actual performance look like as compared to his pre-purchase projections on other deals?  Can he show you other forecasts and the subsequent results?  He may be a good friend and have a great reputation but still screw up a real estate deal.  Your objective is to do your best to sniff that out before your money is on the line.

Then there is the crowdfunding option.  The pros are that they typically offer an 8-10% preferred return.  That's about the only pro I can think of, however (and it's not really a pro--most syndications are at or near 8% these days).  The cons are that you know little about the groups you are actually investing in. 

Then there is the neither pro nor con category: The target IRR.--There is a reason those targets are so high. The whole idea of the fundraising website is to satisfy the need for instant gratification. No need to do DD on a sponsor, no need to deep-dive the underwriting. Just search the grid for the highest return, point, click, and invest. They don't want to post a deal with a target 11% IRR because it won't be as easy to sell as one that targets 20%. But does a 20% target make it better than an 11% target? It does if actuals match estimates, but if the 11% outperforms and the 20% was just a pipe dream, the 20% deal might turn out to be the worse option. Funny story: I'm doing a deal right now where I'm targeting a 14.5% to 17% IRR (depending on hold period) using very conservative assumptions and I was talking with some of the crowdfunding folks about it. They aren't sure if they want to post the deal because the projected IRR is too low. As I told them, I can change my assumptions and show you any IRR you want, which is absolutely true, but I just won't do that. It's just not worth the reputational risk. But do you think that others would? I think so.

Long story short (too late) I don't think this is an A/B decision.  You have options.  Your friend, crowdfunding sites, and other sponsors on a direct basis.  Don't rush into any decision, evaluate all of those options, do thorough due diligence, and then choose the best option overall.  This might land you back with your friend, but on the next deal if it's too late for this one.  If he's that good, he'll have another.