How to Avoid LARGE Loses in Passive Investing

[Don Konipol]

How to avoid large loses in passive investments?

As important as due diligence, analysis, knowledge of the property type, track record of the syndicator, correctly predicting economic trends, and timing is, the number 1 way to avoid a devastating loss is 

NEVER INVEST MORE THAN 10% OF YOUR INVESTABLE ASSETS IN ANY ONE DEAL.  

If your portfolio is large enough, 5% is better.

Now, some people believe that this diversification reduces the chances for a large gain.  Not true.  For that to be true, there would have to be ONLY ONE “best” investment.  It may require more work, more analysis and more time, but if you can find one great passive investment, I bet you can find 5 or 10.  

Just how important is this “rule”.  Consider this, as an “experiment”, 24 months ago I invested $300,000 in equal amounts ($30,000 in each) in 10 speculative small REITs.  The two WORST performers are down 85% each!  If I invested the whole $300,000 in either or both of them, I’d have lost $255,000 of my $300,000. And if this represented my total portfolio, it would be like starting over.  However, one of the other REITs I invested in quadrupled in price, and as a whole I’m $150,000 positive.  By diversifying, but still investing in the most promising deals, you limit the possibility of a devastating loss without limiting your upside.  

[Chris Seveney]

@Don Konipol

100% agree. I would also add for diversification I would diversify across asset classes within real estate (and not in real estate).

I don’t consider investing in 3 MF syndications as true diversification. It’s a start especially if in different markets but still have some risk.

If you are newly accredited and have your first $50k or 100k I would not invest it in one syndication as Don eludes too. Just my 2 cents

[Brian Burke]

Great advice, @Don Konipol. One piece of advice I often repeat is that the goal of diversification is to reduce or eliminate any single point of failure.  This means investing across asset classes, geographical locations, strategies, and sponsors.  Don’t put everything in one deal, with one sponsor, or only one type of property.  And to broaden out further, invest in things outside of real estate, too.

[Justin R.]

@Brian Burke Your more of an honest man, than a salesman.

It’s great that (IMO) the most trusted Syndicator/Operator on here is saying to diversify across other assets.

Brian you are in it for the long game and that is why people trust you.

[G. Brian Davis]

@Don Konipol I totally agree. I actually aim for not having any one real estate investment make up more than 1% of my net worth. I do that by going in on them with other people through an investment club (I can invest $5K in each investment). 

To your point, passive real estate investment returns tend to form a bell curve, with a few underperforming, a few overperforming, and most falling in the middle of the bell curve. When you only invest in one or two, the returns could end up anywhere on that bell curve. When you invest in one a month (like we do), they form a classic bell curve over time, averaging stronger returns than the stock market. 

[Don Konipol]

Quote from @G. Brian Davis:

@Don Konipol I totally agree. I actually aim for not having any one real estate investment make up more than 1% of my net worth. I do that by going in on them with other people through an investment club. 

To your point, passive real estate investment returns tend to form a bell curve, with a few underperforming, a few overperforming, and most falling in the middle of the bell curve. When you only invest in one or two, the returns could end up anywhere on that bell curve. When you invest in one a month (like we do), they form a classic bell curve over time, averaging stronger returns than the stock market. 

Can you tell us a little about the investment club you’re in and perhaps investment clubs in general?  

[G. Brian Davis]

My company SparkRental organizes a passive real estate investment club, called the Co-Investing Club. We meet twice a month: once to vet a passive investment together, and once to bring in an outside expert to present on their area of expertise. 

Any member can go in on any investment with $5K or more, all group investments are optional. My partner and I don't get a cut of any of the money invested, it's a flat-fee membership club. We create a new joint LLC for each investment, and each participant gets listed as an owner of the joint LLC.

We're really big on diversification. We invest in every property type, in cities across the country, with different syndicators or private partners. I don't want to try to predict the next "hot market" or "hot asset class." I've found that every time I've tried to get "clever" in my investments and pick the next hot thing, I've gotten burned. 

I look at it through the lens of dollar cost averaging my real estate investments. If I can invest $5K a pop instead of $50-100K, I can invest every single month, no matter what the "mood" of the market is. I don't have to worry about trying to time the market, which I think is a fool's errand no matter what the gurus say. 

[Jay Hinrichs]

Quote from @G. Brian Davis:

My company SparkRental organizes a passive real estate investment club, called the Co-Investing Club. We meet twice a month: once to vet a passive investment together, and once to bring in an outside expert to present on their area of expertise. 

Any member can go in on any investment with $5K or more, all group investments are optional. My partner and I don't get a cut of any of the money invested, it's a flat-fee membership club. We create a new joint LLC for each investment, and each participant gets listed as an owner of the joint LLC.

We're really big on diversification. We invest in every property type, in cities across the country, with different syndicators or private partners. I don't want to try to predict the next "hot market" or "hot asset class." I've found that every time I've tried to get "clever" in my investments and pick the next hot thing, I've gotten burned. 

I look at it through the lens of dollar cost averaging my real estate investments. If I can invest $5K a pop instead of $50-100K, I can invest every single month, no matter what the "mood" of the market is. I don't have to worry about trying to time the market, which I think is a fool's errand no matter what the gurus say. 

How do you handle  sec regs with your club.. ?  I sure like the concept though.. and I bet its fun.

[Mike H.]

This idea of diversification is a very tricky philosophy to me. I don't think its as easy as people make it out to be.  I think its rare you can take a model you're doing in this are or product and just move it somewhere else or on to some other product.

To me, If you have a niche that works and you're good at it and the numbers are strong,  I believe you should put everything you have into that business model and grow it and grow it fast while the getting is good.  Eventually the masses will catch on and then the model is tougher to continue to do. 

I've found that when I try finding other deal types or other business models or niches, I end up losing a ton of valuable time that goes nowhere.  But at some point I do find that next niche that works for me and I like and go into that full steam. 

To me the value in diversification is that it helps nudge you to look for other opportunities and revenue streams where you might otherwise just be content to stay in your lane and then you'd never find anything new.  And, again, eventually a strong business model/niche will show its numbers and then everyone will be doing it. So if you stick with the one thing and it ends, then you'll be done growing and you become a one hit wonder. 

I've gone from sfh rentals in my area to land flipping and now to building cabins to hold and to sell. The rental deals in my area are not even close to what I was doing before. The numbers are just ugly. The land deals have filtered down a ton too. But I was lucky to get into the cabin building and I'm doing the same with the cabins that I did building my rental portfolio. Margins are every bit as good. More work for sure. But I can BRRR my cabin deals every bit the same way I did my sfh rentals. If i hadn't tried several other things, I would have never found this one and I'd be sitting on the rental portfolio doing nothing right now.

[Jay Hinrichs]

Quote from @Mike H.:

This idea of diversification is a very tricky philosophy to me. I don't think its as easy as people make it out to be.  I think its rare you can take a model you're doing in this are or product and just move it somewhere else or on to some other product.

To me, If you have a niche that works and you're good at it and the numbers are strong,  I believe you should put everything you have into that business model and grow it and grow it fast while the getting is good.  Eventually the masses will catch on and then the model is tougher to continue to do. 

I've found that when I try finding other deal types or other business models or niches, I end up losing a ton of valuable time that goes nowhere.  But at some point I do find that next niche that works for me and I like and go into that full steam. 

To me the value in diversification is that it helps nudge you to look for other opportunities and revenue streams where you might otherwise just be content to stay in your lane and then you'd never find anything new.  And, again, eventually a strong business model/niche will show its numbers and then everyone will be doing it. So if you stick with the one thing and it ends, then you'll be done growing and you become a one hit wonder. 

I've gone from sfh rentals in my area to land flipping and now to building cabins to hold and to sell. The rental deals in my area are not even close to what I was doing before. The numbers are just ugly. The land deals have filtered down a ton too. But I was lucky to get into the cabin building and I'm doing the same with the cabins that I did building my rental portfolio. Margins are every bit as good. More work for sure. But I can BRRR my cabin deals every bit the same way I did my sfh rentals. If i hadn't tried several other things, I would have never found this one and I'd be sitting on the rental portfolio doing nothing right now.

Mike I think Don was making his point with Passive investing what your talking about is active investing.  But I agree with what you wrote Real Estate is ever evolving.. I would have never dreamed of being a new home builder 15 years ago. Real Estate has a lot of niche's one can follow thats what makes it exciting.

[G. Brian Davis]

Quote from @Jay Hinrichs:

How do you handle  sec regs with your club.. ?  I sure like the concept though.. and I bet its fun.

Hey Jay, we handle it by being a subscription-based investment club. We charge a flat membership fee, rather than taking a cut of any of the money invested. Quite the opposite - I invest my personal money as just one more member, in each investment we end up doing as a club. 

So we're not selling securities. Think of it like a stock investing club that meets monthly to discuss, vet, and invest in stocks, except it's passive real estate investments. 

[Don Konipol]

Quote from @Jay Hinrichs:

Quote from @Mike H.:

This idea of diversification is a very tricky philosophy to me. I don't think its as easy as people make it out to be.  I think its rare you can take a model you're doing in this are or product and just move it somewhere else or on to some other product.

To me, If you have a niche that works and you're good at it and the numbers are strong,  I believe you should put everything you have into that business model and grow it and grow it fast while the getting is good.  Eventually the masses will catch on and then the model is tougher to continue to do. 

I've found that when I try finding other deal types or other business models or niches, I end up losing a ton of valuable time that goes nowhere.  But at some point I do find that next niche that works for me and I like and go into that full steam. 

To me the value in diversification is that it helps nudge you to look for other opportunities and revenue streams where you might otherwise just be content to stay in your lane and then you'd never find anything new.  And, again, eventually a strong business model/niche will show its numbers and then everyone will be doing it. So if you stick with the one thing and it ends, then you'll be done growing and you become a one hit wonder. 

I've gone from sfh rentals in my area to land flipping and now to building cabins to hold and to sell. The rental deals in my area are not even close to what I was doing before. The numbers are just ugly. The land deals have filtered down a ton too. But I was lucky to get into the cabin building and I'm doing the same with the cabins that I did building my rental portfolio. Margins are every bit as good. More work for sure. But I can BRRR my cabin deals every bit the same way I did my sfh rentals. If i hadn't tried several other things, I would have never found this one and I'd be sitting on the rental portfolio doing nothing right now.

Mike I think Don was making his point with Passive investing what your talking about is active investing.  But I agree with what you wrote Real Estate is ever evolving.. I would have never dreamed of being a new home builder 15 years ago. Real Estate has a lot of niche's one can follow thats what makes it exciting.

Exactly Jay. Although they may seem similar, there are large differences between active and passive investments.  The biggest difference to me is that YOU have control of every aspect of an active investment, while somebody else is in “control” of a passive investment.  So, you’re at someone else’s expertise, decision making, experience, analytical skills, information flow, managerial capacity, oversight, etc.  

Even with active investments, diversification is better.  That’s why even active investors own a PORTFOLIO of investments, not AN INVESTMENT.  But the diversification may be through a number locations of the same type property, as expertise in one area trumps diversifying into areas where you lack a competitive advantage.  
For active investments I advocate considering how you can diversify WITHOUT ceding your competitive advantage nor the superior profitability of the niche your in.

As an example my business is running an investment fund and syndication high interest commercial mortgage loans secured by income producing real estate. Instead of one large loan of $50 million we hold in our portfolio 27 loans ranging in size from $750,000 to $5.9 million.  We don’t try further diversification by investing in residential mortgage loans, mortgage loans secured by property outside the U.S., loans not secured by real estate, or loans secured by farmland, recreational land, or oil and gas ,mining.  We diversify, but because we are active investors, limit our diversification to assets we believe we have a competitive advantage and are able to obtain our targeted “premium” return.  We believe that we are lowering risk, increasing the average expected return, and leaving the upside unchanged.  

[Justin Moy]

Diversification and due diligence wins here. Being patient with the deals you want to invest in and expanding on your education to know what a 'good' deal really looks like. The problem is, everybody puts together deals they think are good, but in my experience as a lead underwriter, asset manager, and now fund manager, I throw out 99% of deals that are put in front of me.

Listen to podcasts about passive investments and how to conduct due diligence as an LP. 

Invest in different asset classes, sectors, geographies, operators, funds...a little bit everywhere until you start to get the hang of how to actually look at 'good' deals. 

And when in doubt, ask tons of questions before making the investment

[Jay Hinrichs]

Quote from @G. Brian Davis:

Quote from @Jay Hinrichs:

How do you handle  sec regs with your club.. ?  I sure like the concept though.. and I bet its fun.

Hey Jay, we handle it by being a subscription-based investment club. We charge a flat membership fee, rather than taking a cut of any of the money invested. Quite the opposite - I invest my personal money as just one more member, in each investment we end up doing as a club. 

So we're not selling securities. Think of it like a stock investing club that meets monthly to discuss, vet, and invest in stocks, except it's passive real estate investments. 

Thank you !! Sounds like a winner.. 

[Jay Hinrichs]

Quote from @Don Konipol:

Quote from @Jay Hinrichs:

Quote from @Mike H.:

This idea of diversification is a very tricky philosophy to me. I don't think its as easy as people make it out to be.  I think its rare you can take a model you're doing in this are or product and just move it somewhere else or on to some other product.

To me, If you have a niche that works and you're good at it and the numbers are strong,  I believe you should put everything you have into that business model and grow it and grow it fast while the getting is good.  Eventually the masses will catch on and then the model is tougher to continue to do. 

I've found that when I try finding other deal types or other business models or niches, I end up losing a ton of valuable time that goes nowhere.  But at some point I do find that next niche that works for me and I like and go into that full steam. 

To me the value in diversification is that it helps nudge you to look for other opportunities and revenue streams where you might otherwise just be content to stay in your lane and then you'd never find anything new.  And, again, eventually a strong business model/niche will show its numbers and then everyone will be doing it. So if you stick with the one thing and it ends, then you'll be done growing and you become a one hit wonder. 

I've gone from sfh rentals in my area to land flipping and now to building cabins to hold and to sell. The rental deals in my area are not even close to what I was doing before. The numbers are just ugly. The land deals have filtered down a ton too. But I was lucky to get into the cabin building and I'm doing the same with the cabins that I did building my rental portfolio. Margins are every bit as good. More work for sure. But I can BRRR my cabin deals every bit the same way I did my sfh rentals. If i hadn't tried several other things, I would have never found this one and I'd be sitting on the rental portfolio doing nothing right now.

Mike I think Don was making his point with Passive investing what your talking about is active investing.  But I agree with what you wrote Real Estate is ever evolving.. I would have never dreamed of being a new home builder 15 years ago. Real Estate has a lot of niche's one can follow thats what makes it exciting.

Exactly Jay. Although they may seem similar, there are large differences between active and passive investments.  The biggest difference to me is that YOU have control of every aspect of an active investment, while somebody else is in “control” of a passive investment.  So, you’re at someone else’s expertise, decision making, experience, analytical skills, information flow, managerial capacity, oversight, etc.  

Even with active investments, diversification is better.  That’s why even active investors own a PORTFOLIO of investments, not AN INVESTMENT.  But the diversification may be through a number locations of the same type property, as expertise in one area trumps diversifying into areas where you lack a competitive advantage.  
For active investments I advocate considering how you can diversify WITHOUT ceding your competitive advantage nor the superior profitability of the niche your in.

As an example my business is running an investment fund and syndication high interest commercial mortgage loans secured by income producing real estate. Instead of one large loan of $50 million we hold in our portfolio 27 loans ranging in size from $750,000 to $5.9 million.  We don’t try further diversification by investing in residential mortgage loans, mortgage loans secured by property outside the U.S., loans not secured by real estate, or loans secured by farmland, recreational land, or oil and gas ,mining.  We diversify, but because we are active investors, limit our diversification to assets we believe we have a competitive advantage and are able to obtain our targeted “premium” return.  We believe that we are lowering risk, increasing the average expected return, and leaving the upside unchanged.  

Don to me  passive you are not on the Checking account and Active you are on the checking account. There are income tax implications of both..

[Evan Polaski]

@Don Konipol, you bring up a good point both about diversification and active versus passive investments.

To add to your point, it isn't just about diversifying in the way you note, although I understand since you are talking to a real estate investment forum.  The insitutional investors create an entire portfolio allocation; translated for the readers here: an allocation for all of your investable assets.  Here is a link to a recent allocation from Harvard's endowment: https://finance.harvard.edu/files/fad/files/fy23_hmc_letter....

These allocations can help point out asset classes that are getting overheated versus those that are relative values, since the asset classes that are getting over-heated will start to show themselves in outsized allocations within your portfolio.

[Henry Lazerow]

Or just don't invest in passive private real estate deals. Even the best can flop out and losing even 5% of your networth is a huge hit. If want passive just buy stocks or class A lower leverage multifamily which is easy to self manage. 

[Steve Vaughan]

Quote from @Don Konipol:

How to avoid large losses (sic) in passive investments?

NEVER INVEST MORE THAN 10% OF YOUR INVESTABLE ASSETS IN ANY ONE DEAL.  

If your portfolio is large enough, 5% is better.

10 speculative small REITs.  

The two WORST performers are down 85% each! 

But 1 quadrupled in price! 

Don, is there more insight into what happened with the 2 dogs vs the 1 star?  Huge disparity! 

Or generally, for deworsification, just buy into 10?   I bet there were some takeaways looking back. Thanks! 

[Don Konipol]

Quote from @Steve Vaughan:

Quote from @Don Konipol:

How to avoid large losses (sic) in passive investments?

NEVER INVEST MORE THAN 10% OF YOUR INVESTABLE ASSETS IN ANY ONE DEAL.  

If your portfolio is large enough, 5% is better.

10 speculative small REITs.  

The two WORST performers are down 85% each! 

But 1 quadrupled in price! 

Don, is there more insight into what happened with the 2 dogs vs the 1 star?  Huge disparity! 

Or generally, for deworsification, just buy into 10?   I bet there were some takeaways looking back. Thanks! 

Not much insight.  As an experiment I invested $30k each in the 10 REITs which had (according to average estimate of NAV) the largest discounts from net asset value as per market price). No additional analysis or criteria considered.  I held each until a change in either market price or net asset value resulted in the REIT stock discount being lowered by 30%.  I checked each on a weekly basis.  
Most of the REITs are classified as Micro as to size and have great volatility in pricing and net asset value adjustments.  Also, 18 months is too short a period of time to obtain a truly significant result.  However, I saw enough that I believe that the information available is so imperfect and subject to interpretation that large losses would be an inevitable part of the program, as well as large gains.  If I get motivated enough in the near future I may do more research and experimentation with it. 

[Drago Stanimirovic]

Hi Don,

You’ve nailed one of the most important rules of passive investing: diversification. By not putting all your capital into one deal, you protect yourself from major losses and keep your portfolio more resilient. Your example highlights this perfectly. Losing 85% on a single REIT would've been devastating if you were all-in, but spreading out across 10 investments turned the overall outcome positive because of the winners.

Here’s a few extra key tips to avoid big losses in passive investments:

1. Focus on cash flow: Invest in assets that generate consistent income. This cushions potential value drops.
2. Syndicator vetting: Only partner with syndicators who have a strong track record in different market conditions.
3. Market and asset class knowledge: Understand market cycles and the specific real estate types (multifamily, industrial, etc.) you're investing in.
4. Avoid chasing trends: Just because a market or asset is “hot” doesn’t mean it’s solid.

You’re right that this approach doesn’t cap your upside, quality diversification can still generate huge returns while managing risk.

Best regards,

Drago