Why Most Real Estate Investors Can’t Scale Their Investments or Their Business.

[Don Konipol]

I keep coming across posters asking for advice on how to “scale” their investment or business activities.  What they’re missing is that they first need to ask “Is my business / investment process scalable?  Here’s, the hard truth I’ve found in 45+ years in the industry; the vast majority of real estate investors, practitioners and business owners do not have a scalable activity.  Sure, they may be able to grow to a very moderate size,  add a few units, or trade up to a larger investment, but as for real scalability: NO.

Why? Because their investments do NOT have a higher enough ROI adjusted for risk. After paying a competitive rate for the property management and ASSET management that the small operator does himself. So, what is required to scale?

First, most investors and owners of real estate related businesses are in one or more of the following situations

1- they're unable to duplicate their expertise that drives the ROI and they are at their personal max capacity as to time

2- they're obtaining high ROI by use of excessive leverage

3 - they're obtaining high ROI by taking excessive risk

4- they hit correct timing in the correct market, and this is not necessarily repeatable with any probability

In order for an investment or business to scale, we need the ROI (on a risk adjusted basis) to be sufficient to cover a PREMIUM risk adjusted return to passive investors; all expenses of managing the assets and the business, and a significant return to the "sponsor" providing compensation to him making the work, risk and time worth while.

Here's an example. Let's say your filed of expertise is purchasing c type apartment t complexes and upgrading them to b, then holding to stabilization and once stabilized offering for sale. Investors in these type deals look for say 12 - 14% annualized return. You normally handle the whole project yourself. And you're able to confidently predict an 16 - 18% annualized return COMPOUNDED ROI. Well, guess what? Your Not scalable! First, 4% of that ROI is because you're doing the
asset management” work yourself without direct compensation.  Second, as sponsor you want a 1 - 2% annualized return asset management fee AND 20% of the profits after the investors get their money back.  So a MINIMUM 22% Gross ROI is needed to “scale”.  

There are lots of REALLY GOOD investments and businesses out there - but that doesn’t mean they’re scalable.