All Forum Posts by: Joshua Michael Hauman

By understanding how investors perceive gains and losses, as well as their sensitivity to different framing and reference points, you can effectively communicate the potential benefits and manage the perceived risks, ultimately increasing your chances of attracting capital for your real estate projects or landing a deal. Of course, as a wise steward of capital this benefits ethical syndicators by helping their investors make more rational decisions.

What is Prospect theory:

Prospect theory suggests that individuals prioritize perceived gains over perceived losses when making decisions. This is also closely related to "loss-aversion," people tend to choose options framed in terms of potential gains rather than potential losses, even if the choices are otherwise equal.

An example of this is most people are more likely to take a guaranteed $100 rather than a 50/50 chance at winning $200 even though the probability is equivalent.

Olympic Study Example

Another example is the silver and bronze medalist winners at the Olympics. Which athlete do you think was happier, the one with a silver medal around their neck or a bronze?

It may surprise you that in 1995 psychologists conducted a study and observed that the bronze medalists were significantly happier than the silver medalists. I their minds they avoided 4th place and not receiving a medal whereas the silver medalists viewed it as a loss since they “avoided” first place and essentially wore a medal crowing them the first loser.

What can we take away from this knowledge?

Loss Aversion in Real Estate

Understand that real estate investors are often more sensitive to potential losses than gains. This can result in holding onto underperforming properties for longer periods, delaying renovation due to loss of upfront capex or overvaluing properties/ inflating future rent growth to not lose out on a deal. This can also be a difficulty in raising capital as limited partners often resist investing due to potential perceived loss. We see this more when doing development deals rather than buying stabilized assets.

Diminishing Sensitivity

Investors' sensitivity to gains and losses in real estate can diminish as the magnitude of the investment increases. For example, the emotional impact of gaining or losing $10,000 may be more significant for an investor with a smaller portfolio than for someone with a multimillion-dollar real estate portfolio. I’ve found it’s far easier to raise large amounts of capital from select high net worth individuals rather than raising from small retail investors who have, in my experience been more reluctant and take more time to manage.

Reference Points

Investors may evaluate the success of their real estate investments based on a reference point, such as alternative investments like stocks or bonds. If the project you’re working on outperforms alternatives on a risk adjusted basis, highlight this in your pitch and in your quarterly updates to provide a reference point.

Framing Effects

The way real estate investment opportunities are presented or framed can impact investors' decisions. For instance, the perception of risk and potential gains or losses can be influenced by how the investment opportunity is marketed or described. It’s not what you say it’s how you say it. Invest efforts into perfecting your pitch and framing the opportunity. This includes refining your marketing materials, being clear in your speech and dressing the part.

Emotional Impact

Real estate investments can be emotionally charged due to their tangible nature and the significant financial commitment involved. Prospect theory explains how emotions, such as fear, greed, and excitement, can influence investment decisions. These emotions can affect risk perception and lead to impulsive or irrational decision-making. As a savvy investor it’s your responsibility to question your decisions and ensure that you’re not falling victim to your emotions and remain rational.

Conclusion

Hope you found this to be worth the time to read it! I’d love to hear below if you have experience dealing with any of the points I shared above or have anything to add.

One objection you will face when raising capital, especially from accredited investors who have had success doing their own deals is “Why would I passively invest as a Limited partner (LP) when I could just use the capital to continue doing my own deals?”

It’s a legitimate point that is mainly dependent on the investor’s goals and how your offering fits their needs.

Below are 4 points to consider using during that conversation:

Diversification guards against overallocation

Many LP’s I’ve spoken to that have had success in their own real estate investing are overallocated in one or more of these areas: Asset type, geography, housing demographic and or operational approach. They may have a competitive advantage in that style of investing which is a component of why they have become successful. However, it’s impossible to be a master of all niches and to defer to experts when something is outside your domain of expertise.

By investing as an LP, you can leverage the expertise of a GP to gain that competitive advantage in opportunities outside of your area of expertise. By spreading your investment across multiple properties or projects, you are fundamentally diversifying your risk. Many LP’s we take on have real estate investing experience but lack experience and expertise in net lease retail investing and urban Infill development/redevelopment. This allows them to tap into that competitive advantage and mitigate any single property's performance on their overall investment portfolio.

There is risk in responsibility

When an investor buys a property by themselves, whether personally or via an entity, they are signing for the debt and are held liable to repay.

When investing in a fund or syndication, LPs risk is limited to the amount invested since they gain access to financing through the General Partner (GP) without the burden of personally guaranteeing the loan. This shields LP’s from personal liability associated with property ownership, such as lawsuits or property-related issues. In addition, the GP’s track record may also give them access to lower cost financing than they could have acquired otherwise. This key benefit alone not only alters the risk profile of the investment, but it does so without substantially compromising the potential returns.

Active vs passive investing

Anyone that owns property can tell you it’s not purely passive. Even though I have property management for the majority of my residential portfolio I can assure you that the time investment is not zero, especially if you factor in the cost of time to acquire properties.

Eliminating the time component is a strong driver for many LP’s seeking a more passive approach to investing. Real estate syndications and funds often distribute regular income generated by the underlying properties as well as equity upside in ownership. As an LP, you can receive passive income in the form of rental income or profit distributions without the active involvement required in direct property ownership.

Efficiency in scale

Many investors I talk to, especially in the residential space, say lack of capital and time are two drawbacks that hold them back from scaling. Often, this leads to them outsourcing property management and contracting services to other vendors, which chips away at their margins. Speaking from personal experience here as I myself have felt the same way.

Passive investing offers access to larger, more lucrative real estate deals not easily available to individual investors. By pooling resources with others, it enables economies of scale in property management and operational cost reduction. This in turn allows for higher returns through harnessing collective strength.

Conclusion

Passive investing and direct property ownership have their pros and cons. Its important to really understand what problem your investors are trying to solve and tailoring your approach and conversations accordingly.

As with everything in life, the decision depends on personal circumstances, goals, risk tolerance, expertise, and the amount of time and effort you're willing to commit to it.

 Yes Joseph, absolutely. I will send you a private message. I have a lot of resources I picked up over the years and glad to give even more recommendations for what has been helpful for me!

Yes! @John McKee

The amount of deals I've been priced out from 1031 buyers is astronomic. Its a flight to safety with everyone chasing yield.

I've purchased 3 FDs/DGs in the past 6 months and I would tell you you are asking for trouble when interest rate exceeds cap rate on assets of this nature.  

Negative cash flow arises as income falls short of debt payments unless a lot of equity is deployed. This creates financial strain and a heightened risk of default. Refinancing becomes difficult as lenders are wary of such circumstances especially with lower lease terms. The property's value diminishes as debt is a critical component in this type of transaction and there are limited ways to increase upside in an STNL (Single Tenant Net Lease) deal. Putting expensive debt on it limits your flexibility and in turn limits appeal to future buyers and investors. Restricted flexibility, hinders investment adaptation. 

I'm curious to hear from more experienced investors how they think about interest rate exceeding cap rate on other types of commercial assets. I understand that cap rate matters less, with NOI being the focus for multifamily. With less levers to pull in terms of expense management and increasing rents in a net lease deal the relationship between cap rate and cost of debt is of paramount importance. Nice job getting a 30 year am though, those aren't easy to find on a deal like that!

Additional support:

Over a year old but I thought this article was relevant and worth sharing for those that want to read more:

https://bluevaultpartners.com/...

@Jonathan Cisneros

I wrote a post (Linked below) outlining a step by step process I used to raise low 7 figures for my first fund. It took over a year and required a lot of attention, organization and consistent relationship nurturing. This is the way I was taught and its working for me.  
https://www.biggerpockets.com/...

Additional thoughts:

I hear "If you find a good deal the money will come!" all the time and I have not had that experience at all. 

I believe in attacking the biggest constraint in your business. If the biggest lever holding you back from getting into syndication is capital raising, solve that problem. I started this process 6 month before even considering a PPM. 

Ultimately, as a syndicator you are serving your investors. A wise steward of capital doesn't seek what's best for them, they operate with their clients needs first and seek mutually beneficial solutions.

If you're a waiter at a restaurant you wouldn't bring out a dish, tell the patron about it and then serve it to them and ask them to pay. You would begin by asking them what they want and have the forthrightness to educate and advise as best at possible based on their needs and desires and then deliver on that to the best of your abilities. This process extrapolated over the course of hundreds of conversations gave me more direction into my investment strategy. In this way when my investor was ready to "order" I had already been showing them several dishes that I thought they would enjoy most. Flash forward a year and what they ordered looks and tastes exactly as I described. 

A unique perspective shift I had on this topic is to look at LP's in terms of LTV (Lifetime Value). I play long term games with long term thinkers. Trust is a requirement for long term games. You build trust by following though on the commitments you make to yourself and to others.

Wrapping it up:

I'm not some guy that has wealthy connections or has raised 10's of millions of dollars but I feel that what I'm describing is duplicatable and can give any aspiring syndicator a foundation on which to build the business they are out to build. I have plenty more to say on the subject of capital raising so feel free to PM or ask more question on the public forum.

Hey @La'Terrius Campbell!

You can calculate a pro forma cap rate using:

Projected NOI / Expected sale price
Pro forma cap rates are based on projected future performance which may be subject to a range of risks and uncertainties. Its only one metric and you're backing into it in this case so I wouldn't put that much weight on cap rate in this situation.

When I underwrite deals for Net Lease assets I care about the cap rate. When I do the same for multifamily I care far more about NOI. NOI directly reflects a property's cash flow potential. Cap rate is more of a measure of market sentiment rather than return. My personal suggestion is in line with @John Swann, figure out how much is necessary in repairs and what the income stream of the asset is after taking out all monthly expenses. 

Once you have that sorted figure out how much debt service you're comfortable with. You can calculate this to be an absolute minimum of a 1.25 DSCR.

If you have 7 Units at $750 a door thats top line with no vacancies at $5,250 a month and $63,000 a year. On a 7 unit like this depending on the area an expense ratio of .65 would get you an NOI of $22,050. This means that to reach a DSCR of 1.25 your debt service must be below $17,640/year or $1,470/month.

This is absolute bare minimum for DSCR. Once you have your debt service sorted out you will know about how big the loan size will be. This will better inform you of the price you can pay for the asset itself and how much equity you will have to bring to the table.

Without knowing the details of the property and how much work and effort you're willing to put in this is how I would look at it. 

Hey @Kevin L Owens!

I agree with the sound and comprehensive advice of @Nathan Gesner

As a fellow Cleveland investor and native I can tell you first hand I know several pros and mentors in the area personally who I'd be happy to connect you with to see you would be a good fit. They have helped me a lot in my journey. There is a REIA event tomorrow, (Thursday 4/13) that many of them will be at.

I'd love to meet you and introduce you to some of the serious players in this market if you're interested.

Feel free to send me a private message if you'd like to connect and ask any questions before or after the event!

There are so many avenues in real estate. It really depends what space you're looking to get into. I wrote a response for my experience finding and getting an incredible multifamily real estate investing mentor here. I've also paid my way into some other residential mentorships over the years which based on your situation I'd be happy to recommend or at least, point you in the right direction. Shoot me a PM if you'd like to discuss.

https://www.biggerpockets.com/...

Hey @Michael Figueroa! 

Have you considered find a syndicator and investing in one of their deals? This would open up passive investment opportunities across the country. There are many seasoned professionals that specialize in individual markets throughout the country that you could vet out to make sure you're comfortable with them, the deal and the return profile rather than trying to do this at a distance for yourself.