Many people today are dissatisfied with the returns they are getting from their current investments and are looking for alternatives. Of course, CDs and savings accounts don’t go far enough to keep up with inflation and the stock market is such a rollercoaster ride that it’s hard to feel comfortable putting all your retirement savings there.
With so many houses in foreclosure, some people have tried to buy a house to fix it up and resell it. If you know what you’re doing, you might be able to work on it for a few months and sell it for a profit. There are obvious risks with this strategy, but with the right training, mentorship, and a good team, you can make a handsome sum on each property. However, unless you want to make a career of it, fixing and flipping requires a lot of time outside of your regular job.
If you’ve been looking for alternative investments, you’ve probably read about opportunities in commercial real estate. One way to participate in these investments is through a Real Estate Investment Trust, or REIT. Investing in a REIT is much like buying a mutual fund, but managers buy portfolios of apartments, office buildings, or shopping centers instead of stocks. You can get quarterly distributions based on cash flow produced and you co-own the properties.
In the current economic environment, both offices and shopping centers are facing a high number of vacancies. Since all real estate is cyclical, these types of properties should pick up in the future, but apartments are doing well now as everyone needs a place to live.
One reason investors favor apartments right now is the continued growth in the 18-34 age group, which makes up the bulk of apartment residents. Also, houses are no longer viewed as the great investment that people thought they were a decade ago. Not only have thousands of people lost their homes during the economic downturn, but banks have tightened loan requirements so much that even people with decent jobs have trouble qualifying for a loan.
Even if you think apartments might be a good place to invest, you may not be attracted to the returns and control of a REIT. Unless you are very wealthy, it is not practical to buy an apartment building yourself. Is there another way to safely and wisely participate in this current boom without having to deal with renters and toilets?
In fact, there is. You could pool your money with other investors to buy, manage, and sell an apartment property. But what if you personally don’t have the knowledge, experience, and equipment to pull it off? Now what?
You may be lucky enough to have a friend or family member who does these kinds of deals and may be able to offer you a place in one of their syndications. A syndication is a group of investors participating together in a project that no one could carry out alone. Hollywood movies are often the result of syndication, but they can be put together for many purposes, including the purchase of commercial real estate.
Before you put your money into Uncle Bill’s syndicate, there are several things to consider. First of all, do you already believe in commercial real estate as an investment tool? Specifically, do you think the need for affordable housing will continue to grow? Have you seen that new construction has not been able to match current demand, leading to lower vacancy rates and higher rents? I suggest that you don’t let anyone talk you into this model quickly if you don’t believe in it yourself.
Once this obstacle is overcome, there are several more to go. First, are you comfortable with the promoter/sponsor of the deal? They will be partners for several years, so you absolutely must not only trust, but really like this person. You will be putting a substantial amount of cash in their hands, so pay attention to your instincts. Sometimes the best deal you make will be the one you avoid. At the same time, they will judge whether they want to be tied to you for the duration of the project. If you’re hard to get along with or if you’re a micromanager, they may decide that it’s not a good match to have you in the group.
You’ll also want to consider the sponsor’s experience with this type of project. If they’ve done similar deals and they’ve worked out well for investors, that’s all a plus. Everyone has to make a first deal, so if that’s the case, you should feel like your experience with smaller real estate projects has prepared you for this specific offer. If you have owned and operated several fourplexes, you may feel comfortable relying on them for a smaller apartment complex, but perhaps not one with several hundred units. It’s your call.
Make sure they have a professional team in place. No one does this alone, so they should tell you about their real estate attorney, securities attorney, management company, commercial broker, accountant, and title company. Feel free to call them for reference.
Consider your timeline for this type and size of investment. Most apartment projects will require you to commit your funds for several years. If you think you may need your refund sooner than the projected holding period, this is not a good investment for you.
Once you’re satisfied with all of these considerations, it’s time to learn more about the specific offer you’re presented with.
If you’re looking for current cash flow, make sure the property is throwing in enough cash to provide the required return. The sponsor will likely provide you with a spreadsheet that projects the expected gross income, minus all operating expenses. This number is the net operating income, or NOI, and is the basis for calculating the value of the property. After that, mortgage payments are subtracted, and the result is cash flow before taxes. This should be greater than what was promised to investors so you can feel confident that even if things don’t go exactly as planned, you’ll still get the promised return.
Most likely, the group of investors will be promised a percentage of ownership in the deal. You will collect your prorated share of this once the property is sold. The combined result of ongoing cash flow distributions, plus the portion you receive at the end is called the Internal Rate of Return or IRR. You’ll want to make sure this number is substantially higher than what you’re getting with your current investments.
Although apartments seem like a great investment today, all investments carry some risk. Don’t invest money you can’t afford to lose, and whatever you do, don’t take out a loan to put into any investment, including the “can’t-miss” deal Uncle Bill has for you.
Before you mail your check, be sure to read any legal documents provided by the sponsor. Most apartments are purchased through a Limited Liability Company or LLC. You will be a member of the LLC and will actually own a membership in the LLC, not a portion of the real estate itself. Be sure to read and understand the LLC Operating Agreement as it explains in great detail how the project will be run from start to finish. I recommend that you have your accountant, attorney, or financial advisor review it and answer any questions you have. If you’re not comfortable with the risks and benefits, don’t do the deal.
If you go to a luncheon hosted by a promoter, or are introduced to one you don’t know personally, proceed with caution. Putting a group buy together will most likely create a security, so SEC regulations must be followed to the letter. They require the sponsor to have a substantial personal or business relationship with you before making you an offer to invest, so make sure you’ve had enough time to get to know them and their story, and that they know enough about you to feel good. about your ability to participate in this type of opportunity.
Real estate syndications can be a great way for a sophisticated or accredited investor to safely and profitably participate in a commercial real estate deal. If you understand and follow the suggestions presented here, you will be well on your way to a successful investment.