Think passive real estate is safe? Here are 9 hidden risks that could cost you

You cannot eliminate all risk from investing. After all, the zombie apocalypse could strike tomorrow and potentially destroy your entire investment portfolio. But you can reduce your risk even with high-return investments. Actually, These are exactly the investments you want to minimize risk – your Treasury bonds don’t require it.

I Love Real Estate Syndicate As a high return investment. They’re completely passive: you don’t have to worry about financing or contractors, permits or inspectors, tenants or property managers. you don’t have to be A landlordHowever You still get all the benefits of real estate ownership, including cash flow, appreciateand Tax incentives.

If you find terms like “real estate syndication” or “private equity real estate” intimidating, don’t do it. They are simply collective investments, where professional investors hire silent partners to help fund the deal. You effectively become a part owner of a large property such as an apartment complex, mobile home park, or industrial or retail property.

So what risks should you take? pay attention to When screening potential investments? Here are nine to remember.

1. Sponsorship risk

forward watching specific investment, Start with an assessment Syndicates (also known as promoters, general partners or general partners and operators).

Experienced, skilled sponsors who put investors first can find a way to save themselves from a difficult situation sideways trading. Inexperienced or careless sponsors can find ways to screw up even a good deal.

While there are many questions you should ask your sponsor, some of the first questions to ask include:

• How many deals have you closed in your career? How many of these are sponsored syndicated deals?
• How many of them have left full cycle? What returns have you delivered to investors?
• Have you ever lost investor money? Have you ever lost your money trading?
• Have you ever made a capital call?
• Tell me about some deals that went well It’s on you and how you respond.
• What is your niche strategy?

Not investing with any investors you can’t feel it 100% confident exist. If you don’t feel like a “yes!” attitude to a sponsor, think of it as a firm no.

2. Debt risk

Lots of Syndicated deals have collapsed over the past two years due to financing risks. Too many syndicates borrow short-term or floating-rate loans only to find themselves in trouble when interest rates spike. They end up with weak or negative cash flow, It may not be possible to refinance at today’s higher interest rates.

When we review a United Investment Club deal, one of the first things we look at is the debt structure. We ask questions like:

• What is the loan term?
• What is the interest rate? Is it fixed or floating?
• If it’s a float, does the sponsor purchase an interest rate cap or interest rate swap or some other protection against further increases in interest rates?

We turned down an investment The one last year used to be funded and provide a two-year bridge loan. I am unwilling arrive Betting interest rate Capitalization rates decline over the next two years.

Instead of investing in that deal, we invested in a deal in which the sponsor assumed a 5.1% fixed-interest loan from the seller. Seal the deal: Nine years left on the term.

I don’t know what the market will be like in the next two years. But I’m pretty sure that sometime in the next nine years there will be a good sales market.

3. Market risk

Markets are constantly changing and developing, driving up or down down. They rarely sit still.

if cap rate Incomes rise and property prices fall. That is Great for investing in new deals bad for you Existing real estate investments.

recession risk Belongs to the category of market risk. During a recession, both rental delinquencies and vacancy rates increase. both hurt net operating income of the property therefore, Both its cash flow and it is value.

You have no control over cap rates or the recession. The market is constantly changing, sometimes in your favor and sometimes not. But you can invest conservatively in properties with excellent cash flow through long-term, low fixed-rate loans.

As a final thought on market risk, all real estate investments are local. When people talk about “market risk,” they may be worried about macroeconomic markets and the broader economy. but what real What matters most to real estate investors is the local market: local cap rates, vacancy rates, and rents and fees. This is what affects you real The return on that particular investment.

Fortunately, you can Invest passively from anywhere in the world, in any city in the country. I certainly do, in my current hometown of Lima, Peru.

4. Concentration risk

I have no idea In any particular city or state, or for that matter, in any particular asset class (multifamily, mobile home, retail, industrial, ETC.. That’s exactly why we work on these deals together: to spread a small amount of money across many different properties, areas and property types.

At last count, I had interests in about 2,500 units in two dozen properties in 15 states. In most cases, I only invest $5,000 to $10,000 per property.

This means I don’t need a crystal ball. I don’t have to predict (gamble?) on the next hot market or asset class. I simply Continue to invest in different properties in different areas every month as a form dollar cost averaging.

because let us Let’s face it: Any given local market can rise or fall unpredictably. You can avoid this risk by diversification: Spread smaller eggs among many baskets.

5. Supervision risks

Local city and state enforcement my own Landlord and Tenant Rules. Some are investor-friendly, while others lean heavily toward protecting tenants at the expense of landlords.

Properties subject to tenant-friendly regulations pose additional risks. It takes longer to enforce leases and evict defaulting or other non-compliant tenants. I’ve seen evictions take 11 months in tenant-friendly jurisdictions!

In some markets, owners forced Troublesome tenants can be renewed even if their leases expire. They cannot not renew their lease agreement.

That doesn’t mean we never consider investing in the anti-landlord market. But we prefer non-residential investments in these markets. For example, we invested in a short-term cabin rental business in Southern California—exist An unincorporated mountain town supported by tourism. Zero risk short term rental Prohibited When the cabins only support guests for up to a week, the nightmare of eviction ensues.

6. Cash flow risk

I talked earlier about the risk of local rents stagnating or even falling. This could squeeze cash flow.

Your cash flow may also be squeezed from the other direction The form is Expenses increase. No more hesitation Insurance premiums soar Labor costs may have risen significantly in the past two years.

So, how do our investment clubs protect against cash flow risk? We look for deals with conservative forecasts, including low rents grow and high spending growth. If the numbers are still valid even assuming hard Under market conditions, you still have some wiggle room if something goes wrong.

7. Construction risks

When syndicates plan to add value through renovations, they need a great team to actually Swing the hammer and get the job done on budget exist schedule.

Who is doing this work? Is the construction team built in-house or hired from outside? Anyway, how repeatedly Has the sponsor worked with the team before?

if This is the sponsor’s first rodeo with this teamcareful.

8. Property management risks

The same principles apply to property management. who is going Day-to-day management of property? Whether the property management team is internal or external, how repeatedly Have the sponsors worked with them? forward?

Poor property management is a recurring theme in failed syndication deals. Our investment club Look for Work with a proven PM team to reduce this risk.

9. Partner Risks

exist bigger In a syndicated deal, you sometimes see a primary sponsor and several supporting sponsors. Make sure you know who it is Assets will be managed and reviewed centrally.

I’ve seen a deal where the supporting partner sponsor had a proven track record, but they are not The main sponsor may be responsible for asset management. The major sponsors botched the deal, leaving others to pick up the pieces.

Which brings us back to sponsor risk and make sure you understand Exactly who you entrust your funds to.

final thoughts

If you consider these nine risks when investing in passive real estate projects, you can even reduce your risk while earning returns of more than 15%. You can also manage risk by Invest in real estate debt rather than equity.

A few months ago, our United Investment Club invested in a 6-month rolling note with 10% interest and secured by a first-position lien at a 50% loan-to-value ratio. Real estate prices may go up or down, interest rates may go up or down, but we still feel safe. Granted, this is not the 15%+ annualized return our club typically strives for. But short term, flexible terms and incredible collateral keep us away Feel Be confident about taking risks.

You can never completely eliminate risk. But you can mitigate and manage it by finding those asymmetric returns that yield good returns with moderate risk.

Get the best loan now

Find trustworthy, investor friendly A lender who specializes in your strategy.

Notes on BiggerPockets: These are the opinions written by the author and do not necessarily represent the views of BiggerPockets.