Passive Investing in Real Estate – 5 Things to Know
by Omar Ruiz
Over my many years as an apartment investor and operator, I’ve talked to numerous people about passive investing in real estate. Many times it’s a first time person considering passive investing in real estate. I’ve been drilled by many investors’ questions and become adept at responding intelligently by making sure I know everything about a deal. It’s also essential to know what’s important for the investor (cash flow, appreciation, tax benefits, etc.). Here are 5 things to know for passive investing in real estate:
1 – Track Record of Success
An apartment operator with experience and a track record of success is more likely to make money for people interested in passive investing in real estate. It’s especially true for operators with experience and success running apartments in multiple markets. Different cities and states have different environments and challenges. The more an operator has done; learned and overcome the larger the range of knowledge they draw from to quickly make correct decisions.
Effective operators know how to manage people well. They have systems and procedures proven to work. They will know the proper indicators to track and will quickly identify issues before they become major problems and make corrections.
Passive Investing in Real Estate: When challenges arise it’s important that the apartment operator face it head-on with a solution oriented mindset.
2- Skin the In Game from Operator
You have alignment of interest in passive real estate investing when the operator contributes money in a deal. Apartment operators with money invested side-by-side with their investors’ safeguards against them becoming detached from the deal. The risk of losing their money is a motivating factor and helps ensure they make the best decisions. When challenges arise it’s important that the operator face it head-on with a solution oriented mindset. It gives investors’ confidence the operator is engaged and looking out for everyone involved.
3- What are the Risks?
Any time someone seeks a higher rate of return, risk is involved and passive investing in real estate is no different. Apartment operators working with investors will provide an offering memorandum and support documents that describe the passive investing opportunity and risks involved. These documents must be reviewed by investors or their advisors prior to investing.
Different types of properties and different locations involve different risks. These risks should be clearly understood and investors need to be comfortable accepting those risks before investing. One great thing about passive investing in real estate, unlike the stock market or other typical investments is the closer connection and relationship with the operator that allows investors to closely monitor progress and stay up to date on the operations.
4- Is There a Preferred Return?
Having a preferred return means investors get paid first, before the operator. Someone considering passive investing in real estate will do better when there’s a preferred return because they are priority in the payment of cash flow distributions. This creates alignment of interest between investors and operator. The operator knows they need to deliver on their business plan or properly adjust and make good decision in order to participate in cash flow distributions.
5- What is the Equity Split?
Equity is where the wealth is created. It’s nice having cash flow distributions over time. The big payout happens at the sale of an apartment asset. You realize the wealth creation of passive investing in real estate from the operator’s efforts in creating value over time with the help of investor’s money. Depending on how the operations are managed, this is when your investment dollars can multiply.
Different passive investments offer different equity splits – typically at 60/40; 70/30; 75/25; 80/20. A lower split to the investor doesn’t mean it’s a bad deal and shouldn’t be the investor’s main focus. The important thing is to just be aware of what that split is. The economic limitations of the property; the business plan and how the operator structures the deal are what allow a certain equity split to be feasible and fair for all involved. Depending on how much an investor contributes determines how much of the profit pie they receive at the sale of the asset. Investors considering passive investing in real estate must know the equity split to accurately determine their overall return on investment.
The preceding 5 things to know about passive investing in real estate are the minimum necessary for investors to know. Passive investing in real estate is a way to build wealth over time. With the right apartment operator you can mitigate the risk and diversify your investment portfolio into an asset class that provides a basic and essential human need – housing.
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