In my experience as both an active and passive investor I have encountered three common but dangerous believes passive investors often have. Some I learned through hardship (a loss on one of my own passive deals, thankfully relatively early in my journey) and others I see often floating around.
As it has been my mission to create empowered and educated passive investors by sharing my experience, knowhow, and lessons learned, I feel it is important to speak about these misconceptions. I realize this is a sensitive topic and I may get a lot of heat for what I am about to share. But I am ok with that, as I am speaking my truth and the benefit of shedding a light on some hidden nuances exceeds the cost of the criticism this post may raise.
- Wide social media presence of the lead sponsor/syndicators. While it is important that they are out there and known to the public, this should never be one of your key criteria when selecting a lead sponsor. Some syndicators in the space are very strong at marketing but do not necessarily have the finance and/or operational expertise to do proper diligence, operations, and monitoring of the investment.
In prior article I shared key questions to ask the lead sponsors, how to vet their track record, how to find them. It is also imperative that investors perform deep diligence via professional background checks. (Spoiler alert: I will have additional resource on this, which I will share in an upcoming newsletter!)
- Guaranteed returns. There is no such thing as a guaranteed return because all investments carry risk, including the risk for a total loss. Even Treasuries carry risk. After all, projections are exactly that – projections, i.e. the pro forma numbers you see will never match the actual delivered post close. They will be higher or lower.
Often passive investors think (or some sponsors represent) that preferred returns are guaranteed. This is far from the truth. Even though preferred returns rank higher in the cash flow waterfall, this does not mean that they will be paid out, if the deal fails or underperforms.
I also often see debt funds being presented as guaranteed or secure forms of returns. As a former commercial lender, this statement makes me cringe as it implies the probability of loan loss is zero….take a look at any bank’s financials and show me where they show zero allowances for loan losses…
- High risk = high returns. High risk does not equal high return but rather equals a high probability for loss. As such, it is important to understand the risk profile of a deal (I previously posted the 10-part video series on understanding the key risks when underwriting multifamily deals), the risk mitigates, and whether or not such risk profile aligns with your own risk tolerance as well as risk-adjusted expected returns. You should be compensated for taking on higher risk but that alone should not be a reason to take on more risk.
I said my peace and hope this snippet sheds some light on a few common misconceptions, so you can dig deeper next time you encounter one or some of those and hopefully make more informed investment decisions as a result.
Download The Busy Professional’s Quick Guide To Investing In Multifamily here.
Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.