The Hands-Off Investor

An Insider's Guide to Investing in Passive Real Estate Syndications

Brian Burke

• Publisher: BiggerPockets
• Year: 2020
• ISBN:
  9781947200296
• Topic: Personal Development
• Subtopic: Personal Finance

Finding an experienced syndication sponsor matters now more than ever. By learning to select the right sponsors and properties, you'll find the best deals and mitigate risk during times of economic instability!

Want to invest in real estate but don't have the time? No matter your level of experience, real estate syndications provide an avenue to invest in real estate without tenants, toilets, or trash—and this comprehensive guide will teach you how to invest in these opportunities the right way.

Syndications are like the stock mutual funds of the real estate world—multiple investors passively invest into a fund, while a manager is responsible for picking the real estate and managing the portfolio. Author Brian Burke, a syndications insider with decades of experience in forming and managing syndication funds, will show you how to evaluate sponsors, opportunities, and offerings so you can pick the right sponsors and achieve the highest odds of a favorable outcome.

Inside, you'll learn:

• The practical skills you need to understand income, cash flow projections, and investor waterfalls
• How to find syndication investment sponsors and how to evaluate them for the best possible opportunities
• Red flags to avoid and tricks that syndication sponsors don't want you to know
• The biggest and most common underwriting mistakes that sponsors make
• How various debt options affect risk and return
• Typical sponsor fees and profit splits
• The tax implications of syndication investments
• How to measure alignment of interest, judge performance projections, and more!

SECTION III

EVALUATING REAL ESTATE

CHAPTER 5

REAL ESTATE BASICS

My friend Dan was a police officer and real estate investor. He would buy a house, move in, and start fixing it up—while living in it. It might take him two years, it might take him five, but when he was done the house would be amazing. Incredibly talented, he did all the work. But it would only be a matter of time, and usually not a lot, before he would put the house up for sale and then repeat the whole process on the next house. It did seem, however, that he kept each house a bit longer than the one before it, and he progressively stepped up to better houses and better neighborhoods. By the time he retired, he was able to buy his dream home. It was never his goal to be a landlord, yet he was still a bona fide real estate investor and it served him well.

My friend Bob was a radiologist and also a real estate investor. He owns a few rental homes but hasn’t lived in any of them. He is hands-on with his rentals, often doing some of the repair work himself, collecting rent, and screening tenants. But that’s not the only way he invests in real estate; he also buys farmland in Kansas and leases it out to farmers to grow crops. He is hands-on in the sense that he is involved in buying the property and depositing the checks, but aside from that the farmland is totally hands-off for him. The farmer does the farming and pays rent to Bob in exchange for using the land. Bob has an enviable income stream from residential and land rents, and a substantial net worth from the appreciated value of the properties.

My friend Isaac is a full-time active investor. He buys houses at foreclosure auctions on the courthouse steps, fixes them up, and sells them. He gets in and gets out. He also builds new homes and sells them, which supplements his fix-and-sell business for those times when it’s too difficult to find houses at a discount.

The point is that there are a variety of ways to invest in real estate, a variety of desired outcomes, a variety of levels of involvement, and a variety of types of property to use to accomplish those outcomes. As you look at real estate syndications, it’s important to remember that syndications don’t have just one face either. They can take on many forms by investing in different sectors and with different strategies.

People often confuse sector and strategy. Just try asking a real estate investor what their strategy is and see if they get it all mixed up. They might say, “I invest in houses” or “I buy foreclosures.” Neither is a strategy. The first is a sector; the second is a tactic. Let’s clear up the confusion.

Real Estate Sectors

A sector is a type of property, sometimes also called an asset class. Dan, Bob, and Isaac invest in the single-family residential sector; some people invest in hotels or self-storage. All are examples of sectors or asset classes. When many people think about investing in syndications, often the first thing that comes to mind is large apartment buildings. That is one sector, and certainly a very common one, but it isn’t the only sector that syndications operate in. Let’s explore a few unique facts about various sectors.

Multifamily residential. Multifamily properties in a syndication need to be large enough to absorb the fixed costs of syndicating. This is more of a dollar-value threshold rather than a specific unit count, because values vary widely from one region to another. It might be common to syndicate one hundred units and larger in Texas, but in New York City you might see a syndication for a ten-unit building (and that building might be worth the same as a hundred units in Texas!). A fourplex in the Midwest is probably not large enough to support the costs of putting together a syndication offering.

Single-family residential. You won’t typically see a single-house syndication. After being a predominantly mom-and-pop sector for most of modern history, single-family emerged into the limelight as a result of the residential real estate market collapse in 2005 to 2008. Large buyers came forward and bought up houses by the hundreds, many of which were syndication offerings. Now that pricing in the single-family market has returned to normal, you will likely see fewer syndication sponsors offering these opportunities, but they are still out there from time to time.

Office. Syndications in this sector might invest in anything from a single-tenant office all the way up to skyscrapers. Most commonly you’ll see a neighborhood office, which is typically a multi-tenant building or small complex of buildings. Skyscrapers are more often owned by a REIT, although there are syndicate owners as well.

Industrial. There are a lot of subcategories of industrial property, including warehouses, manufacturing, distribution centers, and laboratories, among others. This sector is becoming more popular lately thanks to retail shifting to online retailers, who locate distribution centers in industrial areas and rely on shipping services that use industrial properties for sorting.

Retail. This sector includes single-tenant store buildings, neighborhood retail strip centers, large shopping malls, and everything in between. It’s becoming more challenging due to online retailers taking market share from traditional shopping malls. Expect volatility here as consumer preferences shift.

Hospitality. Primarily hotels and resorts, syndications in this category could be anything from a single roadside motel all the way up to a portfolio of larger branded hotels. Expect some volatility here, since recessions that affect travel can cut a deep swath through hospitality revenue. But there can be a lot of value-add deals here as older hotels are upgraded or rebranded.

Self-storage. Considered by many to be recession-resistant, self-storage is a disposable necessity in the sense that people don’t always need it but they want it. When the housing market suffers, people tend to move around, seeking smaller or cheaper homes, and use self-storage for items that don’t fit in the new house. When the economy is going well, businesses expand and need space to store extra inventory, supplies, files, you name it. Storage is relatively efficient to build and operate, so many consider it to be a great alternative to residential syndications.

Mobile-home parks. These tend to represent affordability, and as a result they can continue to perform well even when other housing sectors are weak. Tenants tend to be sticky and income is steady because it’s expensive to move a home from a park. (Just watch out for rent control, which can restrict the upside.) Although park expenses tend to be fairly low, when repairs are needed, they can be extremely expensive since the park’s main responsibility is maintaining roads and underground utilities. Sometimes management rents the park-owned homes in addition to the spaces occupied by tenant-owned homes. Many investors find parks with park-owned homes to be less desirable because of the maintenance and upkeep costs on the homes, versus the simple and low-maintenance rental of only the spaces.

Land. You’ve probably heard the saying “Invest in land, because they ain’t making any more of it.” While that’s true, land is the riskiest of all real estate sectors because it is at the mercy of markets, governments, federal and state agencies, and all sorts of other factors. Often there is no income to carry the investment, throw off a return, or reduce risk. Remember that raw land is valued by taking the value of whatever can be built on it and subtracting the cost to build whatever that is. As a result, land is one of the few real estate investments that can actually be worth less than zero. It can also represent an amazing opportunity if played right.

Specialty. This encompasses the “everything else” sectors: marinas, hospitals, parking lots/structures, stadiums, airports, transit centers. There are countless uses for real estate that present unique investment opportunities for those who have the right skill set and experience to navigate the idiosyncrasies of special-purpose real estate. If you are thinking of investing in these special-purpose sectors, consider sticking to those in which you have some experience of your own, such as medical offices or hospitals if you are a physician, or marinas if you are a boater. You should also consider investing smaller amounts in these sectors to spread out your risk. Going all-in on a special-purpose property could be disastrous if things go wrong. It’s not as if there’s an unlimited pool of potential buyers to take these off your hands.

Real Estate Strategies

When evaluating syndication sponsors, you should ask them about their strategy—not only because it’s important to see if it’s a good fit for you, but also to find out whether the sponsor can clearly articulate their own strategy, or even knows what their strategy really is. You’d be surprised how often they don’t, and that’s a big red flag. Let’s talk about a few strategies.

Buy and hold. This is probably the most familiar because it’s so time-tested and common: Buy a property, collect the checks, and hold for some period of time. Most syndication investments seek to hold for three to seven years, and occasionally for as long as ten or fifteen. Why such a short time? Three reasons, primarily. First, shorter terms tend to produce a higher return, especially in a value-add strategy (more on that in a moment). Second, investors want to know when they will get their money back. Most don’t want to part with their money permanently, so having a defined investment period is more desirable than an open-ended one. And third, sponsors tend to receive the bulk of their income from the profits on the sale of the property, and sponsors want to get paid.

Buy and flip. If buy and hold wasn’t the most familiar real estate investment strategy, buy and flip would be, thanks to all the TV flipping shows over the last decade or so. If you watch a lot of HGTV, you’ll probably come to the conclusion that everyone is a house flipper. Flipping is easier said than done when there aren’t many fixers on the market and you are competing against everyone who just watched a beginner make a killing on TV. But for those who are seasoned, this business can be sustainable in just about every point in a market cycle. Those with enough volume can syndicate the business with a blind pool fund. A blind pool fund is where investors invest in a single fund that purchases multiple properties over a period of time, and the properties to be purchased are not known at the time the investment is made.

Buy and watch. This one is my favorite, and not only because I invented the term but also because I think it works! The buy and watch strategy means you buy a property, renovate it, and add as much value as you possibly can. Then you watch the market for the most opportune time to exit. It might be as soon as the value-add improvements are complete, or it might be a year or even ten years later. The sooner you can exit, the better this works. But at least you have the flexibility to wait if conditions don’t support an exit or if it looks like holding for longer will produce a lot of additional upside.

Development. Many consider this the riskiest real estate strategy out there. Development syndications are very common and can be very lucrative. They can also wipe out entire investments if they don’t go according to plan. You might get a 100 percent annualized return, or you might suffer a 100 percent loss. Development projects can range from buying raw land an...