If you were to sit down for a second and think about your answer to the question below what would it be?
“What first interested you in real estate syndications?”
For me, being able to create my own path and my own financial success drew me toward passive income. Then real estate syndications got my attention because of the time-freedom available in combination with the passive income and tax advantages.
Most of my investors report that syndications caught their eye because they want to put their money to work so they can eventually replace their income and spend more time with loved ones.
So, now you’re wondering – is it possible? Which leads to the most commonly asked question “How much will I make in returns if I invest in real estate syndications?” People want to know if it’s reasonable and feasible to replace their corporate income.
Now, I love a good return, in the past couple of years, I have syndicated 5 deals totaling $100MM+ in value. The returns are a big part of why I do what I do. However, returns are not the most important aspect I focus on when evaluating potential deals.
I know that might sound crazy to you, but if I do not evaluate and require this specific aspect in every deal I do, the return for every investor involved could be in jeopardy.
The most important thing I focus on in a real estate syndication is capital preservation.
This means I make sure that the deal has multiple plans in place to protect the investor from any loss of capital, just in case things take a wrong turn. I need to make sure your original invested capital is protected in order to make you more.
Why It’s Important to Talk About Capital Preservation
Sure, capital preservation isn’t the most exciting part of investing in real estate syndications, but it is one of the most critical pieces.
It’s easy to just focus on cash flow returns, potential earnings, and brightly colored marketing packages, but when an unexpected situation arises, you’ll be thankful (for this article and) for a sponsor team that gives capital preservation the attention it deserves.
Capital preservation is all about mitigating risk, and as Warren Buffett puts it, there are two rules to investing:
Rule #1: Never lose money
Rule #2: Never forget Rule #1
No matter what you invest in or who you invest with, you should know what to ask and what to look for so you can invest confidently with a team that holds your best interest.
5 Capital Preservations Pillars
At the core of every investment in which we participate, capital preservation is my number one priority. There are 5 building blocks that make up our capital preservation strategy.
#1 – Raise money to cover capital expenditures up front
Imagine the avalanche of problems that can accumulate when capital expenditures (like renovations) must be funded purely by cash flow. In this case, cash-on-cash returns, which vary based on occupancy and maintenance costs, would have to fund sudden HVAC repairs instead of unit renovations according to the business plan. In this case, the business plan falls behind schedule, units aren’t ready as planned, and vacancy persists.
Instead, we ensure the funds for capital expenditures are set aside upfront. As an example, if we need $2 million for the down payment and $1 million for renovations, we will raise $3 million upfront. This means we have $1 million cash for renovations and won’t have to rely on monthly cash-on-cash returns.
#2 – Purchase cash-flowing properties
One great option to preserve capital is to purchase properties that produce cash flow immediately, even before improvements. If units don’t fill as planned or the business plan isn’t going smoothly, just holding the property would still allow positive cash flow.
#3 – Stress test every investment
Performing a sensitivity analysis on the business plan prior to investing allows us to see if the investment can weather the worst conditions. What if vacancy rose to 15% and what would happen if the exit cap rate was higher than expected?
Properties look wonderful when they’re featured in fancy marketing brochures with attractive proformas (i.e., projected budgets), but stress testing those numbers helps us take a look at how the performance of the investment may adjust based on potential variability in variables.
#4 – Have multiple exit strategies in place
In any disaster or emergency, you want to have several ways out. In case of a fire, you want a door and window. The same goes for real estate syndications.
Even if the plan is to hold the property for 5 years, no one really knows what the market conditions will be at that 5-year mark. So, it’s important to account for contingency plans, in case you need to hold the property longer, and the possibility of preparing the property for different types of end buyers (private investors, institutional buyers, etc.).
#5 – Put together an experienced team that values capital preservation
Possibly the most critical pillar of all is to have a team that values capital preservation. This includes both the sponsor and operator team(s) and the property management team. All of these people should be passionate about their role and display a strong track record of success.
The more experience they have in successfully navigating tough situations, the better and more likely they will be able to protect investor capital.
Setting the Capital Preservation Bar High
Capital preservation is definitely not the most exciting part of real estate syndications. It is, however, one of the most critical building blocks I require in a solid deal. Every decision made by the sponsor/operator team should be in consideration of preserving investors’ capital.
The five capital preservation pillars used in real estate syndication deals I do include:
Raise money to cover capital expenditures upfront
Purchase cash-flowing properties
Stress test every investment
Have multiple exit strategies in place
Put together an experienced team that values capital preservation
By making sure these five pillars are in place in all of my deals. Remember, I’m invested in these multifamily real estate syndications alongside you. So, I’m at risk just as much as you are, and trust me, I don’t want to lose any money!
I take solid steps up front in every syndication offered through the Engineered Capital Club to minimize risk and ensure every decision made during the purchase, asset management, and sale is rooted in protecting your hard-earned money.