What initially piqued your interest in real estate syndications? Let me guess.
Most likely, it was the potential to make your money work hard for you using dependable real estate assets, rather than working hard for your money at that 9-5.
How did I do?
Until we talk, I’m going to assume you wanted a long-term plan to generate higher returns and grow your wealth over time, and you’ve seen evidence that real estate syndications can support those financial goals.
You won’t be surprised to hear that’s the most common question new-to-real-estate investors ask when they first consider investing in a real estate syndication with us. They want to know what kinds of returns they might make by investing $100,000 into commercial real estate.
We enjoy a profitable portfolio just like anyone else, and great returns are essentially why we’re here. While returns are essential, we consider one main, overarching key element while assessing potential real estate syndication deals.
“What could be more important than potential returns!?” You ask.
Here’s a hint: it isn’t nearly as exciting as passive income and double-digit returns. It’s more tedious than taxes and K-1s.
The essential thing we concentrate on in a real estate syndication is capital protection. In other words, we make sure the transaction includes several strategies to safeguard investor money in the event of a loss. As uninteresting as it may sound, this is Gibby’s top priority.
Being Upfront About Preserving Your Wealth
Sure, it’s not the most thrilling aspect of real estate syndication investing, but it is one of the most important. You can’t make money if you lose money.
Remember Warren Buffet’s rules?
The first and most important rule of investing is to not lose money.
Rule number two is not to forget rule number one.
It’s easy to swoon over projected cash flow returns, high IRR metrics, and brightly colored marketing packages when you first start looking at real estate investing opportunities. But when things go wrong, you’ll be grateful for a real estate syndication sponsor team that gives capital preservation the attention it deserves when an unexpected scenario arises.
When it comes to investing, there are a few questions you should ask yourself before making any investments in real estate. Regardless of the real estate market or commercial asset type you’re interested in, knowing what to inquire and search for can help you invest confidently with a team who’s got your back.
5 Ways To Minimize Risk In Commercial Real Estate
Capital preservation is our first and most essential objective in every real estate syndication investment we undertake.
We look at it like this – investors have monetarily shown that they trust us enough to invest alongside us in a given commercial real estate opportunity. So, we owe it to them to protect their funds in every way feasibly within our control.
There are five ways we mitigate risk for our real estate investors.
#1 – We Pay For Capital Expenditures Upfront
Imagine the flood of issues that can build up when capital expenditures must be financed exclusively by cash flow from the real estate property. In this scenario, cash-on-cash returns, which are dependent on occupancy and maintenance costs, would have to pay for unexpected HVAC repairs rather than unit renovations according to the value-add business plan. This puts renovation plans behind schedule, units aren’t completed as anticipated, and vacancies linger in this situation.
Instead, one of the first ways to mitigate risk is for the sponsor team to plan and ensure that capital expenditures are reserved upfront. For example, if we require $2 million for the down payment on the real estate asset and $1 million for unit and property improvements, we will raise $3 million in investor capital upfront. This means we have $1 million in cash set aside to renovate instead of relying on monthly rental income.
#2 – We Purchase Already Cash-Flowing Commercial Real Estate
One of the most effective ways to mitigate risk is to acquire properties that generate income right away, even before improvements are made. We look for properties with recurring income that can provide the monthly cash flow to pay for repairs or even investors’ distributions immediately.
This way, even if the market dips and vacancy is a little higher than usual or renovations fall behind schedule, retaining the property and existing tenants would still result in cash flow.
#3 – Every Real Estate Investment Projection Is Stress Tested
When a potential real estate syndication deal first enters our radar, sure, we notice the high numbers and great metrics projected. Of course, those are attractive!
But we go deeper to find out how those numbers were calculated and check if those projection methods are the way we would calculate the potential returns.
Performing a sensitivity analysis on the business plan before investing allows us to see if the investment can withstand the worst scenarios. What would happen if occupancy rose to 15% and the exit cap rate was greater than anticipated?
When real estate syndication properties are presented in gorgeous marketing brochures with nice proformas (i.e., projected budgets), they seem convincing, but stress testing those figures helps us evaluate how the real estate investment’s performance may fluctuate as a result of potential variation in variables.
#4 – Ensure Our Real Estate Investment Deals Exhibit Multiple Exit Strategies
In any crisis or emergency, you’ll want to have several options. For example, you’ll want a door and a window in the event of a fire. Real estate syndications are no exception.
We always look for a plan B, C, and D to create equity and mitigate risk when things go wrong. If an exit strategy is limited to one big sale, it’s not resilient in the case of market pressures or changes in occupancy rates.
Even if the business plan reflects a five-year hold period, no one knows what the market will be like when it’s time to sell. As a result, we must plan for the unexpected. Sometimes the general partners will decide to maintain possession of the property until the market bounces back. In an extreme situation, the sponsor team may remarket the property for different types of end buyers (private investors, institutional investors, etc.).
#5 – Assemble An Experience Team That Values Your Money As Much As You Do
Possibly the most critical pillar of all is to have a team that understands the importance of preserving investors’ trust (i.e.money). This includes the sponsor/operator team(s) and members of property management. We require everyone involved to be passionate about their role in asset preservation and display a strong track record of success.
The more experience they have in successfully navigating challenging real estate situations, the better and more likely they will protect real estate investors’ wealth.
Five Key Elements To Manage Commercial Real Estate Investor’s Risk
While capital preservation may not be very exciting for commercial real estate, it certainly is one of the most critical building blocks of a solid real estate syndication deal. And, of course, there are other ways to mitigate risk in real estate. Still, here at Gibby’s, every decision and initiative by the sponsor/operator team is rooted in preserving investor funds.
The five risk mitigation pillars used in real estate syndication deals we 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
There you have it. These five pillars serve as the foundation for all of our real estate syndication deals. By mitigating risks and protecting your money, these elements will help you move forward with confidence when exploring commercial real estate investments with a group of like-minded individuals who share your passion for equity returns and capital preservation!